Can You File Bankruptcy on Tax Debt?

Navigating tax debt can be a complex experience. When financial difficulties arise, bankruptcy may offer a solution for outstanding obligations, including those owed to tax authorities. While discharging tax debt through bankruptcy is challenging, specific conditions and rules exist that may allow for relief. This article explores when tax debt can be discharged, the impact of different bankruptcy chapters, and the procedural steps involved.

Eligibility for Discharging Tax Debt

Discharging tax debt in bankruptcy depends on several strict criteria, primarily concerning income taxes. For federal income tax debt to be considered for discharge, it must satisfy the “three-year, two-year, and 240-day” rules. The tax return for the debt in question must have been due at least three years before the bankruptcy petition filing date, including any extensions granted.

The tax return must have been actually filed with the tax authority at least two years before the bankruptcy petition is filed. If a tax return was never filed, or if the tax authority prepared a Substitute for Return (SFR) on the taxpayer’s behalf without the taxpayer subsequently filing their own return, the associated tax debt cannot be discharged. The 240-day rule requires that the tax assessment by the taxing authority must have occurred at least 240 days before the bankruptcy petition filing date. An assessment refers to the official recording of a taxpayer’s liability on the tax authority’s books, which establishes the legal right to collect the tax.

Beyond these timing requirements, the tax debt must not be associated with fraud or willful evasion. If a tax return was filed fraudulently or if there was a deliberate attempt to evade paying taxes, the associated debt will be considered non-dischargeable in bankruptcy.

Certain types of tax debt are considered non-dischargeable regardless of the timing rules. These include payroll taxes, also known as “trust fund taxes,” which are taxes withheld from employee wages that an employer is required to remit to the government. These funds are held in trust for the government, making them non-dischargeable. Sales taxes collected by businesses are also non-dischargeable because they represent funds held in trust for state or local governments.

Property taxes can also be challenging to discharge, especially if a tax lien has been placed on the property. While the personal liability for older property taxes might be dischargeable if they were payable more than a year before filing, the lien itself often remains attached to the property. Taxes for which no return was ever filed, or those resulting from a fraudulent return, are also consistently non-dischargeable.

How Bankruptcy Chapters Affect Tax Debt

The specific bankruptcy chapter chosen significantly impacts how tax debt is treated. Chapter 7 bankruptcy, often referred to as liquidation bankruptcy, allows individuals to eliminate certain debts. If a tax debt meets all the eligibility criteria for discharge (the three-year, two-year, and 240-day rules, absence of fraud, and a filed return), it can be eliminated through a Chapter 7 discharge.

However, any tax debts that do not meet these dischargeability requirements, such as recent income taxes, payroll taxes, or sales taxes, will survive a Chapter 7 bankruptcy. The debtor remains obligated to pay these non-dischargeable taxes after the bankruptcy case concludes. While the automatic stay temporarily halts most collection efforts, including those by tax authorities, it is only temporary for non-dischargeable debts. If a tax lien was properly filed against a debtor’s property before the bankruptcy, that lien generally remains attached to the property even if the underlying personal tax debt is discharged.

Chapter 13 bankruptcy, a reorganization bankruptcy, offers a structured repayment plan over three to five years. This chapter is suitable for individuals with regular income who can afford to make payments and need to manage non-dischargeable tax debts. Under a Chapter 13 plan, “priority” tax debts, which include newer income taxes and trust fund taxes, must be paid in full, often with interest, through the repayment plan.

“Non-priority unsecured” tax debts, such as older income taxes that might have been dischargeable in Chapter 7, are treated similarly to other general unsecured debts in Chapter 13. These may receive a partial payment based on the debtor’s disposable income and the value of their non-exempt assets. Upon successful completion of the Chapter 13 plan, any remaining balance on these non-priority unsecured tax debts can be discharged. Chapter 13 offers a tool for managing and resolving tax debt by allowing for a manageable payment schedule and protecting assets during the repayment period.

Information Needed Before Filing for Bankruptcy

Before initiating the bankruptcy process, gathering specific documents and information is essential. A comprehensive collection of tax records is paramount. This includes copies of all federal and state tax returns for at least the past six to seven years to allow for a thorough review of tax liabilities.

It is highly recommended to obtain IRS tax transcripts, which provide a summary of your tax return items and can verify filing and assessment dates. These transcripts are available for free and can be requested directly from the IRS through their “Get Transcript” service online, by mail using Form 4506-T, or by calling their automated phone service. Any notices, demands for payment, liens, or levies received from the IRS or state tax authorities should also be collected, along with records of any tax payments made.

Beyond tax-specific documents, general financial information is also required for bankruptcy filing. This includes proof of income, such as recent pay stubs or profit and loss statements for self-employed individuals. A detailed list of all assets, including bank accounts, real estate, vehicles, and investments, is necessary to accurately assess the debtor’s financial position. A complete list of all debts, such as credit card balances, personal loans, and mortgages, must be compiled.

The Bankruptcy Process for Tax Debt

Once all necessary information has been gathered and the bankruptcy forms are prepared, the formal process begins with filing the bankruptcy petition and schedules with the court. This submission immediately triggers the “automatic stay,” a legal injunction that temporarily prohibits most creditors, including tax authorities, from continuing collection activities. This provides immediate relief by halting wage garnishments, bank levies, and other collection actions.

Following the filing, a mandatory “Meeting of Creditors,” also known as a 341 meeting, is scheduled. During this meeting, the debtor is questioned under oath by the bankruptcy trustee and creditors, including representatives from tax authorities if they have filed a claim. The tax authority will typically file a “proof of claim” in the bankruptcy case, detailing the amount owed and classifying it as priority or non-priority.

The bankruptcy court then determines how these tax claims will be treated based on their classification and the chosen bankruptcy chapter. For dischargeable tax debts, once the bankruptcy case concludes and a discharge order is issued, the debtor is legally relieved of personal liability. However, for non-dischargeable tax debts, particularly those secured by a pre-existing tax lien, the lien typically remains on the property even after the bankruptcy discharge, meaning the tax authority can still pursue collection against the specific assets.