Updated: November 12, 2024

By: Charles P. Corsello, EA|Reviewed by: Kari Brummond, EA

Bankruptcy & IRS Taxes: Types and Requirements

bankruptcy and taxes

Filing bankruptcy can help you eliminate some unpaid taxes. Unfortunately, however, not all taxes are dischargeable through bankruptcy. If taxes are not dischargeable, you may be responsible for paying them after you file bankruptcy.

To protect yourself, you should consult with a tax and/or bankruptcy attorney before filing. In particular, if you're trying to eliminate unpaid taxes, you need to do some research to ensure filing bankruptcy will have the effect you want. To help you out, here is an overview of the essentials and links to resources with more information about different types of bankruptcy.

Can You Get Rid of Tax Debt by Filing Bankruptcy?

Generally, you can only discharge tax debt for which you have personal liability that is at least three years old. But if you filed the returns late, you will need to wait until at least two years after you filed them. If you are an employer, the bankruptcy courts will not discharge unpaid Social Security tax or income tax withheld from your employees' paychecks.

For example, if you filed an income tax return in 2020 and you are filing for bankruptcy in 2024, that tax debt will be dischargeable as long as the other conditions are met for your bankruptcy.

Now, imagine that you owned a sole proprietorship, you didn't pay your payroll taxes from a return filed in 2020, and you filed bankruptcy in 2024. You will not be able to discharge the taxes you withheld from your employees' paychecks, but you may be able to discharge the employer's match part of the payroll taxes as you have personal liability for those taxes.

Say, however, that you are filing bankruptcy in 2024, and you have not filed your income tax returns from 2019 to 2023. Although you may be able to discharge tax debts from older returns, you will not be able to discharge any of the debts related to the returns from 2019 onward.

In all cases, the specifics vary based on the type of bankruptcy you file. Check out the sections below for more detailed information.

Additional Requirements to Discharge Taxes in Bankruptcy

The IRS will only let you discharge qualifying taxes in bankruptcy if you have filed your tax returns for the last four tax periods. After the bankruptcy, you must continue to file returns and pay the tax on time. If you have overpayments (refunds) on returns filed after the bankruptcy, the IRS may apply the overpayments to other tax debts.

Can you discharge state taxes in bankruptcy?

The laws vary from state to state, but generally, you can discharge state taxes for which you have personal liability but not trust fund taxes. In other words, you can discharge state income tax that is at least three years old (unless the returns were filed late), but you cannot discharge sales tax that your business collected but didn't pay.

What to Expect When You File Bankruptcy on IRS Taxes

With some types of bankruptcy, you liquidate your assets to cover unpaid liabilities, and then, the remaining amounts are discharged. However, if you have tax debts that are not dischargeable, they will survive this process, and you will need to pay them after the bankruptcy case is closed.

Some other types of bankruptcy require you to make payments over a three to five year time-period. Then, remaining liabilities including some tax debts over three years old (unless you filed late) are discharged.

In both cases, tax debts must meet very specific criteria to be discharged through bankruptcy. The rules vary based on the type of bankruptcy you're filing. If you decide to file bankruptcy, you need to choose the chapter carefully. You also need to be aware that if your taxes aren't discharged, you will still owe them after the bankruptcy case.

Do I need to notify the IRS when I file for bankruptcy?

When you file, make sure that you list the IRS as a creditor. Then, the courts will notify the IRS. If you want to make sure the IRS knows, call 800-973-0424.

Can I make payments while I'm in the midst of bankruptcy?

If you have an existing installment agreement, it will get suspended during the bankruptcy proceedings. Once the case is over, you can reapply for a payment plan for any tax debts that were not discharged during the bankruptcy.

In terms of sending voluntary payments to the IRS, talk with your bankruptcy attorney for guidance, but generally, if you file Chapter 7, you can make voluntary payments while you file bankruptcy. If you file Chapter 13, you cannot send payments to the IRS, but you can ask the bankruptcy trustee to make payments for you.

Can I receive tax refunds during bankruptcy?

Yes, you can receive tax refunds during bankruptcy. However, there are exceptions.

If you filed a tax return showing a refund before you filed for bankruptcy, the IRS may keep that refund and use it to pay down tax debts incurred before you filed for bankruptcy. Additionally, if you earned any tax refunds for tax years prior to when the bankruptcy was filed, the trustee has the right to take that refund and apply it to your debts.

What if the courts dismiss my bankruptcy case?

The IRS can keep any payments made during the bankruptcy proceedings. You will still owe the tax debt, and the IRS may enforce involuntary collections against you if you don't pay in full or make payment arrangements.

What if my spouse does not file for bankruptcy?

The IRS can take collection actions against the non-debtor spouse as long as you do not live in a community property.

How Filing Bankruptcy Affects IRS Collection Actions

When you file bankruptcy, the judge orders a stay. This prevents your creditors from pursuing collection actions against you, and in most cases, the IRS also has to stop enforced collection actions.

In other words, if you file bankruptcy, the IRS cannot seize your assets, garnish your wages, or use other collection actions while the stay is in place. The statute of limitations on collections also pauses while the stay is in effect. The IRS only has 10 years to collect on unpaid taxes, and that time clock pauses during the bankruptcy process. Then, the extra time gets added on so the deadline is extended.

Bankruptcy and Federal Tax Liens

Filing bankruptcy does not affect federal tax liens that were filed before you filed bankruptcy. In fact, even if a tax is discharged, a federal tax liens can still stay in place. The lien will be attached to the asset until you pay the tax in full or make other arrangements to get the lien released. Note, however, that federal tax liens cannot attach to assets that you acquire after the bankruptcy.

To give you an example, imagine that you file Chapter 7 bankruptcy. The IRS issued a tax lien for $50,000 before you filed. Your only assets were a home with a mortgage, a vehicle with a car loan, and an antique car worth $20,000 with no loan. During the bankruptcy, you liquidated the antique car, and the proceeds were sent to the IRS because they had a lien on all of your assets. However, you were allowed to keep your home and your car with the loan.

After the bankruptcy is complete, the tax lien continues to exist for $30,000. If you sell your home while the tax lien is still in effect, the proceeds from the sale will go to cover any remaining amount due on your mortgage. Then, any leftover amounts will go to the tax lien. You will receive any remaining amounts.

Now imagine that you inherited a house after you filed for bankruptcy. The tax lien will not attach to the new home. Similarly, if you get a new job with a higher income, the IRS will not be able to garnish your income based on the tax lien.

Tax Fraud, Tax Evasion, and Bankruptcy

You cannot discharge any taxes related to fraud or evasion. Regardless of the type of bankruptcy you file, these taxes cannot be discharged even if they meet all the other criteria. You must pay these taxes or work directly with the IRS to resolve them. You also cannot discharge fraud penalties.

Should You File Bankruptcy to Erase Unpaid Taxes? Alternatives to Bankruptcy

As indicated above, not all taxes can be discharged through bankruptcy. If unpaid taxes are your main type of debt, you may want to explore other alternatives such as setting up a payment plan, applying for an offer in compromise, or looking into currently not collectible status. Bankruptcy stains your credit for years, and it can make it difficult to obtain loans, credit cards, and mortgages.

However, bankruptcy can be a useful tool in certain situations. Ultimately, it is designed to provide relief from overwhelming debts, and it can be a financial lifesaver for many individuals and businesses. Just keep in mind, however, that not all debts can be discharged through bankruptcy, and the rules are particularly complicated around tax liabilities.

Chapter 7 Bankruptcy and Taxes

Chapter 7 bankruptcy requires you to liquidate all non-exempt assets and use the funds to pay off your liabilities. Any remaining liabilities are discharged, and this can include some taxes. However, you can only discharge income taxes or other taxes for which you have personal liability in a Chapter 7 bankruptcy. You cannot discharge trust fund taxes (such as the taxes you withheld from your employees' paychecks) in bankruptcy in most cases.

The income taxes must be at least three years old and from a return filed at least two years ago. You may also have to meet additional criteria including filing the last four years of tax returns. After the bankruptcy case, you will be responsible for repaying all taxes that were not eligible to be discharged.

Note that most Chapter 7 cases are "no asset" cases. That means that the person declaring bankruptcy doesn't have any assets to be liquidated. Typically, the courts do not have people liquidate their primary residence, vehicle, or personal property, but there are some exceptions particularly if these assets are very expensive.

Chapter 11 Bankruptcy and Taxes

Chapter 11 bankruptcy is for businesses and individuals with too many liabilities to qualify for Chapter 13. When you file for Chapter 11, you get to make payments on your liabilities for a certain amount of time, and then, some of them are discharged.

The rules around discharging taxes through Chapter 11 bankruptcy are complex. Typically, taxes can only be discharged if they are income taxes or other taxes for which you have personal liability due at least three years ago, but the courts vary their decisions based on the type of tax and the circumstances surrounding non-payment.

Chapter 12 Bankruptcy and Taxes

Designed for family farmers and fishermen, Chapter 12 bankruptcy combines elements of Chapter 11 and Chapter 13. With this type of bankruptcy, you make payments on your liabilities for three to five years, and any remaining debt is discharged at the end of the payment plan.

Most taxes take priority in these cases so they tend to get paid off early in the payment plan. By extension, they often end up getting paid even if they are dischargeable. However, capital gains taxes due to the sale of farm assets often take a lower priority so they are more likely to be discharged.

Chapter 13 Bankruptcy and Taxes

If you file Chapter 13 bankruptcy, the courts will recognize your finances, and you will make payments on your liabilities for three to five years. In some cases, you will repay all of your liabilities including taxes, but in other cases, some of your liabilities will be discharged at the end of the payment plan. To be dischargeable, the taxes must meet specific criteria.

Bankruptcy & IRS Taxes: Frequently Asked Questions

If you still have questions about taxes and bankruptcy, check out this resource. It features answers to frequently asked questions (FAQ) regarding IRS taxes and bankruptcy.

If a taxpayer has many personal or business liabilities in addition to tax issues, they may want to consider bankruptcy. However, you should reach out to a bankruptcy attorney rather than handling this on your own.

You should also consult with a tax professional. They can help you get into compliance with the IRS and make arrangements on any taxes that cannot be discharged through bankruptcy.

Disclaimer: The content on this website is for educational purposes only and does not serve as legal or tax advice. For specific advice regarding your tax situation, contact a licensed bankruptcy attorney or tax attorney.