Bankruptcy & IRS Taxes: Types and Requirements
Only some taxes are dischargeable through bankruptcy. If taxes are not dischargeable, you may be responsible for paying them after you file bankruptcy. Talk with a tax specialist before filing.
Bankruptcy allows individuals, businesses, and organizations to reorganize their finances and get relief from their unpaid liabilities. However, bankruptcy doesn't just erase all of your unpaid liabilities, and in fact, many taxes are not eligible for discharge through bankruptcy.
To protect yourself, you should consult with a tax 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.
Discharging Unpaid Taxes Through Bankruptcy
Some types of bankruptcy require you to make payments over a three to five year time-period. Then, remaining liabilities including some tax debts are discharged. With other types of bankruptcy, you liquidate your assets to cover unpaid liabilities, and then, remaining amounts 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.
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 also pauses while the stay is in effect.
Bankruptcy and Federal Tax Liens
Filing bankruptcy does not affect federal tax liens. 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.
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.
Should You File Bankruptcy to Erase Unpaid Taxes?
As indicated above, not all taxes can be discharged through bankruptcy. If unpaid taxes are your main liability, you may want to explore other alternatives such as setting up a payment plan or applying for an offer in compromise. 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 liabilities, 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 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 in a Chapter 7 bankruptcy. You cannot discharge payroll taxes 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.
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 due at least three years ago, but the courts vary their decisions based on the type of tax and the circumstances surrounding non-payment.
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.
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.
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.