Bankruptcy and IRS Taxes: Frequently Asked Questions
Can you discharge taxes in bankruptcy?
It depends but is possible for individual taxpayers. LLCs, corporations, and partnerships usually cannot discharge taxes in a Chapter 7 bankruptcy.
With Chapter 7, an individual taxpayer can get taxes discharged (erased) if they meet specific criteria. With Chapter 13 bankruptcy, you usually end up paying all your taxes in your repayment plan, but you may be able to get a small percentage of “non-priority” taxes owed discharged. The rules on taxes owed also vary for Chapter 11 and Chapter 12.
What taxes can you discharge in a Chapter 7 bankruptcy?
For a taxpayer to receive a discharge of IRS tax liabilities in a Chapter 7 bankruptcy, the tax must meet the following criteria:
- Income tax.
- At least three years old.
- Based on tax returns filed at least two years ago.
- Assessed at least 240 days before you filed bankruptcy.
- Not linked to fraud or evasion.
Are there exceptions to the Chapter 7 rules for discharging taxes?
There are several situations where the rules on discharging taxes in a Chapter 7 bankruptcy vary. If you request an offer in compromise (OIC) on your taxes owed before filing for bankruptcy, that affects the 240-day assessment rule. The 240-day period pauses when you submit an OIC, and the count does not resume until 30 days after the IRS rejects your offer in compromise. Also, if you filed for bankruptcy in the past, you have to extend all of the deadlines listed above by the length of the bankruptcy proceedings plus 180 days. Furthermore, “priority taxes” are usually not dischargeable.
For more information on IRS taxes and a chapter 7 bankruptcy, see IRM 5.17.9.
Is bankruptcy the best option for IRS tax settlement?
If you are only trying to reduce your taxes owed, bankruptcy may not be the most effective solution. Bankruptcy only discharges select taxes, and you cannot include any taxes owed that is less than three years old. Bankruptcy also stays on your credit report for seven to ten years, and it makes it extremely hard to borrow money in the future. You should only file bankruptcy after you considered all your options.
The cost of a bankruptcy attorney tends to be more expensive than using a tax attorney. If you want help dealing with taxes owed, you should consult with a tax attorney before considering bankruptcy.
Can a tax lien be removed or released in bankruptcy?
If the IRS places a tax lien before you file Chapter 7 bankruptcy, the tax lien generally stays. In most cases, the tax lien will still be present after the Chapter 7 bankruptcy, and you won’t be able to sell your property until you pay the taxes associated with the lien.
In Chapter 13, once your payment plan is complete, the tax lien gets removed, but in most cases, it stays in place during your three or five-year repayment plan.
What are some differences between Chapter 13 and Chapter 7 bankruptcy?
Chapter 7 requires you to sell all your non-essential assets and use the money to repay your creditors. Every state has different rules on which assets you have to sell. Once that happens, the debtor usually receives a discharge. That includes taxes that meets the criteria listed above. For a taxpayer to qualify for a Chapter 7 bankruptcy, your income must be under the state median.
With Chapter 13, you don’t have to sell your assets, but you have to make repayments for three to five years. You end up paying all of your priority taxes and the majority of your non-priority taxes owed.
What assets are exempt in a Chapter 7 bankruptcy?
When an asset is exempt, that means that you don’t have to sell it to repay your creditors. The assets that are considered exempt vary from state to state. In general, here are a few items that are usually exempt:
- 401(k)s, IRAs, and other retirement plans
- Welfare, Social Security, and Unemployment Insurance
- Primary vehicle under a specific value
- Home Equity (varies by state, but typically only $20,000-30,000)
- Books, tools, clothing, and other personal property (varies by state)
Why may you consider a Chapter 13 bankruptcy?
Chapter 13 can be better than Chapter 7 in numerous ways. If you meet any of these qualifications, you may want to consider Chapter 13:
- You earn too much money to qualify for Chapter 7.
- You find out that you cannot discharge certain liabilities with Chapter 7.
- You are behind on your car payments or mortgage payments. With Chapter 13, you can “cram down” these liabilities, so you pay less than you owe.
- You don’t want to liquidate non-exempt assets.
- You want to resolve recent taxes through a Chapter 13 payment plan.
However, in other cases, Chapter 7 is the better option. If you don’t own a lot of assets and don’t have the income to make repayments, you may want to consider Chapter 7.
What makes a Chapter 12 bankruptcy different than a Chapter 7 or Chapter 13?
In a Chapter 12 bankruptcy, usually, the debtor is a family farmer or fisherman. To qualify as a family fisherman, at least half of their income from the previous year must be from fishing. To qualify as a farmer, at least half of a taxpayer’s income for the last three years must come from farming activities. In a chapter 12 bankruptcy, taxes are priority liabilities, and the taxpayer must pay them first.