Eliminating Tax Debts in Bankruptcy

One of the most popular questions people ask bankruptcy lawyers is, "Does bankruptcy clear tax debt?" Unfortunately, the answer isn't straightforward. Your ability to eliminate tax debt in bankruptcy depends on many factors, including the tax type, age, whether you filed your taxes on time, and whether the taxing agency has a lien on your property.

In this article, you'll learn about options for eliminating tax debt, including how to determine whether you can discharge it in Chapters 7 and 13.

Does Bankruptcy Clear Tax Debt?

More often than not, you'll remain responsible for paying your taxes. But it's not always the case because sometimes, bankruptcy does clear tax debt.

So, how do you know whether you can use bankruptcy to get out from under a hefty tax bill? You'll want to analyze the factors you must meet to "discharge" or eliminate tax debt in bankruptcy. Then, decide which chapter will best meet your needs.

What Type of Taxes Can Be Discharged in Bankruptcy?

The only type of taxes you can erase in bankruptcy are qualifying federal income taxes. In other words, you won't be able to discharge property taxes owed on real estate, employee trust taxes withheld by a business, or other tax debt.

When Can You Discharge Federal Income Taxes in Bankruptcy?

When determining whether they can discharge tax debt, bankruptcy filers must consider many factors. The most significant is age because bankruptcy doesn't erase taxes less than three years old.

You can use the "Dischargeable Tax Checklist" below to learn more about discharge requirements. But remember, it doesn't address your particular factual situation. It's best to get an evaluation from a bankruptcy lawyer or contact the Internal Revenue Service (IRS) to verify tax debt discharge eligibility.

Dischargeable Tax Checklist

The conditions you must meet before eliminating federal income in bankruptcy include the following:

1. The taxes are federal income taxes. Taxes relating to payroll or fraud penalties can't be eliminated in bankruptcy.
2. Fraud or willful evasion didn't occur. If you filed a fraudulent tax return or willfully attempted to evade paying taxes, such as using a false Social Security number on your tax return, bankruptcy won't help.
3. The tax debt is at least three years old. The tax return must have been originally due three years or more before filing for bankruptcy.
4. You pass the "240-day rule." The IRS must have assessed the income tax debt at least 240 days before you file for bankruptcy or not at all. Sometimes, the time limit is extended if the IRS suspends collection activity because of an offer in compromise or a previous bankruptcy filing.
5. You filed a tax return. In some states, but not all, you must have filed a tax return for the debt you wish to discharge on time and at least two years before filing bankruptcy. If you file a late return—your extensions expired, and the IRS filed a substitute return on your behalf—you have not filed a "return" and might be unable to discharge the tax. However, this factor doesn't always apply. In some courts, you can discharge tax debt even if you filed a late return when you meet the other criteria.

When Can't You Discharge Federal Income Taxes in Bankruptcy?

Even if you meet all the requirements in the Dischargeable Tax Checklist, you might still run into a problem if the IRS placed a lien on your property or you paid your taxes with a credit card.

IRS Tax Liens

If the IRS has already put a lien on your property, you're likely out of luck. The lien will remain if the IRS records a tax lien on your property before bankruptcy.

In this situation, all bankruptcy will do is wipe out your obligation to pay the qualifying tax and prevent the IRS from going after your bank account or wages. You'll have to pay off the tax lien before selling and transferring the property's title to a new owner.

Credit Card Payments

If you paid off nondischargeable tax debt using a credit card, the credit card balance could be a nondischargeable debt in Chapter 7. However, this isn't automatic. The credit card company must challenge the dischargeability by filing and winning a bankruptcy lawsuit or "adversary proceeding."

Unlike Chapter 7, in Chapter 13, you can discharge a credit card balance incurred due to paying off a nondischargeable tax debt.

What Happens to Taxes in Bankruptcy Chapters 7 and 13?

Filing for bankruptcy can help you resolve dischargeable and nondischargeable tax debt. But each chapter has pros and cons, depending on your situation. Here are key facts to consider when deciding between Chapters 7 and 13.

Taxes in Chapter 7 Bankruptcy

The most significant benefit of Chapter 7 is that you erase dischargeable debts in about four months without repaying creditors. You'll remain responsible for nondischargeable taxes after your Chapter 7 case ends.

One of the problems people encounter with Chapter 7 is failing to qualify because they earn too much. You'll need to take and pass the Chapter 7 means test to determine your eligibility for a Chapter 7 debt discharge. Also, sometimes people can't keep everything they own. You'll lose property you can't protect or "exempt" with a bankruptcy exemption.

However, people with tax debt in Chapter 7 often benefit somewhat from a property sale because the trustee pays sales proceeds toward priority debts first. Because taxes are a priority debt, a property sale could lower the amount owed on nondischargeable tax debt after bankruptcy.

Example. Celine owes $35,000 in dischargeable credit card debt and $15,000 in nondischargeable tax debt when she files for Chapter 7. She can protect everything she owns with bankruptcy exemptions, except for a tropical timeshare in a community regularly visited by TikTok influencers. The Chapter 7 trustee sells the timeshare and pays $10,000 toward her nondischargeable tax debt. After bankruptcy, Celine remains responsible for paying $5,000 of tax debt.

Taxes in Chapter 13 Bankruptcy

Filers pay into a Chapter 13 plan for three to five years, and all come out of Chapter 13 free of tax debt. But all tax debt isn't discharged in Chapter 13. You'll likely pay less than you owe on dischargeable taxes, but you must pay nondischargeable taxes in full.

It's common for people to file for Chapter 13 even when qualifying for Chapter 7 because Chapter 13 offers benefits not available in Chapter 7, such as the ability to keep all property. The lengthy repayment plan gives you time to catch up on missed mortgages and car payments, allowing you to save a home from foreclosure or a car from repossession. You can also use the repayment plan to pay to keep nonexempt property you'd lose in Chapter 7.

However, Chapter 13 is expensive. Not only will nondischargeable tax debt continue to incur interest, but you must also pay the trustee's fee, which can be up to 10%. It's also common to earn too much to qualify for Chapter 7 but not enough to support a Chapter 13 plan.

Example. Charlie wanted to file for Chapter 7, but after she and her bankruptcy lawyer discovered she earned too much to qualify, they began exploring Chapter 13. Unfortunately, the conversation was short. Because Charlie owed $60,000 in nondischargeable taxes, she would need to pay $1,000 monthly for 60 months, plus interest and the trustee's fee. Because Charlie didn't have enough disposable income to pay the required monthly payment, she didn't qualify for Chapter 13.

Example. Hannah qualified for Chapter 7 but was $6,000 behind on her mortgage payment and didn't want to lose her home. She also owed $15,000 in miscellaneous dischargeable debt and $5,000 in nondischargeable tax debt. Hannah would need enough income to repay $11,000 plus interest and trustee fees through her plan. She'll likely pay very little, if anything, on the $15,000 dischargeable debt, which the bankruptcy court will erase when she completes her plan.

How Will Bankruptcy Affect Future Tax Filings and Refunds?

Filing for bankruptcy won't impact your future tax filing responsibilities. However, tax filings can affect how much you'll pay in Chapter 13 or lose in Chapter 7.

Tax Refunds in Chapter 7

If the IRS owes you a tax refund when you file for Chapter 7, you must be able to protect it with a bankruptcy exemption even if you haven't yet filed the return. If you can't exempt it, the trustee will seize it for the benefit of creditors.

In this situation, many people delay bankruptcy until after receiving the return and spending it on necessities such as living expenses. If you choose this approach, keep records of your expenditures.

Example. Phillip filed for Chapter 7 bankruptcy in December 2023. When he attended the 341 meeting of creditors in January 2024, he hadn't yet filed taxes for 2023. At the meeting, the trustee's questions included asking whether he anticipated a tax return. He answered that he didn't know. The trustee continued the meeting to allow for further investigation. During that time, Phillip discovered he was owed a refund of $2,500. Because his state didn't offer an exemption to protect it, he lost the refund to the trustee.

Tax Filings and Refunds in Chapter 13

Chapter 13 filers must complete tax returns promptly each year. The Chapter 13 trustee will likely inspect the return, and creditors could also request a copy.

If your return shows you're making more money than expected, the trustee could file a motion asking the court to increase your monthly payment. Why? Because your creditors are entitled to your discretionary income for the duration of your plan, and typically, a salary increase will increase discretionary income.

The trustee might also be entitled to a Chapter 13 filer's tax return if it is unusually large. A hefty tax return is another salary increase indicator, but it might also signal that a filer's expenses are lower than disclosed in the initial filing. In either case, the trustee might investigate the filer's ability to pay more to creditors.

Example. John received a promotion a few years after filing for Chapter 13 bankruptcy. He called his bankruptcy lawyer because he didn't want to give the additional funds to creditors. John planned to increase his withholdings so his monthly bank deposits appeared unchanged. However, his lawyer advised against it, explaining that intentionally hiding funds from creditors could be considered fraudulent and that a significant tax return could prompt a thorough evaluation of his finances.

Learn more about when a trustee might suspect fraud.

Should You File for Bankruptcy Before or After Filing Taxes?

You must turn over tax returns when filing for Chapters 7 and 13. However, the requirements differ depending on the Chapter filed. It's more important to be current on tax filings before filing for Chapter 13 because the Chapter 13 trustee has a greater need for accurate tax information.

Unlike Chapter 7 filers, Chapter 13 filers must pay certain taxes in the Chapter 13 plan. Here are the details.

Tax Returns and Chapter 7 Bankruptcy

When you file for Chapter 7, the trustee will ask for your most recently filed tax return. It doesn't necessarily have to be the tax return for the last tax year, so you can file for Chapter 7 even if your tax return filings aren't current.

If you are exempt from filing taxes, you can expect the trustee to ask for a written explanation.

Tax Returns and Chapter 13 Bankruptcy

You must be current on tax returns when filing for Chapter 13 because you must provide returns for the previous four tax years to the Chapter 13 trustee before the 341 meeting of creditors. The bankruptcy court will dismiss your case if you don't give the trustee the required returns.

Tips and Financial Assistance to Pay Off Tax Debts

Using Chapter 13 bankruptcy to pay tax debt over time is possible. However, you'll pay interest on nondischargeable tax debt and the Chapter 13 trustee fee, which can be costly. So, before using the bankruptcy route, you'll want to research IRS payment plan options.

You can also explore companies offering to negotiate tax debt. But, research such companies carefully. Not all deliver on their promises. You'll likely fare better working with an experienced lawyer specializing in tax and bankruptcy cases.

When Meeting With a Bankruptcy Lawyer

It is common to seek expert advice about handling tax debt in bankruptcy. A bankruptcy attorney will need information such as the tax type, its age, and whether the taxing agency has filed a lien to assess whether bankruptcy will erase your tax debt or whether managing tax debt using Chapter 13 is possible.

Need More Bankruptcy Help?

Did you know Nolo has made the law accessible for over fifty years? It's true—and we wholeheartedly encourage research and learning. You'll find many more helpful bankruptcy articles on Nolo's bankruptcy homepage, and information needed to complete the official downloadable bankruptcy forms is located on the Department of Justice U.S. Trustee Program.

However, online articles and resources can't address all bankruptcy issues and aren't written with the facts of your particular case in mind. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.