Bankruptcy and Taxes

If you have a tax debt, the rules for bankruptcy and taxes are simple, but often misunderstood.  If you miss a deadline by even one day, you might bet stuck with taxes that would have been dischargeable.  Don’t let confusion about bankruptcy and taxes cost you.

I would like to start by noting that the rules for bankruptcy and taxes can be used to stall the taxman from collecting, or to get you some much needed breathing room.  For details on how to use the bankruptcy system to delay the IRS, and how long that might buy you, consult with an expert.  I am focused on tax debt elimination and not an expert in bankruptcy.

Now to the gist of bankruptcy and taxes:  If you file Chapter 7, and your taxes qualify, they will be discharged.  To qualify, you must wait 3 years from the due date of the return, two years from the date you actually filed the return, and your last four years of tax returns must have been filed.

For example, if you file your 2014 return on April 15, 2015, you can bankrupt that amount due on April 16, 2018.  However, if you file your 2014 return on June 1, 2018, then you can bankrupt those taxes on June 2, 2020.  Remember that you must wait 3 years from the due date, which is April 15, 2015 for your 2014 return, and two years from the date you actually filed it.  So, if you file several years late, you must wait 2 years from that date to request bankruptcy relief.

The above rules are for Chapter 7 bankruptcies.  If you qualify for Chapters 11, 12, or 13, you might get a better deal and make payments over time… maybe for pennies on the dollar.  This is beyond the scope of this article.

One issue to consider before filing for bankruptcy on a tax debt is that the bankruptcy will extend the 10 year collection statute.  The IRS has 10 years to come after you for taxes.  Once that expires, the debt is eliminated.  If you file a Chapter 11, 12 or 13, you might be in a payment plan for years and your collection statute will be on hold this entire time.  If you are dealing with issues around bankruptcy and taxes, be sure to consult an expert in both to ensure the taxes are dischargeable and that you are not unnecessarily delaying the 10 year collection statute.

I said that most taxes are dischargeable in Chapter 7 bankruptcy.  To clarify, most income taxes are dischargeable.  Other taxes, such as payroll taxes, trust fund recovery penalties, and fraud penalties, are not.

Also, you must not have filed a fraudulent tax return or otherwise willfully attempted to evade paying taxes.  If you have been assessed a fraud penalty, or you were charged with a tax crime, seek counsel prior to filing bankruptcy.

Now, here is the rub when dealing with bankruptcy and taxes:  Chapter 7 will discharge the tax debt as described above, but it will not eliminate a tax lien.  If the IRS filed a lien on your home, other real estate, or an IRS or pension plan, then they can foreclose on the lien and seize your assets after you exit bankruptcy.  If you don’t have real estate or a retirement account, then this lien issue does not affect you.  If you do have these assets, consult an expert before filing bankruptcy.

I will end this section on bankruptcy and taxes by suggesting bankruptcy is not a great option if your only significant debt is the IRS.  If you are focused on resolving a tax debt, then an installment agreement throughout the collection statute or an Offer in Compromise is probably a better solution.

Please stay tuned to this site for more on the Offer in Compromise program as an alternative to bankruptcy and taxes.