Discharging Tax Debts through Bankruptcy

Can I Eliminate Tax Debt by Filing for Chapter 7 Bankruptcy?
Many individuals and households live with a great deal of financial stress, which can become
especially burdensome during tax season. Perhaps they manage their finances efficiently most
of the time and have managed to keep debt-levels to a minimum, but underestimated the
amount of taxes they would owe, or encountered unanticipated emergency expenses just before
they were assessed. Regardless of the reason, the inability or failure to pay taxes as they
become due can cause debt to accumulate and make financial control seem out-of-reach.
Thanks to Chapter 7 of the Bankruptcy Code, however, those struggling with debt have a better
chance of obtaining the fresh start they need to improve their financial health. At the end of a
Chapter 7 bankruptcy, most of the debtor’s debts will be discharged, and their liability to pay the
remaining balances on those debts is terminated.
Some debts cannot be discharged, though, so the overall financial impact and benefit of
Chapter 7 bankruptcy varies depending on the type, amount, and nature of the debts that
existed when the debtor filed. Generally, the three categories of non-dischargeable debts are
tax debts, student loan debts, and family support obligations such as child or spousal support.
Discharging Income Tax Debt
Under some circumstances, an exception may apply that renders an otherwise non-dischargeable debt dischargeable. For example, past-due income taxes can be discharged, but
only if the debts meet certain criteria. Other types of tax debt, such as unpaid property or estate
taxes, will never be discharged through bankruptcy.
To be dischargeable, an income tax debt must satisfy each of the following requirements:

  • A tax return was filed for the year the income tax was not paid;
  • The tax return was last due, including any extensions requested, at least three years prior to the date when the debtor filed for bankruptcy;
  • The tax return was filed at least two years before the bankruptcy filing;
  • No fraud or willful evasion was committed by filing the return; and
  • The income tax debt was never assessed, or was assessed at least 240 days before
    the bankruptcy was filed.

Some jurisdictions have more stringent requirements and will not allow the debt to be
discharged unless it was filed on time, for example, or will extend the 240-day filing limit if the
assessment was delayed because the debtor was in bankruptcy or while payment negotiations
were pending.
The Effect of Tax Liens
Even if all of the above criteria are present, an income tax debt that has been filed as a tax lien
against the debtor’s real and personal property cannot be discharged. While the individual’s
personal liability for the debt can be discharged, the lien for the amount of the tax debt remains
against the person’s assets until the bankruptcy is completed. The IRS and state will send
notice to debtors if a tax lien filed against their property.
Taxes Paid by Credit Card
Normally, credit card debt can be discharged in a Chapter 7 bankruptcy proceeding, but this is is
not true when the credit card balance was incurred due to the payment of non-dischargeable
taxes. The debtor will remain liable for such credit card balance even after the bankruptcy ends.
What if I’m Not Eligible for Chapter 7?
Filing for bankruptcy under Chapter 7 offers greater relief from tax debt than that which is
available under Chapter 13, but many debtors are barred from filing under Chapter 7 because
their income and/or assets exceed the designated threshold. Chapter 13 still provides some
benefit to debtors looking to get rid of tax debt, though, by allowing them to make manageable
monthly payments as opposed to paying the entire balance all at once, and by making it easier
to satisfy an IRS lien, as the IRS must honor a Chapter 13 payment plan as long as the debtor
includes all unpaid income taxes and stays current on their tax obligations for the duration of the
plan. Further, and in contrast with Chapter 7, Chapter 13 allows a credit card balance to be
discharged even if the card was used to pay a non-dischargeable debt.
If you are struggling with tax debt and would like an in-depth look at how bankruptcy can help,
please call Reynolds & Gold Law at (417) 883-7800 to schedule a consultation.