Bankruptcy and How It Affects Tax Debts

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If you're considering bankruptcy, you might be informed that you're not able to discharge your tax debts in the process. However, this is untrue. It's possible to not be liable for taxes due before discharge, but you must meet certain requirements.

Income tax debts might be eligible for discharge under Chapter 7 or Chapter 13 of the Bankruptcy Code, depending on the age of the debts and other criteria.

The Different Chapters of Bankruptcy

There are six numbered chapters applicable to bankruptcy filings. Chapters 7, 11, 12,13 are applicable to individuals in different circumstances. There are other chapters, but they are not applicable in this context (Chapters 9 and 15).

Chapter 7 is sometimes called a "straight" bankruptcy because it provides for the full discharge of allowable debts. The bankruptcy court effectively takes control of your assets and liquidates them as necessary to pay off as much of your debt as possible. If you don't have sufficient assets to cover all your debts, you're no longer responsible for those unpaid balances after your bankruptcy is discharged.

Chapter 11 allows for a debt reorganization and repayment plan similar to a chapter 13 filing. Chapter 11 is different in that it is generally used by an incorporated business or for individuals whose debt is in excess of the limits for a chapter 13 filing ($394,725).

Chapter 12 is intended for family farmers and fishermen who are financially distressed by expenses related to their business. It is intended to be a quicker method of filing and designing a repayment plan. There are also limits to how long collectors can collect on debts under this chapter.

Chapter 13 involves a multiyear, court-approved payment plan to repay your debts as much as possible. The goal is to pay them off in full, but some unpaid balances can be discharged.

Tax Debts in Each Chapter

Tax debts are typically considered "priority" debts in all chapter filings. This means that they're addressed and paid first when assets are liquidated in Chapter 7 and nine. They must also be included and paid in full in Chapter 12 and 13 payment plans. Priority tax debts are not dischargeable in Chapters 11, 12, or 13.

While you can receive tax refunds while under bankruptcy, the refunds are more than likely to be redirected to your tax debts. If you are able to receive dischargeable tax debts, they must additionally meet five other criteria.

Five Rules to Discharge Tax Debts

Tax debts are associated with a particular tax return and tax year. The bankruptcy law lays out specific criteria for how old a tax debt must be before it can be discharged. All criteria must be met for the tax debt to be swept away.

If the income tax debt meets all five of these rules, the tax debt is dischargeable in Chapter 7 bankruptcies:

  • The due date for filing the tax return in question was at least three years ago.
  • The tax return was filed at least two years ago.
  • The tax assessment is at least 240 days old.
  • The tax return was not fraudulent.
  • The taxpayer is not guilty of tax evasion.

Apply these criteria to each year's tax debt to determine if that year's unpaid balance is dischargeable through bankruptcy. Some of your debts might be eligible while others might not.

The Return Was Due at Least Three Years Ago

The tax debt must be related to a tax return that was due at least three years before the taxpayer files for bankruptcy. The due date includes any extensions, so if you request and receive an extension for your 2019 return (making it due in October 2020) you would not be able to include it a bankruptcy filing until at least October of 2023. 

The Return Was Filed at Least Two Years Ago

The tax debt must be related to a tax return that was filed at least two years before the taxpayer files for bankruptcy. The time is measured from the date the taxpayer actually filed the return. In most cases, this covers the same period of time as the due date rule—unless you missed the due date and filed the return late.

Tax debts that arise from unfiled tax returns are not dischargeable. This is an important distinction because the IRS routinely assesses tax on unfiled returns. These tax liabilities cannot be discharged unless and until the taxpayer files a tax return for the year in question.

The Tax Assessment Was at Least 240 Days Old

Again, this often covers the same ground as the first two rules. The IRS must assess the tax at least 240 days before the taxpayer files for bankruptcy. The IRS assessment can arise from a self-reported balance due (such as a tax return you filed), an IRS final determination in an audit or an IRS proposed assessment that has become final. In other words, you reported what you owed, or the IRS has officially stated: "This is what you owe."

The Tax Return was Not Fraudulent, and You're Not Guilty of Tax Evasion

The tax return cannot be fraudulent or frivolous. In other words, you can't try to claim your dog as a dependent and then file for bankruptcy when the IRS calls you on it. You cannot be guilty of any intentional act of evading the tax laws.

Other Rules

The bankruptcy petitioner is required to prove that the previous four years' tax returns have been filed with the IRS before a bankruptcy can be granted. These four previous tax returns must be filed no later than the date of the first creditors meeting in a bankruptcy case.

Additionally, bankruptcy petitioners are required to provide a copy of their most recent tax return to the bankruptcy court. Creditors can also request a copy of the tax return, and petitioners must provide a copy to them if asked.