Discharging Income Tax Debt: File a Chapter 7 or Chapter 13?

••• Income tax debts can be discharged in bankruptcy if they meet certain tests. Getty Images

Although there are many reasons to file a bankruptcy case, the goal for most people is a discharge of debt. When the debt is discharged, the bankruptcy laws will relieve the debtor (that’s what we call the person who files the bankruptcy case) of the liability for repaying it. Income taxes can be included in a bankruptcy case and can be discharged. Many people who file bankruptcy have income taxes that are overdue.

In fact, some people use bankruptcy to manage their income tax debts.

Not all taxes can be discharged, however. Whether they can be discharged and how they can be discharged depends on their type, their age, the type of bankruptcy you file, and some administrative issues with the taxes and returns themselves.

Disclaimer: Of course, every taxpayer’s situation is unique. Any rules reflected here may or may not apply to your issues, and we caution you against relying solely on this article or any other article to help you determine how these rules affect you. If you owe income taxes, we strongly encourage you to consult with a qualified consumer bankruptcy attorney or tax professional who can advise you specifically with regard to your personal tax issues.

Are There Other Reasons to File Either a Chapter 7 or a Chapter 13 Case?

Before we can get to the actual tax debt, however, we have to ask a foundation question.

Are there other factors that would influence whether you should file either a Chapter 7 or a Chapter 13 case? Chapter 7 and Chapter 13 cases are designed to accomplish different goals, and they accomplish those in different ways. A straight Chapter 7 is a relatively short term, four to six-month process in which the debtor (you) receives a discharge in exchange for any non-exempt property you may have.

A Chapter 13 case is a longer term case in which the debtor devotes future income and resources to funding a three to five-year repayment plan to pay back a portion of all of the debt.

Some of the factors to consider in determining the best chapter under which to file include

  1. Whether you’re trying to save a house from foreclosure or other collateral like a car from repossession. A Chapter 13 might be appropriate for that because it would allow you to include the arrearages in a payment plan. A Chapter 7 has no provision for that and would not stop a foreclosure in the long term.

  2. If you have a lot of non-exempt property, a Chapter 13 might be a better choice for you because a Chapter 13 does not require that you turn over any non-exempt property immediately to a trustee like you would in a Chapter 7 case. Instead, you pay out the value of the non-exempt property over the three to five-year course of the Chapter 13 case,

  3. Whether you can you qualify for a Chapter 7 under the Means Test.

  4. If you have a co-debtor on a personal debt, you may be able to protect that co-debtor in Chapter 13, but not in Chapter 7.

  5. Whether you have income tax debt that would not qualify to discharge in a Chapter 7 case.

  1. If you have a significant amount of student loan debt, you may be able to use Chapter 13 to manage it.

  2. Whether you received a discharge in a Chapter 7 case or a Chapter 13 case previously. Depending on the type of the previous case and the type of new case, there are varying minimum time limits to which you will have to adhere.  

For more on which chapter might be best for your situation, see When to Consider Filing Under Chapter 13 Instead of Chapter 7.

Of course, much of the decision may be a balancing act. It may be that the answer is clearly a Chapter 13 because you want to save a house. Or it could be that you have a lot of student loan debt, but even more tax debt that can be discharged efficiently in a Chapter 7 case.

It may also be possible under certain circumstances to file a Chapter 7 case, obtain a discharge of all debt that can be discharged, then immediately file a Chapter 13 case to manage debt that could not be discharged in Chapter 7.

This is sometimes referred to as a Chapter 20 case (because 7 plus 13 equals 20).