Does Bankruptcy Remove Federal Tax Debt?

When you find yourself in financial trouble, bankruptcy might seem like a good option. It is important you recognize that not all debt is taken away, which might mean you go through the process and deal with the disadvantages, such as the negative impact to your credit score, for no reason. Therefore, it is important you understand exactly what debt can be discharged–and what cannot–before you start the process. One debt category that is not always removed is your tax debt.

Types of Bankruptcy

Although there are several types of bankruptcies, the most common for businesses and individuals are Chapter 7 and Chapter 13. In Chapter 7 bankruptcy, you have the chance to actually discharge the debt from medical bills and credit cards. You might also be able to get your student loans or tax debt discharged as well, but you most likely will still be liable for alimony and child support payments. The proceedings usually liquidate any assets to help pay down some of your debts, so you will most likely not be able to retain any of your property, although there are certain assets exempt by law from liquidation.

Under Chapter 13, rather than liquidating assets and discharging the debt, you create a payment plan to pay it off over a period of time, usually between three and five years. Chapter 13 is the most common type of bankruptcy filed by individuals. You might have also heard of Chapter 11 bankruptcy, which is typically for corporations or partnerships or other businesses, although individuals might also choose to file under it. There are other types as well that will have their own guidelines.

Generally, federal and state tax debt does not fall under the qualified debt for discharge. The type of bankruptcy for which you file might play a role in your ability to get your tax debt included. For example, those who file under Chapter 7 typically have a more likely chance of discharge than those who file under Chapter 13. There are other guidelines as well.

Criteria for Tax Debt Discharge

There are a few criteria you have to meet in order to qualify to have federal income tax debt discharged under Chapter 7 bankruptcy. Beyond the type of bankruptcy, the main factors include the age of the debt, whether it is income tax or another type of tax, and if there was a return filed. If you meet all the following criteria, there is a good chance you might be able to discharge the debt:

  • There is no evidence of tax fraud or willful tax evasion.
  • You filed your tax return for the appropriate year at least two years prior to your bankruptcy filing and are up to date on all other taxes.
  • You are asking for income tax to be discharged. Other types of taxes, including penalties due to fraud or payroll taxes, are not eligible.
  • More than three years have passed since the original due date for the tax liability.

The IRS also reviews your taxes under what is known as the 240-day rule. This basically means that the IRS has assessed the debt at least 240 days prior to the bankruptcy filing.

If your tax debt is discharged, any penalties you might owe are also removed from your liability. This means that you no longer have responsibility for these funds, and any collective action will cease and cannot be instigated in the future for that particular tax debt. The only exception to this is if a lien has already been placed on your property. That lien remains until you pay off the lien to clear the title. If you accrue any new debt, then you would still be held accountable to pay and face collection action if you do not.

What Happens If It Is Not Eligible for Discharge

In the case that your tax debt is not discharged in bankruptcy, you still will see some relief. The IRS is unable to proceed with collective action during the period known as Automatic Stay. This typically lasts a few months, and then you will have to start repaying your taxes. However, this should give you time to prepare your finances so that you can handle the debt once the Automatic Stay is over. In Chapter 13 bankruptcy, you make payments over time and as long as you are up to date on you repayments, the Automatic Stay remains.

If you find yourself drowning in debt beyond just your federal income taxes, then bankruptcy might be a valid option to help you get back on track. However, for those whose main debt is just from the IRS, there are other options that do not affect your credit like bankruptcy does. You can file for an Installment Plan, Offer in Compromise or Penalty Abatement. Call Fidelity Tax Relief at 877-372-2520 to learn more about your options for repaying your tax debt.

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When you owe money on your federal taxes, one of the common collection actions taken is IRS tax garnishment, typically on your wages or salary. Wage garnishment can leave a person with very little money on which to live. 

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