Both Chapter 7 bankruptcy and Chapter 13 bankruptcy can offer relief from many types of unsecured and other debt, as well as help to reduce financial pressure from creditors that can reduce the quality of your life in a number of ways. However, bankruptcy’s benefits are less certain for taxes than other types of debt. Just about everyone has heard of the saying about death and taxes being the only certain things in life; to a great extent, that saying is true. If you are behind on your taxes, it doesn’t mean all hope is necessarily lost, but timing can make a big difference when it comes to how much of your tax debt can be eliminated with a bankruptcy.
Chapter 7 vs. Chapter 13
One of the first decisions to make when filing bankruptcy for most is whether to file Chapter 7 or Chapter 13. The basic difference is that filing Chapter 7 poses some income and property ownership limitations, but eliminates unsecured and other qualifying debts, which may, under certain special circumstances, include tax debt.
Chapter 13, on the other hand, reorganizes debt and allows the filer to keep higher valued property. For most debts, a portion of the debt is paid to the creditor over a 3-5 year period, with the remaining debt discharged after this time. However, during Chapter 13, tax debt is not pro-rated according to your ability to pay the way other debts are, but it is included in the repayment plan, which can be helpful by giving you a longer time to re-pay your past due taxes, especially if the IRS or State “wolf” is at your door.
What tax debt may be discharged with a Chapter 7 filing?
There are some tax debts that may be eliminated by filing a Chapter 7 bankruptcy, however, timing plays a big role in how much of the debt can be legally discharged. Generally, in order for tax debt to be discharged in a Chapter 7, it must meet the following requirements:
- You must have filed the tax return for the debt in question at least two years before filing bankruptcy. If you never filed a return for money you owe, that tax debt does NOT qualify for discharge, no matter how old it may be.
- The debt in question must have been due for at least 3 years before filing bankruptcy. If the IRS granted any extensions, the 3 year period does not begin until the extended due date has passed.
- At least 240 days must have passed between the date the debt was “assessed” (i.e., officially declared due in a “Notice of Assessment” sent to you) by the IRS and when you file bankruptcy.
- You must not have attempted to defeat or evade your tax debt in any way.
If your tax debt meets ALL of these criteria, it may be eligible for discharge in a Chapter 7 bankruptcy, forever relieving you of the obligation to repay it. However, even if your debt does not qualify for Chapter 7, filing a Chapter 13 instead may help, as doing so will give you 3-5 years to pay off your tax debt. While you are repaying your debt under Chapter 13, you are protected against any wage garnishments or other aggressive attempts by the IRS to collect the debt.
Tax liens may still apply
For taxes that are successfully discharged, there is still a chance you may ultimately need to pay them if the IRS had previously imposed a tax lien against any of your property. By discharging the debt, you won’t have to worry about day-to-day collection efforts against you personally, but the previously acquired lien may still validly attach to your property. For example, selling property that has a previous lien on it, may cause the lien to resurface, thereby requiring you to pay it to “free” that property from the lien.
If you do not qualify for a discharge of your tax debt, bankruptcy may still help
Even if you don’t meet all the conditions to have all your tax debt discharged, it can still be helpful to eliminate other qualifying debt. Without the burden of your other debts, more of your financial resources can be freed to focus on resolving otherwise non-dischargeable tax debt. However, this is a very complex area of Bankruptcy and Tax law. An attorney can help you navigate these difficult waters and counsel you on how to time things properly so that as much of your debt can be discharged or eligible for reduced payments as possible, which will give you an opportunity to regroup and move forward, financially speaking.