Tax Liabilities and Bankruptcy

Despite what you may have heard in commercials, eliminating tax liabilities in bankruptcy is not as simple as it sounds. In fact, most tax bills can’t be wiped out in bankruptcy. The liability will still be there at the end of a Chapter 7 bankruptcy, or they’ll have to be repaid in full in a Chapter 13 bankruptcy repayment plan.

A Chapter 7 bankruptcy is likely the better option if you need to discharge tax liabilities; although only if your liabilities qualify for discharge and you are eligible for Chapter 7 bankruptcy. Two qualifiers that unfortunately eliminate the majority of people looking to discharge tax liabilities.

When Discharging a Tax Liability is Allowed

You can discharge (wipe out) liabilities for federal income taxes in Chapter 7 bankruptcy only if all of the following conditions are true:

The taxes are income taxes. Taxes other than income, such as payroll taxes or fraud penalties, can never be eliminated in bankruptcy.

You did not commit fraud or willful evasion. If you filed a fraudulent tax return or otherwise willfully attempted to evade paying taxes, such as using a false Social Security number on your tax return, bankruptcy can’t help.

The bill is at least three years old. To eliminate a tax liability, the tax return must have been originally due at least three years before you filed for bankruptcy.

You filed a tax return. You must have filed a tax return for the liability you wish to discharge at least two years before filing for bankruptcy. (In most courts, if you file a late return (meaning your extensions have expired and the IRS filed a substitute return on your behalf), you have not filed a “return” and cannot discharge the tax. In some courts, you can discharge tax liability that is the subject of a late return as long as you meet the other criteria.)

You pass the “240-day rule.” The income tax bill must have been assessed by the IRS at least 240 days before you file your bankruptcy petition, or must not have been assessed yet. This time limit may be extended if the IRS suspended collection activity because of an offer in compromise or a previous bankruptcy filing.

Federal Tax Lien Are Not Eligible To Be Discharged

If your taxes qualify for discharge in a Chapter 7 bankruptcy case, your victory may be bittersweet. This is because bankruptcy will not wipe out prior recorded tax liens. A Chapter 7 bankruptcy will wipe out your personal obligation to pay the bill and prevent the IRS from going after your bank account or wages, but if the IRS recorded a tax lien on your property before you file for bankruptcy, the lien will remain on the property. In effect, this means you’ll have to pay off the tax lien in order to sell the property.

To find out more about which liabilities you can eliminate in bankruptcy, feel free to contact us at 833-419-RISE (7473). Our Tax Resolution Experts will be happy to help you.

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