Chapter 7 Overview And Tax Debt
As we mentioned, federal income taxes qualify for discharge under Chapter 7 Bankruptcy. If the required criteria are met, the tax debt, all associated penalties and interest will most likely be discharged. If some of the criteria are not met, this only means that the tax debt will need to be paid, and other debts entered into the bankruptcy filing may still be discharged.
Chapter 11 Bankruptcy Is Best For Businesses But Individuals Can Also Apply
Whereas Chapter 7 and Chapter 13 bankruptcy are for individuals, Chapter 11 bankruptcy is tailored towards businesses and business owners. It is very similar to chapter 13, as it is also a reorganization plan to pay down creditors over a longer period of time. It is substantially more expensive than Chapter 7 or Chapter 13, as well. Individuals can also file for Chapter 11 bankruptcy and generally do so only when their debt exceeds the limits established by Chapter 13.
What Happens To My Irs Tax Debt If I File Bankruptcy In 2021
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In a Nutshell
The most common of all of debts owed to the IRS is unpaid income taxes, also known as back taxes. Chapter 7 bankruptcy is an option if your tax debt meets certain requirements.
Written by Attorney Jonathan Petts.
Debts owed to the IRS come in many shapes and sizes. The most common type of debt people owe to the IRS is back taxes, also known as unpaid income taxes. Now that more people freelance full time or moonlight part time, back taxes are a bigger issue than ever.
Looming unpaid debt can be stressful, and the IRS can be aggressive in its efforts to collect back taxes. As a public entity, the IRS is the worldâs largest debt collector, and it has many tools that private debt collectors can only dream of. Fortunately, filing Chapter 7 bankruptcy is a straightforward way to stop IRS harassment. In many cases, as outlined below, bankruptcy might end IRS harassment for good.
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Timing Of Filing And Age Of Tax Debt
As our IRS tax debt attorneys noted above, tax debts are generally treated as non-dischargeable . However, some exceptions can arise around income taxes, depending on when the tax in question was due:
- Three-Year Rule The pertinent tax return must have been due a minimum of three years prior to the bankruptcy filing date. This includes any tax filing extensions the debtor might have obtained.
- Two-Year Rule The debtor must have filed the pertinent tax return a minimum of two years before filing for bankruptcy.
- 240-Day Rule The IRS must not have assessed the debt within the 240 days preceding the debtors bankruptcy. Keep in mind that some events can extend this window of time, such as the debtor making an offer in compromise .
Due to these timeframes, more recent income taxes may be impossible to wipe out through bankruptcy. However, older income tax obligations that meet these criteria could be eligible for discharge.
Does Bankruptcy Clear State Tax Debt
State tax debts can sometimes be cleared by filing for bankruptcy. It depends on the type of tax debt that is owed. Many of the same rules apply to state income tax debt and tax debt owed to the Internal Revenue Service , but not all. In this article, youll learn about:
- state rules for wiping out tax debt
- state taxes that arent dischargeable in bankruptcy, and
- paying off nondischargeable tax in Chapter 13 bankruptcy.
Be aware that tax liability resulting from business ownership, such as sales, withholding, and franchise tax, have specific rules that vary between states. Youll want to speak with an experienced attorney about your particular case.
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What Happens To Tax Liens In A Chapter 7 Bankruptcy
Since these existing tax debts are not discharged when you file bankruptcy, it is important to know what will happen to them. In many cases, individuals are still obligated to pay them, but your bankruptcy filing may buy you some additional time.
Chapter 7 bankruptcies trigger an automatic stay that bars creditors, including the IRS, from trying to collect debts. This can provide you with valuable time to put your financial affairs in order and get straight with the IRS.
Stops Post-Bankruptcy Tax Liens
A Chapter 7 bankruptcy can also bar the IRS from attaching new tax liens on pre-bankruptcy tax debts that have been discharged. This creates a clean slate or fresh start that limits the property the IRS can attach to a lien. The IRS may be able to levy property you owned before the bankruptcy, but the new property you acquire after the bankruptcy is in the clear.
Other Ways to Deal with Existing Tax Liens
In addition to the options above, here are a few other ways to eliminate tax liens:
Consult an Attorney Before Making a Decision
Talk to a bankruptcy attorney or CPA before making a decision. Filing for bankruptcy and removing a tax lien are two things you may not want to do by yourself. to receive a free, no-strings-attached consultation with an experienced tax professional.
When You Can Wipe Out A Tax Debt
You can discharge debts for income and/or general excise taxes under Chapter 7 and Chapter 13 bankruptcy only if you are able to meet all the following conditions:
Tax is Income Tax or General Excise Tax
Tax other than income or general excise tax, such as fraud penalties and payroll taxes, cant be wiped out in bankruptcy. So, if you want to get rid of income or general excise tax, then there are possibilities for you to become debt-free.
You Didnt Commit Willful or Fraud Evasion
If you filed a deceitful tax return or willfully tried to avoid paying taxes, like using a wrong Social Security number on your tax return, then bankruptcy cannot help you at all.
The Debt is at Least 3 Years Old
In order to get rid of tax debt, your tax return needs to have been due at least 3 years before you file for bankruptcy.
You Filed a Tax Return
Youd need to file a tax return for the debt you want to wipe out at least 2 years before filing the case.
You Must Qualify For the 240-Day Rule
The income tax debt needs to be assessed by the taxing entity at least 240 days before filing for the bankruptcy.
To learn more about the requirements for getting rid of income tax and general excise tax debt, our seasoned bankruptcy lawyers have over 30 years of experience in this area. Our highly experienced attorneys will explain the whole process to you and provide the best solution for your case.
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Tax Debt In Chapter 7 Bankruptcy
With Chapter 7 bankruptcy, known as straight bankruptcy, things are more straightforward. If you meet the five criteria defined above, then the tax debt gets discharged. The discharge will also include penalties and interest generated by that debt.
If the tax debt doesnt meet those criteria, then it and any penalties generated from it will not be discharged. You can still file for bankruptcy and have your other debts discharged, but you will still owe those taxes and must repay them.
What Conditions Should Be Met To Discharge Tax Debt
Do you want to discharge your tax debts? If you do, filing for Chapter 7 bankruptcy will be your best option. But you should make sure that the tax debt will be qualified for discharge, making you eligible to file for Chapter 7. With that said, here are the conditions you must meet in order to discharge your tax debt through Chapter 7 bankruptcy:
Furthermore, aside from the conditions mentioned, some jurisdictions have also additional requirements. For example, in the Ninth Circuit, filing for tax returns promptly is a must, and filing late automatically precludes a discharge.
There are other complications if you are a dual-status alien with tax debt and want to file for bankruptcy.
Moreover, it is also applicable in Chapter 7 that if you have paid off non-dischargeable taxes through a credit card, the credit card balance will be subject to a non-dischargeable debt too.
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The Automatic Stay Does Not Apply To Debt Incurred After Filing Bankruptcy
The auto-stay serves to protect you from creditors trying to collect debt you incurred before you filed bankruptcy. The auto-stay does not prevent creditors from trying to recover debt you incurred after you filed your bankruptcy, also called “post-petition debt.” If you incurred tax debt after filing a Chapter 7 or 13 bankruptcy, the automatic stay will not prevent the IRS from attempting to collect.
Can Bankruptcy Get Rid Of Debt Owed To The Government
Whether a bankruptcy can wipe out debt owed to the government is one question that many people have when considering filing for a chapter 7 or chapter 13 bankruptcy. Whether a bankruptcy discharge will eliminate this type of debt depends on the specific nature of the debt owed to the government. One common form of government debt is tax debt. Tax debt is generally not dischargeable in bankruptcy.
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What Are Some Other Solutions For Tax Debt
If unpaid tax debt has you considering bankruptcy, you may want to explore other solutions first especially in light of the complex rules for bankruptcy and taxes.
These alternatives could include entering into an installment agreement with the IRS, making a deal with the IRS to delay collection efforts, or entering into an offer in compromise. An offer in compromise is an agreement between you and the IRS that allows you to pay a reduced amount.
There are pros and cons to each of these approaches. For example, youll need to pay a user fee for an installment agreement and will owe fees, interest and possible penalties. And the IRS wont always accept an offer in compromise.
Still, because these solutions address only your tax debt and dont affect other areas of your finances as much as bankruptcy does, they could be worth considering.
Are State Taxes Dischargeable In Chapter 7
Yes, state taxes are dischargeable in Chapter 7 bankruptcy, in certain circumstances. Generally speaking, state income tax discharge factors line-up with those used by the federal government. So, if you are able to discharge your federal income taxes with a Chapter 7 bankruptcy, you should be able to discharge state income taxes.
However, since these circumstances can vary state-by-state, especially when it comes to business taxes, you should speak with one of our tax professionals before moving forward to get the most up-to-date information.
If you cannot discharge your state income taxes with a Chapter 7 bankruptcy, a Chapter 13 bankruptcy may be more helpful. With a Chapter 13 bankruptcy, the taxes wont go away, but they can be spread out over the course of three to five years to make paying them more manageable well cover more on Chapter 13 bankruptcy below.
Regardless of what chapter bankruptcy a debtor decides to file, the tax may still be collectible from the debtors pre-bankruptcy property if the IRS filed a Notice of Federal Tax Lien before the bankruptcy petition was filed. If the IRS did not file a lien before the bankruptcy petition was filed, the tax lien will generally be removed as a result of the bankruptcy.
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Income Tax May Be Dischargeable In Minnesota
However, income tax debt may be dischargeable if it meets certain criteria. First, the income tax debt must have become due, at least, three years before the date the bankruptcy petition is filed. For example, tax debt for the 2017 tax year, which became due on April 15th, 2018, would meet this requirement for a bankruptcy case that is filed after April 15th of 2021.
Second, the person filing for bankruptcy would have had to have filed the taxes no less than two years prior to filing for bankruptcy. Filing tax returns with an extension is acceptable, but when the government files a tax return for the debtor, this requirement is not met. Lastly, the government cannot have assessed the tax debt within the 240 day period before filing for bankruptcy for the debt to be dischargeable.
If the debtor has not received anything from the government taxing authority within this time period, stating that the taxes are being assessed by the government, this is a good indication that this requirement has been satisfied. Only when all of these requirements are met, will the income tax debt be considered dischargeable and wiped out by the bankruptcy.
Are The Taxes You Owe Greater Than Three Years Old
You will only be eligible to have tax debt that is greater than three years old discharged. If you filed for a particular year late, you will be eligible to have that debt discharged three years after the file date. This means that if you owed taxes for 2012, but did not file your 2012 return until 2017, you will not be eligible for those taxes to be discharged until the year 2020.
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You Can’t Discharge A Federal Tax Lien
If your taxes qualify for discharge in a Chapter 7 bankruptcy case, your victory may be bittersweet. Why? Bankruptcy won’t wipe out prior recorded tax liens. Chapter 7 bankruptcy will wipe out your personal obligation to pay the qualifying tax and prevent the IRS from going after your bank account or wages. But if the IRS recorded a tax lien on your property before the bankruptcy filing, the lien will remain on the property. You’ll have to pay off the tax lien before selling and transferring the property’s title to a new owner.
Concluding The Tax Debt Debate
We have finally answered the epic question.
Does bankruptcy clear IRS debt?
The answer is, it can. But you need to know the facts in order to make an educated decision.
Take time to educate yourself or consult a professional to decide if bankruptcy is the right choice for you.
We can help you decide if bankruptcy is the right choice for you.
Contact us today for a free consultation!
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Restrictions On Access To Bankruptcy
Even while the treatment of taxes in Chapter 13 has grown to more closely resemble that of similar liabilities in Chapter 7, the BAPCPA has imposed a new means testing system for those with primarily consumer debt, preventing many debtors from filing under Chapter 7 at all. However, income taxes are not considered consumer debt. And thus a debtor whose biggest creditor is the IRS may avoid the problem altogether. Consequently, an element of all future pre-bankruptcy planning will be measuring and perhaps managing the balance between the clients consumer and nonconsumer debt.
Under the BAPCPA, a Chapter 7 involving primarily consumer debt will be dismissed upon a finding of abuse. Such a finding can be based on a presumption applicable under certain circumstances, or on general grounds including bad faith considering the totality of the facts. If the debtors income is above the median income for the state in which the case is filed, either the presumption or the general grounds standard can be raised by the Court, the trustee, or a creditor. The presumption is inapplicable if the debtors income is below the median income level for the state.
If the means test applies, it compares monthly income to allowable deductions. Income is defined as the debtors average income over the six full months prior to the petition date.
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Do You Have To File A Tax Return When Going Through Bankruptcy
While you can sometimes deal with past tax debt through a bankruptcy filing, you wont be protected from all past, current or future tax liability or obligations to the IRS.
- Chapter 13 filers are required to file returns for tax periods ending within four years of the bankruptcy filing before you have a meeting with creditors to work out your debt repayment plan.
- In Chapter 7 and Chapter 11, the bankruptcy estate that takes ownership of your assets is also required to file a separate tax return. The return must be filed by the trustee appointed to manage assets but sometimes in Chapter 11, the bankruptcy filer acts as the trustee and thus must take on this obligation.
And, no matter what chapter of bankruptcy you file under, all tax returns due after you file must be submitted on time unless you file for an extension. Failing to file or request an extension can result in dismissal of your bankruptcy proceedings or conversion of your bankruptcy to a different type.
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Eliminating Tax Debt In Bankruptcy
The following set out the rules to discharge an IRS debt in Bankruptcy:
You can get your IRS transcripts by going to Get Transcript FAQs
When I explain the above mentioned rules to clients they look at me glassy eyed. I dont blame them. The rules are legalistic and confusing.
For 99% plus of clients I have had there are only 3 rules that apply:
The following is an example of the most common situation: