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Does Bankruptcy Clear Tax Debt?

Patrick Austin, J.D. | September 27, 2024

Patrick Austin
Attorney from George Mason
Patrick Austin, JD

Patrick Austin is a licensed attorney with a background in data privacy and information security law. Patrick received his law degree at George Mason University's Antonin Scalia Law School, where he served as the Editor-in-Chief for the National Security Law Journal.

Edited by Hannah Locklear

Hannah Locklear
Editor at SoloSuit
Hannah Locklear, BA

Hannah Locklear is SoloSuit’s Marketing and Impact Manager. With an educational background in Linguistics, Spanish, and International Development from Brigham Young University, Hannah has also worked as a legal support specialist for several years.

Summary: You may be able to clear some tax debt by filing for bankruptcy, but it will depend on your unique circumstances and the types of tax debt owed. For example, you may only be able to clear income tax debt if you file for Chapter 7 bankruptcy, while other types of taxes (e.g., property taxes, recent tax assessments, etc.) cannot be discharged.

If you are struggling with significant amounts of debt, including tax debt, then you may be considering bankruptcy. This may lead you to ask, “does bankruptcy clear tax debt?” The answer is - it depends.

The question is complicated by the fact that federal tax debt - taxes owed to the Internal Revenue Service (IRS) - is typically treated as a “nondischargeable priority debt” in bankruptcy proceedings. This basically means filing for bankruptcy will not, automatically, erase tax debt. Nevertheless, there are scenarios where taxes can be considered a form of “dischargeable debt” that can be cleared via a bankruptcy filing.

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Tax debt collection by IRS

Despite being a federal agency funded by taxpayer dollars, the IRS can act quite similar to a debt collection company when someone owes back taxes. In many instances, the tax debt collections process will start with a notice of past-due taxes. This notice will then be followed by another letter, then another, and so forth. Each letter will be slightly more aggressive and threatening than the last. At a certain point, the letters turn into legal notices which may lead to the IRS filing a lien, seizing your bank account, and/or garnishing wages.

If you decide to file for bankruptcy, an automatic stay will be entered by the bankruptcy court. For context, an automatic stay basically acts like a pause button on debt collection efforts, including the efforts of tax debt collectors. Once an automatic stay is entered, creditors - including the IRS - are generally prohibited from even sending you a letter about your debt.

What type of bankruptcy is best for tax debt?

You may be able to get tax debt discharged by filing for Chapters 7 or Chapter 13 bankruptcy. Though, your eligibility to get tax debt discharged will depend on an array of factors.

Chapter 13 bankruptcy is generally considered to be the most common type of individual bankruptcy filing when significant tax debt is at issue. Chapter 13 bankruptcy, known as a reorganization bankruptcy, involves negotiating a repayment plan with your creditors that will last a period of time, typically anywhere between three and five years. This means, under Chapter 13, your tax debts are not erased. Rather, they will be repaid under your reorganization plan. During the payoff period, you must also make sure to file timely tax returns and pay new income taxes that come due.

If you opt to file for Chapter 7 bankruptcy, a trustee will be empowered to sell some of your assets with the proceeds being paid to your creditors. If there are insufficient assets to repay creditors, then eligible debts still get discharged by Chapter 7 and creditors receive nothing. When it comes to tax debt, it can be erased via Chapter 7 if the debt is at least three years old and you filed returns for the last four years.

Does filing bankruptcy clear tax debt?

As mentioned above, the answer is - it depends. There are specific rules for bankruptcy discharge and that the IRS will object to discharge if it has any reason to do so. It is also important to note that filing for bankruptcy will not discharge a federal tax lien. This means the IRS, or other taxing authority, may still have a viable claim to your property even if you are able to get tax debt discharged through bankruptcy proceedings.

The limitations imposed on the discharge of tax debt is due to their status in bankruptcy proceedings. For example, in Chapter 7 bankruptcy proceedings, only income tax debt can be discharged. This means if you owe unpaid property taxes or trust fund taxes, you may not be able to get these cleared through Chapter 7.

In addition, there are specific requirements that must be met for bankruptcy to be a viable path for clearing your tax debt. For example, your income tax debt must be at least three years old and you may have filed tax returns for the past four years. Furthermore, your tax assessment cannot be more than eight months old. This means if the IRS has not assessed the tax debt within the last 240 days, it cannot be discharged via bankruptcy.

Does bankruptcy clear state tax debt?

Here is the answer to the question, “does bankruptcy clear state tax debt?” It depends. I know it’s an underwhelming response, but it’s the truth. Tax debt can be tricky. When it comes to state tax debt, it can potentially be cleared by filing for bankruptcy, much like federal tax debt. Whether such debt can be discharged will depend primarily on the type of debt owed. Many of the same rules apply to state income tax debt and tax debt owed to the IRS.

It is also important to note that some state taxes cannot be discharged in bankruptcy. For example, you’ll likely remain responsible for paying for following state tax debts:

  • Income taxes less than three years old
  • Income taxes on a return filed less than two years before the bankruptcy
  • Fraudulently reported income taxes

Does bankruptcy clear tax debt in Canada?

Canada, in contrast to the United States, allows individuals to clear their tax debt through bankruptcy. Specifically, when you declare bankruptcy in Canada, the majority of your debts - including unpaid tax debt - will be discharged upon successful completion of bankruptcy proceedings. Though, it is important to note that dischargeable tax debts must be for tax years that ended prior to the date of bankruptcy. In addition, you need to have filed any required tax returns for those years. If there are any tax returns that have not been filed, then you need to file them beforehand to determine the exact amount of tax debt owed.

Does declaring bankruptcy clear tax debt?

As mentioned earlier, simply declaring bankruptcy does not automatically clear your tax debt. The process for getting tax debt wiped off the books is complex and will depend on an array of factors.

In the event your tax debt cannot be cleared, there are other options you may want to consider:

  • Make Installment Payments: If you have sufficient funds, it may make sense to offer to make installment payments on your back taxes. The IRS may be amenable to an installment plan since their goal is to recoup the amount owed.
  • Participate in an “Offer in Compromise” Program: In addition to installment payments, you may want to consider an “Offer in Compromise” program. These types of programs are made available through the IRS and entail taxpayers paying what they can while the IRS agrees to forgive the remainder. Though, qualifying for such a program can be difficult due to rigid eligibility requirements.

Key Takeaways

In summation, unpaid tax debt is generally treated differently than other kinds of debt when you file for bankruptcy. Income tax is typically the only kind of tax debt that may be eligible to get cleared away in a Chapter 7 bankruptcy filing. In a Chapter 13 bankruptcy, you are not actually discharging your tax debts. Rather, you are agreeing to participate in a repayment program that can last between three and five years.

If you’re considering bankruptcy, you should also look into your options for debt settlement. Learn more in the following video:

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