Can you eliminate your tax debt by filing for bankruptcy? Read on to find out if filing for bankruptcy erases tax debt.
In 2019, there were 774,940 bankruptcy filings. Over 97 percent of these were consumer filings.
Thousands of Americans used bankruptcy to address financial hardships. When filing for bankruptcy, you appear before a judge to inform the court you are unable to repay debts.
From there, the process varies case-by-case. In some situations, debts get erased altogether. Other times, the court reduces the amount owed. They often create a repayment plan that is more manageable for the debtor.
Filing for bankruptcy is often used to reduce credit card or medical debt. Using this means to target tax debt can be tricky. There are various types of bankruptcy filings—and not all are successful in reducing tax debt.
For more information about when filing for bankruptcy can potentially provide tax debt help, keep reading!
Filing for Bankruptcy
There are six different types of bankruptcies, also known as different “chapters.” This refers to the chapter of the US Bankruptcy Code that lays out the law for that situation.
The most common types of bankruptcy are Chapter 7 (liquidation) and Chapter 13 (repayment plan). There are also various lesser-used paths for bankruptcy:
- Chapter 9: Municipalities
- Chapter 11: Large reorganization (business)
- Chapter 12: Family farmers
- Chapter 15: International cases
Of the two most common types, tax debts are not always eligible for discharge.
When considering means to reduce tax debt, it’s also important to differentiate the concepts of tax debt and tax liens. Sometimes, the difference between these two can be unclear. However, they carry very different legal circumstances.
Tax debt refers to money owed for tax payments to either the state or federal government. On the other hand, a tax lien is a legal judgment placed on your personal property. Courts use this to recoup losses for unpaid taxes to the state or federal government.
Unfortunately, it is impossible to eliminate a tax lien through bankruptcy. You may be able to have the liens discharged, which stops the IRS from going after your bank account. But it does not eliminate the debt altogether.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy is also known as liquidation or “straight bankruptcy.” It only applies to those who can prove to the court they do not make enough money to repay the debt they owe.
In this case, the court appoints a trustee. The trustee oversees the sale (liquidation) of the debtor’s assets. They use the funds from these sales to repay creditors.
Some types of property may be exempt from liquidation, but it varies by case.
After exhausting the sale of non-exempt assets, any other remaining debt is usually erased. This usually applies to credit card debt or medical bills. It usually does not cover tax debt—though this may still be an option for some cases.
As for federal tax liens, there may be some leeway under a Chapter 7 bankruptcy filing.
You may be able to eliminate your personal obligation to repay the funds. It will also stop the federal government (via the IRS) from targeting your income or personal bank account.
However, if the tax lien is placed on a property prior to the bankruptcy petition, these liens will remain in effect. If you desire to sell the property, you will have to satisfy the lien first.
Chapter 13 Bankruptcy
Unlike Chapter 7 bankruptcy that can erase debts, Chapter 13 more or less reorganizes it.
If you have a regular income, you can seek an adjustment of debts with this option. This won’t remove your obligation altogether, but it can reduce how much you owe.
This is particularly advantageous as it allows you to protect your home from foreclosure. The court allows you to “catch up” on overdue payments under a payment plan.
Most of the time with a Chapter 13 bankruptcy repayment plan, you will still have to repay tax debts in full. Plus, you usually need to be up to date on tax filings to apply for this. Chapter 13 bankruptcy is usually not a successful option for tax debt help.
Tax Debt Relief
Unfortunately, most taxes cannot be completely wiped out by filing for bankruptcy. This includes items like fraud penalties or payroll taxes that are unable to be eliminated in the bankruptcy process.
However, some regular tax payments can be discharged. This applies to people who did not file tax returns at all, filed fraudulent returns, or willingly evaded their taxes. Only law-abiding citizens who are struggling to make payments will qualify for discharge situations.
Furthermore, the original tax return leading to the debt must be at least three years old. Finally, the IRS also has what is known as the “240-day rule.”
This means that the income tax debt has been assessed by the IRS at a minimum of 240 days before the bankruptcy petition is filed. If the debt has not been assessed yet, it can still qualify.
You may be able to reduce or eliminate some of your this money owed when filing for Chapter 7 bankruptcy.
This is where it is key to hire a seasoned bankruptcy attorney. They can help you best understand your options, and to find tax debt help resources applicable to your unique situation.
Even if you are unable to achieve tax debt consolidation when filing for bankruptcy, you can still indirectly address this. By getting other debts erased or reduced, more funds are made available to dedicate to repaying tax debts.
However, it is important to note that filing for bankruptcy goes beyond financial effects.
This major life event can come back to bite you when trying to buy a house, get a job, or start a business. It does have many financial benefits, but it can come at a cost.
While it can provide a “fresh start” in some respects, it is a major decision that should not be taken lightly. There may be other alternatives to bankruptcy that better suit your situation.
The best course of action is to sit down with a trusted bankruptcy attorney to determine the best course of action for your situation.
Turning to the Experts
If you are considering filing for bankruptcy to help reduce or erase tax debts, the process can be confusing.
It’s best to turn to an expert attorney who is well-experienced in this area of law. They can guide you down the best path based on your situation. They will provide an expert opinion to help you weigh all of your options.
In the Omaha, Nebraska area, Husker Law is your solution. Call (402) 415-2525 today to schedule a free consultation—and find out how to make the most of your tax debt relief.