Tax debts in Chapter 7 bankruptcy can be discharged, but not in all circumstances. Whether you qualify for discharge or remain liable depends on a number of factors such as what kind of tax you owe, how old your debt is, the reason you weren’t able to pay, and if you were able to file a return or not.
But you definitely have a better chance of having your tax debt discharged in Chapter 7 bankruptcy rather than if you were facing a Chapter 13 bankruptcy, which involves a repayment plan.
So let’s look at what exactly makes federal income taxes in Chapter 7 dischargeable. Note that you need to meet all these criteria for your taxes to be forgiven. Otherwise, you won’t escape your tax obligation, even in a bankruptcy case.
Only income taxes are eligible for discharge. This pertains to taxes on income related to your wage or, if you own a business, taxes on gross receipts. Penalties for dischargeable taxes are also included.
Records should show that you filed for a legitimate tax return for the tax being questioned and the corresponding tax years. Also, the return must have been filed two years or more before your bankruptcy case was filed. This doesn’t apply though if the return was filed late or if it is a substitute return that the IRS filed for you on your behalf.
Your tax debt should be at least three years old, that is the tax return for that tax debt must be have been due for a minimum of three years before you file for bankruptcy. In the case of an extension, the due date specified in the extension is when the three-year clock starts.
The IRS tax assessment is a process wherein tax is entered on the books in order to assess your liability for the tax debt. Under the 240-day rule, at least 240 days must have passed between the date the assessment was completed and the date of your bankruptcy filing. This period will only be extended if you have been negotiating with the IRS and the IRS suspended their collection activity because of your pending offer in compromise.
No tax evasion or fraud
You must not have tried to deliberately escape your tax obligation during the tax year in question or provided false information in your tax return. The following are considered evasive actions: changes in your name or how it is spelled, changes in your Social Security number, a blank or incomplete tax return on file, and hiding the fact that you withdrew cash from a particular bank account. Forms of fraud include untrue accounts and forged paperwork. However, what constitutes “willful tax evasion” is subjective and depends on the decision of the IRS personnel assigned to your case.
Nondischargeable tax debts
There are also certain tax debts that you can never have discharged, even though a Chapter 7 bankruptcy. That list is made up of:
- Penalties from tax debt that are not qualified for a discharge
- Tax debts that you owe due to unfiled tax returns
- Trust fund taxes
- Taxes that your employer withheld from your paycheck
- Property taxes that have been due for less than a year
- Payroll and excise taxes, custom duties and other business-related taxes
Federal Tax Lien
A federal tax lien complicates matters a bit. If the IRS placed a federal tax lien before your bankruptcy case, your tax debt will become a secured obligation.
And you will have to repay this, even if your tax is old and dischargeable and whether you file a Chapter 7 or 13 bankruptcy.
The bottomline: As long as your tax debt ticks off all the boxes in the qualification guidelines checklist, you can look forward to your debt being wiped up. The bankruptcy court will issue the discharge, your case will be closed, and you’ll be able to start over with a clean slate.