IRS Taxes - Chapter 7 Bankruptcy Requirements & Details

IRS Chapter 7 BankruptcyWith a Chapter 7 Bankruptcy, IRS income taxes can be discharged as opposed to a Chapter 13 where you would have to pay back the debts via a payment plan that lasts 36-60 months. However, in order to wipe tax debts clean you will need to liquidate non-exempt assets (determined by each state), and meet certain qualifications or conditions. A typical bankruptcy proceeding can last anywhere from 90-180 days and will cost you a few hundred dollars in adminstrative fees. 

Chapter 7 Bankruptcy Requirements to Discharge IRS Income Taxes

As discussed above, the IRS will not discharge taxes through bankruptcy unless certain conditions are met. These conditions are applicable to tax returns and tax assessments independently. If any one of the qualifications below are not met, or off by a day or two, the taxes will still be due at the end of the bankruptcy proceedings. Here are the conditions:

  • Solely Income Taxes - Only income taxes can be discharged in bankruptcy as opposed to payroll taxes, and other types of taxes.

  • Taxes Must Be At Least 3 Years Old - In other words, the tax debts and their respective returns must be at least three years before filing for bankruptcy. This is often called the 3 year rule. Understand that this includes filing extensions as well. So if you received a 6 month extension, then it would be 3 years from the extension date (typically October 15th, October 17th in 2011).

  • Tax Returns Filed 2 Years Before Bankruptcy Filing - What this basically means is that any IRS taxes you want discharged must have been filed 2 years before you filed for bankruptcy. Therefore, a taxpayer cannot file unfiled tax returns today from 3 years ago and then file for Chapter 7. Substitute tax returns do not count.

  • Taxes Were Assessed At Least 240 Days Ago - The IRS needs to have assessed your taxes at least 240 days before you file a petition. Taxes can be assessed more than once in a year. An assessment is when the IRS reviews unpaid taxes, and makes any changes (adding to the balance for example) to the tax return and taxes owed. Therefore, any taxes that don't meet this 240 day rule cannot be discharged.

  • No Fraudulent Tax Activities or Evasion - If you are convicted of tax evasion or fraudulent tax activities, you can kiss qualifying to have your taxes discharged goodbye.

Again, realize in addition to these conditions, you must prove to the court that your last 4 years of tax returns have been filed and you must have a copy of your most recent return. Also, take note that tax liens will not be removed with a Chapter 7 bankruptcy.

General Requirements to File for Chapter 7

Although we have talked about the conditions or requirements that need to be met in order to discharge IRS taxes with bankruptcy, below are some general rules to even file for Chapter 7 regardless of taxes:

  • Taxes from the previous year are filed

  • Your current monthly income over the last 6 months is below or equal to your state's median income for your family size. You can find your State's median income Here. If you are below this, you will need to pass a "means test," which determines whether you have the ability to pay back taxes and debts with your disposable income. This calculation can be complex.

  • Credit Counseling with a Federal Government agency must take place before you file

  • You will need to complete a form as well for the court called the "Statement of Financial Affairs"

All in all, bankruptcy is something to pursue as a last resort as it can leave a stain on your credit for many years. Moreever, bankruptcy will not discharge trust fund penalties and other penalties not related to income taxes. It will surely not discharge recent taxes (as discussed above). Therefore, before you look to bankruptcy for unpaid IRS taxes consider its requirements as well as other forms of tax debt settlement.