IRS Income Taxes and Bankruptcy Frequently Asked Questions (FAQs)

Bankruptcy and IRS Taxes: Frequently Asked Questions

Q. Can you Discharge or Release Taxes in Bankruptcy?

tax lien faqs

A. It depends. IRS taxes can be discharged or forgiven in a Chapter 7 Bankruptcy as long as the taxes that you want discharged meet these five conditions:

  1. Were ssessed 240 days before you filed
  2. Are income taxes
  3. Were filed two years before filing for Chapter 7
  4. Are three years or older
  5. No fraudulent activity or tax evasion is involved

Realize that recent taxes (not older than three years) cannot be discharged and you must file the last four years tax returns to qualify for Chapter 7. In a Chapter 13 Bankruptcy, taxes cannot be discharged but rather they are repaid utliizing a payment plan.

Q. Is Bankruptcy the Best Option for IRS Tax Settlement?

A. Bankruptcy should be arguably the last resort if you are solely trying to reduce the amount you owe in taxes. First, only certain taxes that meet certain conditions under Chapter 7 can be discharged. If you don't qualify for Chapter 7, you won't release your taxes. Second, bankruptcy becomes public knowledge and is much more destructive to your credit than delinquent accounts - not to mention it can stay on your credit from 7-10 years. Third, the costs for a bankruptcy attorney (needed) can be over $10k, which is three times what normally a tax relief company will charge you to settle or resolve taxes. Lastly, recent taxes cannot be reduce or settled (not older than three years).

Q. What Changes Chapter 7 Rules for Discharging Taxes?

A. First, if an Offer in Compromise (OIC) was filed before you filed for bankruptcy, this impacts the 240 day assessment rule pushing it back. The time delay is the duration that passed from the day it was filed to when it was rejected plus 30 days. Second, if you had filed for bankruptcy in the past, you must delay the tax rules related to discharging by the length of the bankruptcy proceeding plus one-hundred and eighty days.

Q. Can a Tax Lien Be Removed or Released in Bankruptcy?

A tax lien will not be removed or released if it was placed before you filed for Chapter 7 Bankruptcy. This means that in most cases, the tax lien will be present after bankruptcy and you cannot sell your property until the lien is satisfied. In Chapter 13, once your payment plan is fully completed (after 3-5 years) the tax lien will be removed but rarely is it removed before the completion of your restructuring and payment plan.

Q. What Are Some Differences Between Chapter 13 and Chapter 7?

A. First, in Chapter 7, tax debt can be discharged as opposed to "repaid" with Chapter 13. Second, in Chapter 7 you only get to protect certain assets and the rest must be liquidated (determined by the state) whereas in Chapter 13 assets do not have to be sold because your income secures the payment plan. Third, Chapter 7 is more difficult to obtain and you must pass a "means test" to qualify - in other words, if you made more over the last 6 months than the state's median income, you will not qualify for Chapter 7. This also includes staying below your state's limit for disposable income.

Q. What Assets are Exempt in a Chapter 7 Bankruptcy?

A. Assets that are exempt (or protected) from creditors depends on the state you live in. In general, here are a few things that are exempt:

  • 401(k)s, IRAs and other retirement plans
  • Welfare, Social Security and Unemployment Insurance
  • Home Equity (varies by state, but typically $20-30k)
  • Books, tools, and other personal property (varies by state)

Q. Reasons Why Chapter 13 May Be Better?

  • You are behind on your car payments or mortgage payments
  • You did not qualify for Chapter 7
  • You have unpaid taxes that are recent that you want to resolve
  • You find out that you cannot discharge certain debts with Chapter 7
  • You want to stop the liquidation of non-exempt assets