Considering Bankruptcy for Taxes? See If You Can Settle Instead

Bankruptcy & IRS Taxes: Types and Requirements

Bankruptcy is a legal process whereby individuals, businesses, and organizations can discharge or pay back debts with the help of a court appointed trustee. Realize there are different types or chapters and each will treat tax debt differently. Many argue bankruptcy should be used as a last resort because not only does it have negative consequences (discussed below) but it may also not discharge recent taxes.

Negative Consequences of a Bankruptcy?

Bankruptcy can leave a stain on a taxpayer’s credit with the 3 credit bureaus for several years. In fact, it (depending on the type) can be left on your credit report. It is arguably much more severe than if you have collection accounts or unpaid creditor accounts. When your credit shows bankruptcy, lenders are hesitant to loan money whether its a mortgage, car loan, credit card. Moreover, even landlords who see this on a credit report may be reluctant to take this type of tenant because it shows you are not reliable in making payments.

Bankruptcy Types for Individual Federal Income Taxes

The two common types of bankruptcy relevant to discharging or repaying tax debts is Chapter 7 and Chapter 13 which is discussed below. Chapter 11 is a better fit for businesses looking to reorganize debts, and Chapter 12 applies to individuals with farms. With all types of bankruptcy, there are certain conditions or requirements that need to be met in order to qualify.

Chapter 7 Bankruptcy and Taxes

In Chapter 7, nonexempt assets (set on the state level) are liquidated and any remaining IRS tax debts are discharged unless qualifications are not met. If qualifications are not met, then the tax debt will need to be repaid after the bankruptcy process is over. Realize recent tax debt (not older than 3 years) cannot be discharged.

Chapter 11 Bankruptcy and Taxes

With Chapter 11 bankruptcies, businesses generally reorganize their finances to pay off debts. This type of bankruptcy also applies to individuals who do not qualify for Chapter 13. In certain cases, some types of taxes can be discharged under certain circumstances.

Chapter 12 Bankruptcy and Taxes

Chapter 12 bankruptcy is relatively a new type of bankruptcy that applies to family farmers and family fishermen.  This is similar to chapter 11 in terms of it allowing farmers and fishers to reorganize debts through a payment plan. In some cases, taxes can be discharged if they are unsecured.

Chapter 13 Bankruptcy and Taxes

In Chapter 13, the more common of the applicable income tax bankruptcies, some IRS tax debt may be forgiven but typically these taxes have to be repaid with a payment plan. Normally assets do not need to be liquidated as a taxpayer’s income will finance the payment plan.

Bankruptcy & IRS Taxes: Frequently Asked Questions

Answers to frequently asked questions (FAQ) regarding IRS taxes and bankruptcy.

If a taxpayer has many personal debt issues in addition to tax debt issues, they may want to consider bankruptcy. If interested, working with an experienced bankruptcy attorney is in their best interests.

Disclaimer: The content on this website is for educational purposes only and does not serve as legal or tax advice. For specific advice regarding your tax situation, contact a licensed tax professional or tax attorney.