IRS Taxes and Chapter 7 Bankruptcy Requirements & Details

IRS Taxes and Chapter 7 BankruptcyChapter 7 applies to individuals who cannot make consistent monthly debt payments regardless if the individual is solvent or insolvent. With a Chapter 7 bankruptcy, you can discharge some tax debts, but first, you need to liquidate your non-exempt assets. The definition of non-exempt assets varies from state to state, but generally, you can keep homes with a moderate amount of equity, a vehicle, and your personal belongings. Typically, filing Chapter 7 takes 90 to 180 days, and it costs a few hundred dollars in administrative fees.

Chapter 7 Bankruptcy Requirements to Discharge IRS Income Taxes

The IRS only discharges tax debt in bankruptcy if the tax debt meets certain conditions. If you do not meet these or if you miss a deadline even by a day, the tax debt may be due at the end of your bankruptcy proceedings. Here are the conditions:

  • Only Income Tax — You can only discharge income tax through a Chapter 7 bankruptcy. You cannot usually include payroll taxes, business sales taxes, excise taxes, or other types of taxes.
  • At Least Three Years Old — This is the three-year rule. You can only include taxes that are at least three years old. The clock starts on the return due date. That is usually April 15 of every year. If you request an extension, the three year period begins on the tax-filing extension due date. That is usually October 15.
  • Filed at Least Two Years Ago — You must have submitted the tax return associated with the tax debt at least two years ago. For example, you cannot file an old return from three years ago and include that tax debt in bankruptcy the following week. In this situation, the tax debt is old enough, but the filing is too recent.
  • Not From a Substitute Return — A substitute return is when the IRS files a return on your behalf. You cannot include taxes from a substitute return in your bankruptcy. You must file the tax return yourself.
  • Assessed at Least 240 Days Ago — If the IRS makes changes to your return or adds to your unpaid tax debt, that is a tax assessment. You can only include assessed taxes if the assessment occurred 240 days ago or more.
  • No Fraud or Evasion — If you are convicted of tax evasion or fraud, you cannot include tax debt in your bankruptcy.

On top of these requirements above, you must prove to the courts that you have filed the last four years of tax returns. You also need a copy of your most recent tax return. Unfortunately, if you have any tax liens, a Chapter 7 bankruptcy will not get rid of them.

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General Requirements to File for Chapter 7

To qualify for Chapter 7, you also have to meet some additional criteria. Here are some of the most important requirements:

  • Your current monthly income over the last six months is equal to or below your state’s median income for your family size.
  • You take a means test to determine whether or not you have the ability to pay some of your back taxes and debts with your disposable income. If you pass the means test, you may need to file Chapter 13. With Chapter 13, you make repayments on your debt for a certain amount of time.
  • You complete credit counseling with a government-approved nonprofit organization.
  • You complete a “Statement of Financial Affairs” form for the courts.
  • Provide a copy of your most recent tax return to the bankruptcy court (sometimes they may ask for the last two years).

It is essential that if you file for bankruptcy that you do not incur additional liabilities. In other words, you may need to adjust or make estimated tax payments or adjust IRS withholding, so you do not continue to accrue tax debt.

Documents You Need to Provide Bankruptcy Trustee

To prove many of the requirements above, the official appointed to your case (aka bankruptcy trustee) will need documents required by section 521 of the bankruptcy code. Alternatively, you may file them with the court (depends on local practices).  As discussed above, your trustee usually will request these documents (although your trustee’s document demands may be different):

  • Copy of your most recent tax return (sometimes the last two years)
  • Previous 2 months of bank statements
  • Last two months of pay stubs

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Other Documents Your Trustee Might Request

Your trustee, in most cases, may request additional documents from you. Therefore, it is in your best interests to have these documents available. Some of these documents include:

  • Mortgage statements
  • Bank statements past 60 days
  • Investment account statements
  • Retirement account statements
  • Pension account statements
  • Car loan statements
  • Life insurance statements
  • Divorce or marital settlement related paperwork
  • Appraisals of your car, house, or other property
  • W-2s, 1099s, receipts for expenses

Discharge At the End of Chapter 7 Bankruptcy 

Once your Chapter 7 bankruptcy comes to a conclusion, you will receive a discharge of your debt. In other words, for those debts that are dischargeable, you will not be personally liable anymore. In regards to taxes, if you meet the specific rules above, then you will not owe the tax debt anymore. However, the circumstances and facts of each case largely determine whether you can discharge your tax debt and other debts.

Because it has such serious consequences on your credit, you should only pursue bankruptcy as a last resort. Moreover, bankruptcy doesn’t get rid of trust fund penalties or several other types of taxes. Before filing bankruptcy, make sure to explore all other options, particularly regarding setting your tax debt. Consult with a licensed tax professional if you solely looking at bankruptcy because of tax debts you cannot pay. If you have other debts, consult with a bankruptcy attorney.