If you are thinking about filing for bankruptcy, understanding how different types of bankruptcy can impact your tax responsibilities can help you to make informed decisions about your debt relief options.
When you file for bankruptcy, an automatic stay goes into effect. This means that most collection efforts, including those from the IRS, must stop temporarily. This does not mean that your tax debt will automatically disappear. Nor does it mean that you don’t have to file taxes while your bankruptcy case remains unresolved.
What you need to keep in mind
If you are thinking about filing for bankruptcy partially to manage tax debt, it’s important to understand that the issue of whether tax debt can be discharged—or erased—depends on several factors. In general, income tax debt may be eligible for discharge in Chapter 7 bankruptcy if it meets the following criteria:
- The taxes are at least three years old.
- The tax return was filed at least two years before the bankruptcy filing.
- The tax debt was assessed by the IRS at least 240 days before the filing.
- There was no fraud or willful tax evasion.
If your tax debt meets all these conditions, it may be discharged along with other qualifying unsecured debts in a Chapter 7 bankruptcy. However, recent tax debts, payroll taxes and penalties for fraud are generally not dischargeable.
If you alternatively file for Chapter 13 bankruptcy, tax debts that cannot be discharged will be treated as part of your repayment plan. Your repayment amount will be based on your income and expenses, and it may allow you to repay your tax debt over time without interest or penalties continuing to grow.
It’s also important to keep in mind that filing for bankruptcy does not relieve you of the responsibility to file future tax returns. You must continue to file returns on time and pay any new taxes that come due after filing. Failure to stay current can lead to dismissal of your bankruptcy case or future legal issues.
It’s also important to be aware that in some cases, canceled debts may be considered taxable income. However, debts discharged in bankruptcy are not taxable. The IRS offers a specific form (Form 982) to address this, and your attorney or tax professional can help you complete it properly.
Bankruptcy can be a powerful tool for managing overwhelming debt, but it does not completely erase tax responsibilities. Seeking legal guidance to learn more is wise.