Does the IRS Allow Bankruptcy to Clear a Federal Tax Debt?
Yes and no. Some tax debts qualify for discharge, others don’t. Under Chapter 7 bankruptcy rules, a taxpayer may have a tax debt wiped out if:
- Tax debts are not the result of tax evasion or fraud.
- Tax debts are more than three years old.
- A tax return documenting the debt was filed two or more years before the taxpayer filed Chapter 7 bankruptcy. If the IRS filed a tax return on behalf of the taxpayer, the IRS would not consider that a return and may not discharge the debt.
- The taxpayer passes the 240-day rule, meaning the IRS evaluated the tax debt at least 240 days prior to the person filing bankruptcy. However, the 240-day limit may be extended if collection activity was suspended due to the taxpayer submitting an Offer in Compromise or previously filed for bankruptcy.
Does Chapter 7 Bankruptcy Clear Tax Liens on Properties?
No. While Chapter 7 bankruptcy may discharge income tax, medical and credit card debt, it won’t discharge tax liens on properties. Before a property with a tax lien can be sold, the owner must pay off the lien.
What About Chapter 13 Bankruptcy and Tax Debts?
Chapter 13 allows taxpayers to repay debts over a period of several years if they have enough disposable income after deducting essential expenses. This type of bankruptcy generally permits dischargeable taxes over three years old to be forgiven, as long as the taxpayer proves they do not have the financial resources to repay personal debts and tax debts. In addition, IRS tax liens can be satisfied with a Chapter 13 bankruptcy payment plan.
Tax returns must be current before filing Chapter 13. In some cases, taxpayers may not be required to file a federal tax return. Instead, they can give the trustee an affidavit or letter explaining the reason why a tax return was not filed.
What is Chapter 11 Bankruptcy and Can It Wipe Out a Tax Debt?
Corporations generally use Chapter 11 when their tax debt exceeds the amount allowing them to file Chapter 13. Individuals owning businesses that are not corporations may also file for Chapter 11 bankruptcy.
Much more complicated than Chapter 7 or Chapter 13, Chapter 11 bankruptcy does allow for some tax debts to be discharged. How much tax debt can be erased depends on various factors, such as the type of tax owed, how long the tax debt has continued and financial resources available to the corporation or individual.
Unless a corporation’s tax debt far exceeds the limit imposed by Chapter 13, bankruptcy experts recommend trying to find ways to qualify for Chapter 13 simply because filing Chapter 13 allows for more tax debt to be discharged.
Are There Alternatives to Settling a Tax Debt Without Filing for Bankruptcy?
If you are considering filing for bankruptcy largely because of a tax debt, Wiztax can help you settle your tax debt for less with the IRS Fresh Start Program. Wiztax makes it easy to submit an Offer in Compromise with the IRS that reduces the amount you owe before entering into a payment plan. Wiztax can also determine whether you qualify for Hardship Status if you are unable to afford making payments due to your current financial situation.
To get started with Wiztax, answer a few simple tax questions with our Free Evaluation. You’ll instantly see your Offer in Compromise settlement amount, whether you qualify for Hardship Status, and your monthly payment plan options. Wiztax’s online system will fill out all the IRS forms for you, plus a Wiztax Expert with decades of IRS and Tax Law experience will do a Ready to File™ review with you before you submit.
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