Discharging Tax Debts in a Bankruptcy Filing

Can Overdue Taxes Be Discharged in a Chapter 7 Bankruptcy?

It’s not uncommon, when struggling to meet your financial obligations, to have some past-due tax debt. If you qualify to discharge debts under Chapter 7, you want to know if some or all of your tax arrearages can be wiped out. Let’s look at how bankruptcy law applies to tax debt, specifically whether you can permanently rid yourself of tax obligations.

Can Taxes Owed Be Discharged in a Chapter 7 Bankruptcy?

As with many things in life, there’s no hard and fast answer to this question. The extent to which tax arrearages can be cleared depends on a number of factors:

• The type of tax—To qualify for discharge, an arrearage must be for income tax due. You cannot discharge employment or payroll taxes, or property taxes that are less than a year old.
• How old the tax liability is—To qualify for discharge, the arrearage must be for a tax return that was due more than three years prior to the date of your bankruptcy filing.
• Whether you filed the tax return for the debt at issue—You can only discharge a tax debt if you personally filed the tax return showing the debt. If you failed to file and the taxing authority filed a substitute return on your behalf, you do not qualify to discharge that tax debt.
• Whether you intentionally avoided paying taxes or engaged in tax fraud—Discharge is not available to taxpayers who have submitted a false or fraudulent return or intentionally failed to file a return or pay a tax debt. For example, if you misstated income or deductions or falsified your social security number on a return, you will not be eligible for discharge of income tax arrearages.
• Time between assessment of the tax and your bankruptcy filing—This is commonly referred to as the “240-day rule.” If the Internal Revenue Service assessed the tax more than 240 days before the date of your bankruptcy petition, you can seek to discharge the debt. You also should qualify if the IRS has not yet assessed the tax at all.

Can a Chapter 7 Bankruptcy Discharge a Tax Lien?

When you have unpaid federal taxes, the IRS may file a tax lien, which allows the government to seize assets to satisfy the tax debt. The lien may apply to real estate or personal property.

If the tax lien was imposed before you filed for bankruptcy protection, the lien is not affected by your bankruptcy filing. Even if the tax debt itself is discharged, the claim to your property represented by the lien is not extinguished. So the IRS or other taxing authority cannot take steps to collect any tax debt that is discharged by the bankruptcy court. For example, your wages cannot be garnished, and you can continue to live in a house with a lien on it. However, if you sell the house, you will need to pay off the tax lien out of the sales proceeds.