Most people understand that bankruptcy clears unsecured debts like credit cards and medical bills. However, misunderstandings remain about discharging tax debt with bankruptcy. In reality, bankruptcy can clear some tax debts that are owed to the IRS or another tax authority. It’s critical to understand that certain taxes aren’t eligible for this relief, and it is not always easy to determine which are eligible and which are not.
Conditions under which tax debt may be discharged
It is possible for filing bankruptcy to discharge state and federal tax debts, but only if certain conditions are met, including the following:
- The tax debt is at least three years old or older.
- Assessment of the tax is a minimum of 240 days old.
- Tax returns were timely and correctly filed.
- Tax debt is either income tax or, in some cases, property taxes.
Note that it’s generally not possible to discharge taxes on sales, payroll and employment. Similarly, tax penalties cannot be cleared with bankruptcy.
Bankruptcy may limit the power of the IRS
The IRS and other tax authorities have considerable power to collect balances that are past due. Among the actions that the IRS may take against people include garnishing wages, seizing property or placing liens.
Filing for Chapter 7 or Chapter 13 bankruptcy may place limits on the collection options that are available to the IRS. Upon filing bankruptcy, an automatic stay is put in place. This means that no creditor, even the IRS, can continue with collection attempts while the stay is active.
With bankruptcy, an extension to pay more recent tax debts over three to five years can be arranged while other tax debts can be erased.
Owing back taxes is stressful, but bankruptcy can be a common-sense solution that brings relief.