Filing bankruptcy on tax debt is a complex topic that often leaves many uncertain about their options. Yes, you can file for bankruptcy on certain types of tax debts, under specific conditions.

It’s crucial to understand the distinctions between Chapter 7 and Chapter 13 bankruptcy and how they apply to income tax debts.

Chapter 7 bankruptcy can potentially discharge some tax debts, provided they meet criteria such as being at least three years old and having been assessed by the IRS 240 days prior to filing.

On the other hand, Chapter 13 bankruptcy involves a repayment plan that spans three to five years based on the debtor’s income.

Navigating the intricacies of tax debts in bankruptcy requires careful consideration. Consulting with a legal professional can help in understanding eligibility and the most effective forms of bankruptcy to address one’s financial situation.

Understanding Bankruptcy and Tax Debt

Filing for bankruptcy can help individuals discharge tax debt under certain conditions.

Understanding Bankruptcy and Tax Debt

This process involves understanding the types of bankruptcy available, the eligibility criteria, and the specific tax debts that qualify for discharge.

Types of Bankruptcy

There are two main types of bankruptcy that individuals can file for when dealing with tax debt: Chapter 7 and Chapter 13.

Chapter 7 Bankruptcy: This is often referred to as “liquidation bankruptcy.” It involves the sale of a debtor’s non-exempt assets by a bankruptcy trustee.

The proceeds are then used to pay off creditors. Under Chapter 7, certain types of tax debts, specifically income tax debts, may be discharged if they meet specific criteria.

Chapter 13 Bankruptcy: Known as “reorganization bankruptcy,” this type allows debtors to keep their property and pay off debts over a 3-5 year period.

In Chapter 13, tax debts are included in the repayment plan. Although not all tax debts can be discharged, some can be reduced and any remaining balances after the repayment period may be forgiven.

Eligibility For Discharging Tax Debt

To discharge tax debt through bankruptcy, there are strict eligibility criteria that must be met.

  • Three-Year Rule: The tax return for the debt in question must have been due at least three years before filing for bankruptcy. This includes any extensions.
  • Two-Year Rule: The tax return must have been filed at least two years before the bankruptcy petition date. Late returns still count, but the two-year period must be adhered to.
  • 240-Day Rule: The tax debt must have been assessed by the taxing authority at least 240 days before filing for bankruptcy. This period can be extended if an offer in compromise was pending during that time.
  • Fraud or Willful Evasion: The tax debt must not be associated with fraudulent returns or any willful attempt to evade taxes. Honest mistakes are permissible, but intentional evasion disqualifies the debtor.

Tax Debts Qualifying For Discharge

Certain types of tax debts can be discharged in bankruptcy, provided they meet specific criteria.

  • Income Taxes: Only federal and state income taxes can be discharged. Other types of taxes, such as payroll taxes and trust fund taxes, are not dischargeable.
  • Property Taxes: Generally, property taxes cannot be discharged in bankruptcy. They may be included in a Chapter 13 repayment plan, but they must still be paid.
  • Penalties and Interest: Penalties related to dischargeable taxes can be wiped out in both Chapter 7 and Chapter 13. Interest on these penalties may also be discharged.

For anyone considering bankruptcy to handle tax debt, consulting with a bankruptcy attorney is crucial to navigate these complex rules and ensure eligibility.

The Bankruptcy Filing Process

Filing for bankruptcy involves several critical steps, and understanding the nuances can help ensure a smoother process.

The Bankruptcy Filing Process

Key components include the actual filing, the involvement of a bankruptcy attorney, and the implications of an automatic stay on tax debt.

Filing For Bankruptcy

The process begins with gathering essential documents such as recent tax returns, bank statements, pay stubs, and credit reports.

These documents help evaluate whether Chapter 7 or Chapter 13 bankruptcy is applicable.

Next, the individual must complete a means test to determine eligibility for Chapter 7. Those ineligible may need to file for Chapter 13 instead.

The filing itself requires submitting a bankruptcy petition and schedules, listing all debts, assets, income, and expenses.

Completing pre-bankruptcy credit counseling from an approved agency is mandatory before filing. After submission, a trustee is assigned to the case to oversee proceedings and liquidation of non-exempt assets if necessary.

The Role Of A Bankruptcy Attorney

A bankruptcy attorney plays a crucial role in guiding individuals through the complex process.

They assist with gathering required documentation and ensuring all paperwork is accurately completed and submitted on time.

Additionally, attorneys offer valuable advice on the best type of bankruptcy to file based on the individual’s financial situation.

They represent the filer in court and during creditor meetings, providing a buffer against potential legal challenges or disputes.

Legal expertise is particularly important when dealing with tax debts, as the rules for discharging tax liabilities are intricate.

For instance, only income tax debts are dischargeable under Chapter 7, and specific criteria must be met for this to apply.

Rebuilding Financial Stability

Rebuilding financial stability involves creating and adhering to a new budget, focusing on essential expenses and avoiding unnecessary spending.

Opening a secured credit card is a commonly recommended first step to slowly rebuild credit. This type of card requires a security deposit that serves as the credit limit, helping to demonstrate responsible credit usage without the same degree of risk to creditors. 

Additionally, exploring financial education programs and seeking advice from a financial advisor can provide valuable insights and strategies for managing finances effectively.

Establishing an emergency fund, even a small one, can also help prevent future financial crises. Developing new financial habits will be crucial for long-term stability and avoiding the pitfalls that led to bankruptcy.