Can IRS Debt be Discharged in Chapter 7?
If you owe money to the Internal Revenue Service (IRS) for past due taxes, you may be wondering if Chapter 7 bankruptcy can help you eliminate or reduce this debt. While some debts can be discharged in Chapter 7, not all debts are eligible, and some require special conditions or procedures. IRS debt is one of the more complex and contested types of debt in bankruptcy, but it is possible to discharge or reduce it under certain circumstances. In this article, we will explain how IRS debt is treated in Chapter 7 bankruptcy, what factors may affect your eligibility, and what alternatives you may consider.
I. What is Chapter 7 bankruptcy?
Before we dive into the specifics of IRS debt, let’s briefly review what Chapter 7 bankruptcy is and how it works. Chapter 7 is a type of bankruptcy that allows individuals or businesses to liquidate their non-exempt assets and use the proceeds to pay off their debts. In exchange for surrendering their assets, the debtors receive a discharge of most or all of their unsecured debts, such as credit card debt, medical bills, personal loans, and some tax debts. However, not all debts are dischargeable, and some assets may be exempt from liquidation.
To file for Chapter 7 bankruptcy, you must pass a means test, which compares your income to the median income for your state and household size. If your income is below the median, you may qualify for Chapter 7 automatically, but if it is above the median, you may need to pass a second test that evaluates your disposable income. If you pass both tests or meet other exceptions, you can proceed with filing your bankruptcy petition, which includes a list of your creditors, assets, income, expenses, and other financial disclosures.
Once you file your petition, an automatic stay goes into effect, which stops most collection efforts against you, including wage garnishments, bank levies, lawsuits, and phone calls from creditors. Instead, your case will be assigned to a bankruptcy trustee, who will review your documents, conduct a meeting of creditors, and oversee the liquidation of your assets, if any. You may be able to keep some or all of your assets, such as your primary residence, vehicles, retirement accounts, and personal belongings, if they are exempt under federal or state law.
After the trustee liquidates your non-exempt assets, you will receive a discharge order, which relieves you from liability for most of your debts. However, some debts are not dischargeable, such as most taxes, student loans, child support, alimony, and debts incurred fraudulently or maliciously. Additionally, some debts may be deemed nondischargeable if the creditor objects to their dischargeability and proves certain grounds, such as willful or malicious injury, embezzlement, or breach of fiduciary duty.
II. What is IRS debt?
IRS debt refers to the taxes that you owe to the federal government for federal income tax, employment tax, excise tax, and other taxes regulated by the Internal Revenue Code. If you fail to pay your taxes on time or in full, the IRS may take several actions to collect the debt from you, such as sending you notices, filing a tax lien, seizing your assets, and assessing penalties and interest. Unlike most creditors, the IRS has broad enforcement powers and can take collection actions without obtaining a court judgment first.
IRS debt also differs from other types of debt in its treatment in bankruptcy. While most unsecured debts can be discharged or reduced in Chapter 7 bankruptcy, tax debts require special conditions and calculations to determine their eligibility for discharge. This is because the bankruptcy code provides several exceptions and limitations on when and how tax debts can be discharged.
III. How is IRS debt treated in Chapter 7 bankruptcy?
To determine if your IRS debt can be discharged in Chapter 7 bankruptcy, you need to answer several questions:
1. What kind of taxes do you owe?
The dischargeability of your tax debt depends on the type of taxes you owe and when they were due. Generally, only income taxes can be discharged in Chapter 7 bankruptcy, while other types of taxes, such as payroll taxes and trust fund taxes, are given priority status and cannot be discharged. Income taxes are further divided into three categories:
a) Priority taxes: These are income taxes that were due within three years before you filed for bankruptcy, including any extensions. Priority taxes have a higher priority for payment than most other debts, but they may be dischargeable if you meet the following criteria:
– You filed a tax return for the applicable year at least two years before filing for bankruptcy;
– The tax assessment was made at least 240 days before filing for bankruptcy;
– You did not commit willful tax evasion or fraud.
b) Non-priority taxes: These are income taxes that were due more than three years before you filed for bankruptcy, or for which you did not file a tax return on time, or for which the IRS filed a substitute return on your behalf. Non-priority taxes may be dischargeable regardless of when the assessment was made or when you filed the return.
c) Recent taxes: These are income taxes that were due within the last year before you filed for bankruptcy, including any extensions. Recent taxes are not eligible for discharge, but they are included in your debts and must be paid in full.
2. Have you filed your tax returns?
To qualify for the discharge of income taxes, you must have filed your tax returns for the corresponding years at least two years before filing for bankruptcy. If you have not filed your tax returns, the IRS may take the position that your tax debt is non-dischargeable or that you are not entitled to any discharge at all. Therefore, it is important to file your tax returns as soon as possible, even if you cannot pay the full amount of taxes owed.
3. Have you obtained an Offer in Compromise or a Collection Due Process hearing?
An Offer in Compromise (OIC) is an agreement between you and the IRS to settle your tax debt for less than the full amount. An OIC may be granted if you can prove that you are unable to pay the full debt, or that paying it would cause undue hardship. If you obtain an OIC before filing for bankruptcy, you may be able to discharge the remaining balance of the debt that is not covered by the offer.
A Collection Due Process (CDP) hearing is a proceeding that allows you to challenge the IRS’s collection actions and propose alternative payment arrangements, such as an installment agreement or an offer in compromise. If you have requested a CDP hearing and the IRS has not issued a final determination before you file for bankruptcy, your tax debt may not be eligible for discharge until the CDP process is exhausted.
4. Do you owe any penalties or interest?
Penalties and interest are not considered taxes per se, but they are part of the overall tax debt that you owe to the IRS. Generally, penalties and interest are treated as non-priority unsecured debts that can be discharged in Chapter 7 bankruptcy, if they meet the applicable rules for discharge. However, some tax penalties and interest may be exempted from discharge if they are based on fraud, willful evasion, or other legal grounds.
5. Do you have any assets that are subject to a tax lien?
A tax lien is a legal claim that the IRS can attach to your property, such as real estate, vehicles, or bank accounts, if you owe taxes and fail to pay or resolve them. A tax lien can impair your ability to sell, refinance, or use the affected property, as well as require you to pay the taxes before you can remove the lien. In some cases, a tax lien may survive the discharge of your personal liability for the tax debt, and you may need a separate order from the bankruptcy court to remove or avoid the lien on your property.
IV. What are some alternatives to discharging IRS debt in Chapter 7?
If you cannot discharge your IRS debt in Chapter 7 bankruptcy or if you want to explore other options, here are some alternatives to consider:
1. Chapter 13 bankruptcy: Chapter 13 is a type of bankruptcy that allows you to reorganize your debts and repay them over a period of three to five years. Chapter 13 may be a better option than Chapter 7 if you have non-exempt assets that you want to keep or if your IRS debt is not entirely dischargeable. Under Chapter 13, you can pay off your priority tax debts in full, while potentially reducing or discharging your non-priority tax debts based on your disposable income and other factors.
2. Installment agreement: An installment agreement is a payment plan that allows you to pay off your tax debt over time, usually within six years or less. You may be eligible for an installment agreement if you owe less than $50,000 in combined tax, interest, and penalties, and can afford to make regular payments. An installment agreement may be more flexible than a Chapter 13 plan, but it may also be more expensive due to the continued accrual of interest and penalties.
3. Offer in Compromise: As mentioned earlier, an OIC is a settlement option that may allow you to reduce your tax debt if you qualify. However, an OIC is not guaranteed, and it requires a thorough evaluation of your financial situation and tax history. You may want to consult with a tax professional or seek free assistance from the IRS’s Taxpayer Advocate Service to see if an OIC is feasible for you.
4. Collection appeals: If you disagree with the IRS’s collection actions, such as a levy or a lien, you may have the right to appeal them administratively or judicially. The appeals process can delay or suspend the collection efforts while you make your case. You may also want to explore Innocent Spouse Relief, which may relieve you of the joint and several liability for tax debt incurred by your spouse, in some situations.
Q: Can I discharge all of my tax debt in Chapter 7 bankruptcy?
A: No, not all tax debt is dischargeable in Chapter 7. Generally, only income taxes that meet the criteria for priority or non-priority taxes may be eligible for discharge, subject to other conditions and exceptions.
Q: Do I need to file all of my tax returns before filing for bankruptcy?
A: Yes, you must file all of your tax returns for the years you owe taxes at least two years before filing for bankruptcy to qualify for the discharge of income taxes. If you are missing some returns, you may be able to obtain copies from the IRS or file them late.
Q: Can the IRS continue to collect my tax debt if I file for bankruptcy?
A: No, most collection actions by the IRS must stop once you file for bankruptcy due to the automatic stay. However, the IRS may ask the bankruptcy court to lift the stay or exceptions may apply.
Q: Can I discharge tax penalties and interest in Chapter 7 bankruptcy?
A: In most cases, tax penalties and interest are treated as non-priority unsecured debts that may be dischargeable in Chapter 7 bankruptcy, subject to the applicable rules and exceptions.
Q: What happens to my IRS debt if I file for Chapter 13 bankruptcy?
A: Under Chapter 13 bankruptcy, you must pay off your priority tax debts in full over the life of your plan, which can be up to five years. Your non-priority tax debts may be reduced or discharged based on your disposable income and other factors.
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Chapter 7 bankruptcy can discharge or reduce IRS debt under certain circumstances. However, not all taxes are dischargeable and some require special conditions or procedures. IRS debt is one of the more complex and contested types of debt in bankruptcy, but it is possible to discharge or reduce it. The type of taxes owed, whether you have filed your tax returns, whether you have obtained an Offer in Compromise or a Collection Due Process hearing, whether you owe any penalties or interest, and whether you have any assets that are subject to a tax lien are all factors that can affect your eligibility for discharging IRS debt in Chapter 7 bankruptcy.