Does Bankruptcy Clear IRS Debt?
Bankruptcy is a legal process that offers individuals and companies a fresh start by discharging their unsecured debts or restructuring their debts, and enabling them to get back on their feet. However, when it comes to IRS (Internal Revenue Service) tax debts, many individuals wonder if bankruptcy can get rid of their unpaid taxes. This article will explore the options available for discharging or managing IRS tax debts through bankruptcy.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy is also known as “liquidation bankruptcy.” It involves the liquidation of assets to pay off debts. However, some assets are exempt from liquidation under federal or state law. Most unsecured debts, such as credit card debts, medical bills, and personal loans, are dischargeable under Chapter 7 bankruptcy.
When it comes to IRS tax debts, the rules are slightly different. To discharge tax debts, the following conditions must be met:
1. Three Years Rule – The tax debt must be from income taxes that were due at least three years before filing bankruptcy. If a taxpayer filed their taxes late, the three years start counting from the date the tax return was filed.
2. Two Years Rule – The taxpayer must have filed their tax returns for the tax debt at least two years before filing bankruptcy.
3. 240-Day Rule – The IRS must have assessed the tax debt at least 240 days before filing bankruptcy.
If the taxpayer meets all three rules, they can discharge their IRS tax debt just like any other unsecured debt in Chapter 7 bankruptcy. However, if they do not meet all three rules, their tax debt is not dischargeable.
Chapter 13 Bankruptcy
Chapter 13 bankruptcy is also known as “wage earner’s bankruptcy.” It involves repayment of debts over a three to five year period. Unlike Chapter 7 bankruptcy, all eligible debts must be included in the repayment plan, and no assets are liquidated.
When it comes to IRS tax debts, Chapter 13 bankruptcy provides more advantages than Chapter 7 bankruptcy. Taxpayers can include their IRS tax debt in their repayment plan, and the IRS must accept the plan. Also, interest and penalties stop accruing on the tax debt when the repayment plan is confirmed, and the taxpayer has three to five years to repay the debt.
However, to qualify for Chapter 13 bankruptcy, the taxpayer must have a regular income and meet the debt limits set by the bankruptcy court. The debt limits change periodically and depend on the state’s median income and the taxpayer’s household size.
Offer in Compromise
An offer in compromise is a negotiation with the IRS to settle a taxpayer’s tax debt for less than the total amount owed. The IRS may accept an offer in compromise if the taxpayer meets the following conditions:
1. Doubt of Collectibility – The IRS doubts that they can collect the full amount owed from the taxpayer.
2. Doubt of Liability – The taxpayer disputes the amount of the tax debt.
3. Effective Tax Administration – Paying the tax debt would create a financial hardship on the taxpayer.
An offer in compromise can be a useful option for taxpayers who cannot pay their tax debt in full, but it is a complicated process that requires careful consideration and professional help.
Consequences of Bankruptcy on IRS Tax Debt
Filing for bankruptcy can have consequences on a taxpayer’s IRS tax debt, such as:
1. Automatic Stay – Bankruptcy’s automatic stay stops all collection actions by the IRS, including liens, levies, and wage garnishments. The automatic stay remains in effect until the bankruptcy case is concluded.
2. Priority Debt – If the IRS has filed a tax lien on the taxpayer’s property, the tax debt becomes a priority debt in bankruptcy. Priority debts must be paid first before other unsecured debts in Chapter 7 bankruptcy. In Chapter 13 bankruptcy, the tax debt is included in the repayment plan.
3. Tax Liens – Bankruptcy does not discharge tax liens. However, the IRS may remove the lien from some or all of the taxpayer’s property if there is no equity in the property or the bankruptcy court allows the lien to be avoided.
4. Fraudulent Tax Returns – Bankruptcy does not discharge tax debts resulting from fraudulent tax returns. The IRS can challenge the dischargeability of the tax debt in bankruptcy court if it suspects fraud.
1. Can bankruptcy remove all my IRS tax debt?
No. Bankruptcy can only discharge IRS tax debt that meets the conditions listed earlier in the article. If the tax debt does not meet the criteria, the taxpayer has to pay the debt.
2. Will I lose all my assets in Chapter 7 bankruptcy?
No. Bankruptcy laws exempt some assets, such as a primary residence, personal property, retirement accounts, and tools of the trade, from liquidation. Consult with a bankruptcy attorney to learn more about exemptions in your state.
3. Can the IRS challenge the dischargeability of my tax debt in bankruptcy court?
Yes. The IRS can file a complaint in bankruptcy court to challenge the dischargeability of the tax debt if it suspects fraud, or if the taxpayer did not meet all the conditions for discharging tax debt.
In conclusion, bankruptcy is not a silver bullet for eliminating IRS tax debt. It can offer relief to individuals and companies burdened with overwhelming debt, but it is a complicated process that requires the guidance of an experienced bankruptcy attorney. Taxpayers should explore all options for managing their tax debt, such as an offer in compromise or an installment agreement, before considering bankruptcy.
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Bankruptcy may be used to discharge IRS tax debts, but there are several conditions that must be met. For Chapter 7 bankruptcy, the tax debt must be from income taxes due at least three years before filing; the taxpayer must have filed their tax return for the debt at least two years prior to filing bankruptcy; and the IRS must have assessed the tax debt at least 240 days before filing bankruptcy. Meanwhile, Chapter 13 bankruptcy can provide more advantages than Chapter 7 bankruptcy, as taxpayers can include their IRS tax debt in their repayment plan, and interest and penalties stop accruing when the plan is confirmed.