Regardless of the reason for owing back taxes, failing to pay can lead to accrued interest, making it even harder to settle. Without a means to pay, taxpayers could lose a portion of their wages or assets through liens. Those drowning in tax debt might see bankruptcy as a beacon of hope.
Bankruptcy is a legal process that gives individuals or businesses that are having difficulty repaying their debts a chance to start over financially. Depending on the type of bankruptcy filed, it can help debtors discharge or restructure their debts while protecting them from creditors.
However, not all debts, such as certain tax debts, are dischargeable in bankruptcy.
What tax debts are dischargeable in bankruptcy?
Generally, certain types of tax debts are not dischargeable in bankruptcy, such as those that are not income tax and are recent. However, if the taxpayer satisfies the requirements of bankruptcy, they may be able to eliminate or reduce a portion of their back taxes.
Chapter 7 bankruptcy
Chapter 7, also known as liquidation bankruptcy, helps debtors pay off creditors through the sale of their nonexempt assets. After the trustee liquidates the debtor’s assets, they distribute the profits to creditors. Any remaining debt is discharged.
Tax debts are dischargeable under Chapter 7 bankruptcy only if they are:
- Income tax
- At least three years old before filing for bankruptcy
- Not a result of tax evasion
Furthermore, to discharge back taxes, a taxpayer must have filed a tax return for it at least two years before filing for bankruptcy. It’s also important that the IRS has officially assessed the amount the taxpayer owes at least 240 days before the bankruptcy filing.
Chapter 13 bankruptcy
Chapter 13 bankruptcy, also known as the wage earner’s plan, allows debtors with a regular income stream to repay debts through a repayment plan. It is the preferred option for many as it allows a debtor to keep their assets and gradually repay debts over a period of three to five years.
The repayment plan also allows taxpayers to include and repay a portion of their back taxes. Additionally, there are certain types of tax debts that Chapter 13 may discharge that Chapter 7 cannot, such as:
- Debts from intentionally damaging someone’s property
- Debts incurred as a result of paying nondischargeable tax obligations
- Debts from divorce or separation proceedings
Owing a significant amount of back taxes can be overwhelming for anyone. Though bankruptcy can discharge certain debts, it does not automatically free an individual from their tax obligations. The type of back taxes owed can influence whether clearing it through bankruptcy is possible.