Bankruptcy and Tax Debts: Understanding Your Options

The short answer is it depends. Bankruptcy can be effective for managing most debts, but tax debt follows different rules. Some tax debts can indeed be discharged/eliminated through the bankruptcy process, but there are those that must be paid even if you file for bankruptcy. Understanding this distinction and the potential impact of bankruptcy on the specific type of tax debt you owe is crucial to help you decide if filing for bankruptcy is the right step for you.

At the Law Offices of Wenarsky and Goldstein, LLC, we help individuals and businesses navigate the complex rules surrounding bankruptcy and how those rules can impact their unique debt situation. We can analyze your tax obligations, explain your legal options, and provide you with the information you need to make an informed decision. If you do decide to file for bankruptcy, we’re here to guide you through the legal process so you don’t have to face it alone.

Read on as we discuss the general impact of bankruptcy on different types of tax debts. Do not hesitate to contact us if you have further questions afterward.

This type of bankruptcy involves the liquidation of the debtor’s assets (excluding certain protected assets) by the bankruptcy trustee to pay off the debts owed. It eliminates many types of unsecured debt and can also clear certain tax debts if specific conditions are met.

Some of those conditions include the following:

• The tax must be an income tax debt. Payroll taxes, fraud-related tax debts, and penalties generally don’t qualify.
• The debt must be at least three years old. Recent tax debts aren’t eligible for discharge.
• The tax must have been assessed at least 240 days before filing. If the tax authorities have recently reviewed or adjusted your tax balance, this could affect your eligibility for a discharge under this requirement. 
• You must have filed the tax return at least two years before filing for bankruptcy. If you failed to file a return, the tax debt usually cannot be discharged.

If these conditions are met, Chapter 7 bankruptcy could eliminate your tax debt and provide a fresh financial start. However, it’s important to note that this type of bankruptcy typically stays on your credit report for up to ten years, which may affect your ability to obtain credit/qualify for loans in the future.

Chapter 13 Bankruptcy

This type of bankruptcy restructures debts into a manageable repayment plan over three to five years. Unlike Chapter 7, it doesn’t eliminate debts (including tax debt )outright )but allows individuals to pay off what they owe gradually while preventing creditor collection actions.

During the process, priority tax debts, such as recent income taxes, must be paid in full through the repayment plan.

Older tax debts may be discharged if they meet specific conditions similar to those prescribed for Chapter 7.

Other Options for Tax Debts That Cannot Be Discharged

From the details provided in the above sections, it is clear that the impact of bankruptcy on tax debts is limited since not all such debts can be discharged.

The obligation to pay certain tax debts such as recent income taxes (less than three years old) and payroll taxes from businesses still remains even after filing for bankruptcy. Tax debts that arise after filing the bankruptcy petition also remain payable.

If these types of tax debts apply to you, you may need to consider other options, such as IRS payment plans or offers in compromise, to make the debt more manageable. Additionally, consider seeking professional legal advice from an experienced attorney who can thoroughly evaluate your unique circumstances and devise an appropriate strategy.

Choosing the Right Bankruptcy Option for Tax Debt

Deciding between Chapter 7 and Chapter 13 depends on several factors, including:

• The type of tax debt you owe (e.g., income tax vs. payroll tax).

• How much of your tax debt qualifies for discharge under the Chapter 7 rules.

• Whether you have other debts that also need restructuring (mortgages, credit cards, medical bills).

• Your income level and ability to repay some debts over time.

Each case is different, and choosing the right path requires careful analysis. Our legal team can provide personalized advice and help you make an informed choice based on your unique situation.