Does Bankruptcy Clear Tax Debt?

Bankruptcy can clear some tax debt, but only certain types under specific conditions — it is far more restricted than for ordinary consumer debt. Whether it clears your back taxes depends on the type of tax, how old it is, when it was assessed, and whether you filed the returns. Federal income tax has the clearest rules; payroll and state taxes are different.

What is bankruptcy?

Bankruptcy is a legal process for declaring yourself unable to pay your bills. People or business owners file when they cannot pay their debts. If the court approves, an order is passed that forgives qualifying debts.

There are caveats. Your assets are valued by the court. Anything of value may be used to pay down debt. Bankruptcy stays on your credit file for up to ten years.

Chapter 7 vs. Chapter 13

Chapter 7 bankruptcy is for individuals or business owners without regular income. Some property is sold to repay part of the debts.

Chapter 13 is for individuals with regular income. You set up a payment plan over three to five years to settle debts. In exchange, you keep your assets.

Does bankruptcy clear federal tax debt?

Federal income tax debt can be discharged in bankruptcy only if all of the following apply:

• The debt is income tax. Payroll tax and other types do not qualify.
• The tax return was originally due at least three years ago.
• You filed the tax return for that debt at least two years before filing bankruptcy.
• The IRS assessed the debt more than 240 days ago.
• You filed the returns honestly, with no allegations of fraud or willful evasion.

Does bankruptcy clear state tax debt?

State income tax debt follows similar rules. Specifics vary by state. Sales tax, property tax, and other state-administered taxes typically cannot be discharged.

Tax liens and current taxes

A tax lien that attached before bankruptcy survives bankruptcy. The personal liability may be discharged, but the lien stays on property until released.

Current taxes (taxes for the year of bankruptcy) are not discharged. You still pay them.

Alternatives to bankruptcy

For most clients, bankruptcy is not the best path. We can usually negotiate a tax resolution that is faster, less destructive to credit, and addresses the debt without a court process. An Offer in Compromise, Currently Not Collectible status, a partial-pay installment agreement, and penalty abatement are all worth evaluating first.