Several people think that wiping out tax debt by filing for bankruptcy is simple. However, truth is that while it is possible to wipe out certain types of tax debt through bankruptcy, this does not apply to all the money you owe to the Internal Revenue Service (IRS).
Since the legalities involved in bankruptcy and taxes can get complicated, you need to understand the implications that filing for bankruptcy will have on your tax debt. In most cases, seeking advice from an attorney who specializes in bankruptcy and taxes is the way to go.
The Possibility of Discharging Tax Debt
If getting your tax debts discharged is among your top priorities, filing for Chapter 7 bankruptcy might be the best way forward. This is only if you’re eligible for file for Chapter 7 and your tax debt qualifies for discharge. In Chapter 13, you typically need to repay all or part of the tax debt you owe through a repayment plan.
Discharging your debt via Chapter 7 bankruptcy is possible if:
- You only owe income taxes. Eliminating payroll taxes and penalties is not possible.
- You have not evaded taxes willfully, falsified information, or committed fraud.
- You have filed a tax return for the tax debt in question at least two years prior to filing for bankruptcy. If the IRS has filed a return on your behalf during this period, it might or might not count, depending on where you file for bankruptcy.
- The tax debt you owe has been due for a minimum of three years.
- The IRS has not assessed your income tax debt yet or it did so at least 240 days before you file for bankruptcy. There could be a possible extension to this limit in case the IRS halted collection activity in between owing to a previous filing or an offer in compromise.
Can Federal Tax Liens Qualify for Discharge?
Even if your tax debt qualifies for discharge through a Chapter 7 ruling, you would still be responsible for paying previously recorded tax liens. This holds true as long as the federal tax lien on your property has been in place since before you file for bankruptcy. In any such scenario, you are required to pay the lien off completely before you can sell and transfer the property to someone else.
Are There Other Ways to Deal With Tax Debt?
If the main reason you wish to file for bankruptcy is to get your tax debt discharged, you might benefit by exploring other alternatives first. These include getting the IRS to accept your offer in compromise, or getting it to delay the collection process.
Both options come with their share of pros and cons, which is why discussing them with an attorney is in your best interest. For instance, arriving at an installment agreement will require paying a user fee, interest, and possible penalties. However, since both options don’t have an effect on your overall finances like bankruptcy does, they might be worth considering.
What Effect Does an Automatic Stay Have on Tax Debt?
The automatic stay that comes into effect when you file for bankruptcy has an effect on IRS’ collection activity. Once in effect, the stay prevents the IRS from:
- Pursuing collection activity
- Garnishing your wage
- Seizing your property
- Issuing a new Notice of Federal Tax Lien (NFTL)
- Using your existing refund to pay off tax debt
However, the IRS can still:
- Send notices of deficiency
- Carry out audits to determine your tax liability
- Ask for a tax return (in case you haven’t filed yet)
- Re-file an NFTL
- Seize your tax refund to cover for past-due spousal or child support payments
If you have further questions about what effect bankruptcy has on tax debt, or if you wish to move forward with filing for bankruptcy, consider contacting an attorney who specializes in this realm at the earliest.