Effects of Bankruptcy on Tax Liability
Many people considering or going through bankruptcy want to know what effect their filing either Chapter 7 or Chapter 13 could have on their tax liability. The simple answer is “probably very little,” but as with all legal issues, there are many nuances and details to be addressed; for this, you should consult an experienced tax attorney, bankruptcy attorney, or other professional well-versed in both bankruptcy and tax law.
What follows, however, are some basic principles of how bankruptcy and tax liability work together:
Most Tax Liability Is Not Discharged in Bankruptcy
The overriding principle regarding bankruptcy and taxes is that most tax liability will not be erased in bankruptcy no matter whether you file Chapter 7 or Chapter 13.
That said, if you are looking to discharge tax debts through bankruptcy, you will likely be better served by filing Chapter 7; there is a test (detailed below) whose requirements, if met, will allow you to discharge tax debts. Normally for Chapter 13 filings, you will still be responsible for outstanding tax debts through a repayment plan.
Some Tax Liability May Be Discharged in Bankruptcy
If you are eligible to file Chapter 7 bankruptcy, you may be able to discharge tax debts through the filing. In order to do so you must meet all of the following conditions:
- The tax debts you desire to discharge are income taxes.
- You have not committed fraud or willful tax evasion in order to avoid paying your taxes.
- You filed a tax return for the debt you’re seeking to discharge at least two years before your bankruptcy filing.
- The tax debt was originally due at least three years before your bankruptcy filing.
- You must meet the “240-day rule,” which requires that the IRS must have either not yet assessed the debt or must have assessed it within 240 days before your bankruptcy filing.
Note that if you do not meet all of the above requirements, you will still owe your tax debts at the end of your Chapter 7 bankruptcy.
Tax Liens Are Not Discharged
Even if you get your personal responsibility to pay the tax debt erased through bankruptcy, federal tax liens on property are never erased in bankruptcy; accordingly, if you want to sell the property to which the lien is attached, you would have to pay off the lien first.
As always, be sure to consult an attorney who can best advise you regarding your specific situation.