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One of the common reasons that people file for bankruptcy relief is back taxes. Income tax debt is one of the most common types of debts people owe. Although most income tax debt is not dischargeable in bankruptcy, certain old tax debt is eligible for a bankruptcy discharge. Let’s look at back taxes in bankruptcy a little more closely.

Is Income Tax Debt Dischargeable in Bankruptcy?

Most debts owed to the government, including personal income taxes, cannot be eliminated in bankruptcy. However, if your income tax debt meets certain criteria, you might be able to eliminate back taxes in bankruptcy.

The tax debt must meet these criteria to be eligible for a bankruptcy discharge:

  • The tax debt must be for personal income taxes;
  • The income tax debt must have become due at least three years before you filed your bankruptcy petition;
  • The tax returns associated with the income taxes were filed at least two years before you filed your bankruptcy petition; and,
  • The IRS must have assessed your income tax debt at least 240 days before you filed your bankruptcy petition.

If your income tax debt meets the above criteria, you might be able to eliminate back taxes in bankruptcy. 

How Are Personal Income Taxes Treated in Chapter 7?

If your personal income taxes meet the criteria, the Chapter 7 bankruptcy discharge eliminates the tax debt.

However, if your income tax debt is not eligible for a discharge, you continue to owe the debt even though you received a Chapter 7 discharge. You may work out a repayment plan with the IRS or state tax authority after you complete Chapter 7. 

How Are Personal Income Taxes Treated in Chapter 13?

Whether the personal income tax debt is eligible for a discharge dictates the treatment of the tax debt in Chapter 13.

If the personal income tax debt meets the discharge criteria, the tax debt falls into the category of general unsecured debt. General unsecured creditors receive a portion of the debt owed to them through the Chapter 13 plan. Therefore, the taxing authority receives a portion of the old tax debt through the Chapter 13 case. Completion of the Chapter 13 plan discharges (forgives) the remaining balance of the old tax debt.

However, if the income tax debt is not eligible for a discharge, it becomes a priority unsecured debt. Chapter 13 plans must fully pay priority unsecured debts. Your Chapter 13 plan must include enough money to pay the full amount owed to the IRS or state taxing authority. 

Even though you repay the tax debt in full, you spread out the payments over your Chapter 13 plan, making it more affordable to repay back taxes. Also, you do not typically incur additional penalties and interest on the tax debt during the Chapter 13 plan, which saves you money compared to repaying the tax debt under an IRS repayment plan.

How Are Other Taxes Treated in Chapter 7 and Chapter 13?

Other taxes owed to the IRS and state taxing authorities are generally not eligible for a discharge in Chapter 7 or Chapter 13. Tax debt that is typically non-dischargeable in bankruptcy includes, but is not limited to:

  • Employment taxes
  • Sales tax
  • Real estate property taxes (if you intended to keep the property)
  • Payroll withholding taxes
  • Overpayment of tax refunds
  • Excise taxes and custom duties
  • Tax Liens

If you file Chapter 7, the liability to pay the above taxes continues after you receive your bankruptcy discharge. You must work out an arrangement to pay the tax debt or the IRS or state taxing authority will continue collection efforts, including but not limited to wage garnishments, levies, and tax liens.

Your Chapter 13 plan can include your tax liability. The type of debt and other circumstances may impact whether the debt is a secured debt, priority unsecured debt, or general unsecured debt. The debt category determines whether the Chapter 13 plan fully or partially pays your tax debt.

Tax Debts in Bankruptcy Can Be Complicated

Determining whether income tax debt is dischargeable can be complicated. Changes to the Bankruptcy Code and the Federal Tax Code made it more difficult to discharge tax debt in bankruptcy. Also, it complicated the determination of exact amount owed for tax debt because the new rules allow interest and penalties to accrue or categorized as priority tax debts.

Owing a tax debt is an indication that you might want to consult an experienced bankruptcy attorney before you file a Chapter 7 or Chapter 13 case. Your case may warrant a careful analysis of the current Bankruptcy Code and tax laws.

Do You Owe Tax Debts You Cannot Pay?

If so, a Chapter 7 or Chapter 13 bankruptcy case might be the best way for you to handle back taxes. Ascend can help you determine if you qualify for Chapter 7 or Chapter 13 and compare your options for debt relief. If you have issues that require legal advice, we can help you locate a bankruptcy attorney near you. Let’s get started now to see how bankruptcy can help you.

Post Author: Ben Tejes

Ben Tejes is a co-founder and CEO of Ascend Finance. Before Ascend, Ben held various executive roles at personal finance companies. Ben specializes in Chapter 13 Bankruptcy, Debt Settlement, Chapter 7 Bankruptcy and debt payoff methods. In his free time, Ben enjoys spending time going on adventures with his wife and three young daughters.

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