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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 owed by individuals. Although most income tax debt is not dischargeable in bankruptcy, some old tax debt is eligible for a bankruptcy discharge. Let’s look at back taxes in bankruptcy a little more closely to see how you can handle back taxes you cannot afford to pay.

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 get rid of 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 must have been filed at least two years before you filed your bankruptcy petition; and,
  • Assessment of the income tax debt by the IRS must have occurred at least 240 days before you filed your bankruptcy petition.

Provided your income tax debt meets the above criteria, you might be able to get rid of the 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 receive a Chapter 7 discharge. You may be able to 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 criteria for a discharge, the tax debt is a 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. Any remaining balance owed on the old tax debt is discharged (forgiven) when you complete your Chapter 13 plan.

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

Even though you are repaying 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.

In a Chapter 13 case, the tax liability can be included in your Chapter 13 plan. The type of debt and other circumstances may impact whether the debt is a secured debt, priority unsecured debt, or general unsecured debt. The category of debt determines whether the tax debt is paid in full or receive partial payment through your Chapter 13 plan.

Tax Debts in Bankruptcy Can Be Complicated

Determining whether income tax debt is dischargeable can be complicated. The changes to the Bankruptcy Code and the Federal Tax Code made it more difficult to discharge tax debt in bankruptcy. Also, determining the exact amount owed for tax debt can be complicated because of new rules regarding interest and penalties that may continue to accrue or be included in priority tax debts owed in bankruptcy.

Owing a tax debt is typically an indication that you might want to consult an experienced bankruptcy attorney before you file a Chapter 7 or Chapter 13 case. A careful analysis of the current Bankruptcy Code and tax laws is required before you proceed with a bankruptcy filing.

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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