Some IRS debts can be discharged in Chapter 7 bankruptcy, but only if they meet very specific conditions.
Carrying debt you cannot repay can put a dark shadow over your life, particularly when some of it is IRS debt. If the IRS is threatening you with collection actions such as wage garnishment or bank levies, you will certainly want to know whether bankruptcy can clear your IRS debt.
When Can IRS Tax Debt Be Discharged in Chapter 7?
Bankruptcy laws treat tax debt differently from debts such as medical bills and credit card debt, two of the big reasons people file for Chapter 7.
To discharge IRS debts, you must meet certain strict conditions. You will probably not be able to have all your IRS debts discharged, but you may very well be able to clear some of them.
If you have substantial IRS debt that does not meet the conditions for a Chapter 7 discharge, you may want to discuss Chapter 13 and alternative solutions outside of bankruptcy with your attorney.
The following are the conditions you must meet in order to have your bankruptcy clear IRS debt.
Income Tax Only
Only income tax debt may be discharged in a Chapter 7 bankruptcy. There are different types of IRS debt beyond income tax, including payroll taxes, trust fund taxes, and Social Security and Medicare withholding taxes.
If the debt is not for income tax, it may not be discharged. Tax penalties tied to an income tax that can be discharged may also be discharged. But that’s just the beginning.
No Fraud
You must have operated in good faith. If you have committed fraud, such as filing a fraudulent return, or if you have evaded tax laws, you cannot then turn around and discharge your IRS debt in a Chapter 7 bankruptcy.
The 3-2-240 Rule
You must meet the time requirements of what is known as the 3-2-240 Rule.
- Return Due Date (Three Years): The tax return for the debt in question must have come due at least three years before you filed for bankruptcy. This time requirement includes extensions.
- Tax Return Filing Date (Two Years): You must have filed the tax return for the debt in question at least two years before you filed for bankruptcy. Any returns the IRS filed for you are excluded.
- Assessment Date (240 Days): For your IRS debt to be eligible for discharge, the IRS must have assessed it at least 240 days before you filed for bankruptcy. Sometimes this time period may be longer, such as in the case of certain disputes, an Offer in Compromise, or other actions.
Needless to say, once you file for bankruptcy, any new tax debt you incur may not be discharged in Chapter 7.
Can Bankruptcy Clear IRS Debt if I Paid by Credit Card?
If you paid off tax debt more than three years old using a credit card and you filed a timely return, that debt may be discharged in bankruptcy, assuming all other conditions are met.
But if you paid off debt less than three years old with a credit card, sorry, you may be out of luck. This gives the credit card company valid grounds for challenging the discharge of the amount in question.
It is recommended in general that you stop using credit cards 90 days before filing for a Chapter 7 bankruptcy.
Tax Liens Are Not Dischargeable in Chapter 7 Bankruptcy
Be aware that the conditions just discussed apply to tax debt only, not to tax liens.
- IRS tax debt is the money you owe the IRS.
- A tax lien is a legal claim the IRS has against your property due to a tax debt.
This next part is a little tricky. If the IRS recorded a tax lien before you filed for bankruptcy, even though the underlying debt may be discharged by your bankruptcy, the lien will usually not be removed.
That means your bankruptcy may stop the IRS from trying to collect, but that doesn’t mean they don’t still have a valid lien. The impact is that if you want to sell that property in the future, you will need to pay off the tax lien despite your bankruptcy.
Will Filing a Chapter 7 Bankruptcy Stop IRS Collection Actions?
One of the benefits of filing for bankruptcy is that it triggers an automatic stay. An automatic stay puts an immediate stop to most collection actions, including IRS efforts, which may include collection calls, collection notices, wage garnishment, liens, bank levies, penalties, interest, and filing lawsuits on debt owed before the bankruptcy was filed.
However, an automatic stay does not remain in effect permanently. If some of your IRS debt is not discharged in bankruptcy, the IRS can restart its collection efforts against those debts. If specific interest and penalties were not dischargeable, they will keep accumulating even during the automatic stay, during which time they cannot be collected.
An automatic stay will not prevent the IRS from taking the following actions:
- Tax audits
- Issuing tax deficiency notices
- Assessing new taxes
- Sending informational notices that are not intended to collect a debt
- Demanding that you file previously unfiled tax returns
- Refiling a Notice of Federal Tax Lien
- Withholding a tax refund to pay past-due spousal or child support
Can I File Bankruptcy on Back Taxes if I Am Not Up to Date on My Tax Returns?
Though certainly it’s best to be up to date on all your tax returns before filing for bankruptcy, you should have at least the last four years filed. You will still need to file the missing returns at some point, and any unresolved issues or refunds may impact your bankruptcy case.
Can Arizona State Tax Debt Be Discharged in Bankruptcy?
Most of what was discussed here for IRS debt also applies to Arizona state tax debt, including an automatic stay being put in place when you file for bankruptcy. You must also meet the conditions for discharge of IRS tax debt previously described for state tax debt to be eligible for discharge.
See how Arizona’s community property laws affect tax debt in bankruptcy.
For more detailed information, you will want to discuss state tax debt with an experienced Arizona bankruptcy attorney.
So, Does Bankruptcy Clear IRS Debt?
As we have seen, IRS tax debt may be discharged in a Chapter 7 bankruptcy if certain conditions are met.
But is Chapter 7 your best option to discharge IRS tax debt? Can IRS debt be discharged in Chapter 7 in your case?
You will want to speak with a bankruptcy and debt relief lawyer to determine whether filing Chapter 7 or Chapter 13 is right for you, or if using alternative debt relief solutions would be better for your situation.
Contact Us at Stone Rose Law for a Free Consultation
Schedule a consultation with one of our experienced bankruptcy attorneys to discuss your options for stopping aggressive IRS and state collection actions. We will work with you and your individual circumstances to determine your best course to reduce your debt and get back on track to financial stability.
Call Stone Rose Law at (480) 739-2448 or use our online contact form to make a plan that will take you into the future.
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