Income tax debts may be eligible for discharge under chapter 7 or chapter 13 bankruptcy. In chapter 7, all allowable debts get discharged in full. Chapter 13 allows for either discharge or repayment of the tax debts via the repayment plan. Since not all tax debts can be discharged, there are a few criteria that need to be met.
• The due date for filing the tax return needs to be at least three years prior to filing bankruptcy.
• The tax return was filed at least two years ago.
• The tax assessment was at least 240 days ago. IRS assessments may arise from a self-reported balance due, an IRS determination in an audit or a proposed assessment that has become final.
• The tax return is not fraudulent.
• The petitioner is not guilty of tax evasion.
Tax debts arising from unfiled returns cannot be discharged until the petitioner files returns for any unfiled years. Before the bankruptcy is filed, the petitioner must prove that returns have been filed for the four previous years by providing them to either their trustee or to the bankruptcy court before the first meeting of creditors. If a creditor requests a copy of the return, it must be provided to them.
The IRS can object to the chapter 13 repayment plan for lack of good faith, lack of feasibility of the plan or if they feel that the plan is not in their best interest. If an objection is made, the debtor or their lawyer can negotiate with the IRS. If no agreement is reached, the bankruptcy court will step in and make a decision.
Once bankruptcy is filed, the automatic stay goes into effect. The IRS must stop all collection efforts and legal proceedings against the petitioner. The IRS is still able to audit, send notice of tax deficiency and make tax assessments.
Neither chapter 7 nor chapter 13 will wipe away any tax liens in place before the bankruptcy was filed. While bankruptcy does prevent the IRS from garnishing wages or a bank account, if a lien was in place before, it will remain in place until it is paid off and not be included in the bankruptcy estate.