Does bankruptcy clear Internal Revenue Service (IRS) debt? In some cases, the answer is yes, but most of the time you continue to owe. For most individuals, the most common type of bankruptcy is Chapter 13, but if you need your balances discharged Chapter 7 is your best option.
- 7 is for low-income people who cannot pay their obligations. Courts liquidate more under this than any other type of bankruptcy.
- 13 is for regular income earners who can pay some toward their balances. Courts restructure, so it is easier to pay. They also discharge some unsecured liabilities.
- 11 is for corporations and individuals with high amounts. Courts restructure most and only discharge some.
While this may clear your tax liabilities it may not be the best solution for you. Before you make a decision sit down with a bankruptcy lawyer and find out what all of your options are.
Does Bankruptcy Clear IRS Debt in Chapter 7
The court may discharge your IRS liabilities under Chapter 7, but You must meet all these conditions to qualify:
- Income tax only – Payroll taxes and fraud penalties don’t qualify
- You did not commit fraud or willful evasion – If you committed either of these crimes you won’t be eligible
- You filed a tax return
- The debt is at least three years old
- You pass the “240-day” rule” – The IRS assessed your debt at least 240 days before you filed for bankruptcy
You must file a tax return at least 2 years before you file bankruptcy. If you file a late return, some courts consider that the same as not filing and they won’t discharge your balance. Other courts may discharge the obligation if you meet all the other criteria.1
Can IRS Debt be discharged in Chapter 13?
The court may discharge some IRS obligations in Chapter 13. It divides tax liabilities into two categories. Courts may discharge nonpriority obligations. The qualifications are the same as the Chapter 7 qualifications listed above. The court may discharge these as general unsecured liabilities.
The second category is the priority obligations. Most taxes fall into this category, and you can’t eliminate them. However, it does allow you a way to restructure your tax liabilities and pay them over three to five years. Priority tax obligations include:
- Recent, nonpriority income taxes
- Property taxes within one year of your filing
- Withholding taxes (payroll taxes for businesses)
- Excise, employment and customs taxes
- Penalties for non-dischargeable taxes
Even if you can’t discharge your IRS obligations you can restructure them.2
Does Bankruptcy Clear IRS Debt in Chapter 11?
Courts can discharge IRS obligations in Chapter 11. This type of bankruptcy is primarily for corporations, but some individuals do file this way. Individuals who file have too much to qualify for Chapter 13. Since Chapter 11 deals with very large liabilities, the laws get complicated. Here are some things to consider about it, though:
- Courts do discharge tax obligations, but it depends on the type and your personal situation.
- It is important that you do not continue to accumulate more liabilities after you file.
- Generally, courts will discharge more balances under Chapter 13 than Chapter 11.
- The court examines your plan and decides if you can keep up with current taxes. If they decide you can’t they won’t approve your plan.
You should only apply for Chapter 11 if you don’t qualify for Chapter 13. The process is simpler, and you have a better chance of getting more liabilities discharged under Chapter 13.3
Does a Tax Lien Ever Go Away?
A tax lien is a claim the government puts on your property for not paying taxes, and it can go away. You probably face other problems before then, though. The lien only means that the government asserts it has a right to the proceeds of your property’s sale ahead of other creditors and yourself.
- The government files a tax lien after you receive a Notice and Demand for Payment.
- Next, they issue a Final Notice of Intent to Leve and a Notice to Your Right to a Hearing.
- The levy is a seizure of your property in order to pay the bill. These are not public records and aren’t submitted to the credit bureaus.
- State and federal authorities can place liens on your property in order to recover unpaid taxes.
- The statute of limitations is 10 years for most federal cases.
So yes, a tax lien can go away, but the taxing authority will probably take more serious actions before then.4
Can the IRS Seize Your 401(k)?
Private lenders cannot take money from your 401K, but the IRS can. It depends on if you are eligible to take a distribution out of your retirement plan.
- If you are, then the IRS can seize it to settle your taxes.
- If you aren’t, the IRS can’t override distribution rules.
State and local authorities cannot force you to use 401(K) funds to pay back taxes, only the federal government can.5
Final Thoughts on Does Bankruptcy Clear IRS Debt
Does bankruptcy clear IRS debt? It can take away some. It depends on how much income and the liabilities you have. If you have little or no income and can’t pay your liabilities, the court may discharge most or all of it. People who suffer a medical crisis or lose their job another way often find themselves in this situation, and they must file Chapter 7.
For most people that have a job, but they can’t pay their balances, the courts restructure most of their liabilities under Chapter 13 and discharge some, including tax obligations. For people with substantial resources and balances, the courts generally restructure most and discharge little.
Whatever your situation, if you owe back taxes bankruptcy may be the answer, but it isn’t the only possible solution. The IRS does have plans to help people behind, including an IRS payment plan or an offer in compromise. If you are thinking about filing, then consult with a local bankruptcy attorney before you make any decisions.