Can IRS Debt Be Discharged in Chapter 13?

If you owe money to the IRS, you might be considering bankruptcy as an option. Whether you can discharge your IRS debt depends on what type of tax it was and the timing.

This post is provided for general information only. Please confirm the details and circumstances of your unique situation with your tax accountant or other appropriate advisor before taking action.

What IRS taxes can you discharge in bankruptcy?

As a general rule, you can only discharge personal income taxes in bankruptcy. This typically includes income taxes for self-employment or a sole proprietorship that gets reported on your personal tax return.

Not all income taxes are dischargeable. It depends on when they were due and when you filed your tax return (more below).

Other types of IRS taxes are generally not dischargeable in Chapter 13 bankruptcy. This includes:

  • Income tax withholding from employees
  • FICA/Medicare/Social Security tax withholding from employees
  • Employer’s share of employment taxes
  • Excise taxes, custom duties, and similar taxes

If you haven’t sent taxes you withheld from employee pay to the IRS, you should familiarize yourself with the trust fund recovery penalty and be aware of the possibility of facing criminal charges.

When can you discharge income taxes?

The legal distinction between taxes you can and can’t discharge is called priority versus nonpriority.

Priority means you have to pay the tax in full and can’t include it in your Chapter 13 bankruptcy.

Nonpriority means the tax is dischargeable.

In order for your income tax to be dischargeable, you generally need to meet several criteria.

  • It’s been at least three years since your tax return was due. If you requested an extension to file, the three years starts from the extended deadline.
  • You filed your tax return at least two years before you filed for bankruptcy. So if you filed late, you generally can’t file for bankruptcy without waiting the two years.
  • The IRS assessed the tax at least 240 days (sometimes longer) before you filed for bankruptcy. This waiting period usually comes into play if the IRS adjusted your tax return resulting in you owing more.
  • You didn’t commit fraud or tax evasion. Bankruptcy isn’t a get-out-of-jail-free card when the IRS figures it out.

If you don’t meet those criteria, your income tax is generally not dischargeable.

If you owe income tax for multiple years, each year is generally looked at separately. So you may have some income taxes you can discharge and some that you can’t.

How do you prove the timing?

In some cases, you may be cutting it very close to the minimum periods to have filed your tax return or for the IRS to have assessed your tax debt.

Your first step is to get your tax transcript from the IRS. Your tax transcript shows the date of when you filed, when you made any payments, and when the IRS assessed any additional taxes.

If you disagree with the dates the IRS shows, you may be able to use other proof. For example, if you sent a payment via certified mail and the IRS didn’t properly mark it paid as of the postmark date, you may be able to use your certified mail receipt.

Can you discharge a federal tax lien in bankruptcy?

A tax lien can complicate things including if it’s for income taxes that would normally be dischargeable.

Since a tax lien is a secured debt, it can make the debt a priority debt instead of a nonpriority debt. That can make it nondischargeable instead of dischargeable.

The timing of the lien also matters. If the IRS places the lien too late, especially after you filed for bankruptcy, the lien might get ignored for bankruptcy purposes. Your debt may stay nonpriority.

Dealing with tax liens in bankruptcy can be very complex, and you should discuss this with your bankruptcy lawyer or tax attorney.

What happens to dischargeable tax debt in Chapter 13 bankruptcy?

Once you determine that tax debt is dischargeable, the rest usually gets handled according to the usual Chapter 13 bankruptcy rules.

  • You’ll make payments over three to five years
  • What you pay towards your dischargeable taxes depends on your income, expenses, and other debts
  • The IRS can’t add additional interest or penalties
  • If you successfully complete your bankruptcy payment plan, any remaining tax debt gets forgiven

There are a couple of things to keep in mind.

  • If you file or pay other taxes late during your Chapter 13 plan, you may lose the right to have your taxes discharged in bankruptcy
  • If you also have nondischargeable tax debts, you may need to pay them in full by the end of your Chapter 13 plan

Is Chapter 13 bankruptcy the best option for tax debt?

Bankruptcy is a good option in some situations but isn’t always the best option. There are several things you may want to consider when it comes to tax debt.

IRS debt doesn’t affect your credit score.

Federal tax debt, including tax liens, does not affect your credit score.

With private debts, a reason people choose bankruptcy is so they can start rebuilding their credit after completing bankruptcy.

With IRS debts, there’s generally no credit score benefit to declaring bankruptcy versus having the debt for a few more years.

The IRS has payment plans.

If you only have federal tax debt, you definitely need to look into whether an IRS installment agreement is right for you.

With an IRS installment agreement, you generally need to be able to pay the tax debt, penalties, and interest in full within 72 months. That gives you a little more time than the 36 or 60 months you have for a Chapter 13 payment plan.

While tax debt doesn’t affect your credit, bankruptcy does. Bankruptcy also comes with expensive legal fees, while IRS payment plans generally only cost a few hundred dollars.

Penalties and interest don’t stop with an installment agreement, but the math could still work out in your favor.

An installment agreement may not be available if you have large debts or certain other tax issues, but you should always ask your tax lawyer about this option.

You may not be collectible.

The IRS has a tax status you can apply for called currently not collectible status. This status means you don’t have enough income or assets to pay off your taxes.

If you request currently not collectible status, penalties and interest continue to accrue. But, you can generally stay currently not collectible status forever.

This move is most common for people past working age or with disabilities. It’s also common if you have a temporary hardship and will be able to fully pay your back taxes in the near future.

You may be able to make an offer in compromise.

An offer in compromise is when you’re able to pay something but not everything. This is commonly called settling your tax debt, but it’s different from a legal settlement, because you’re usually not questioning the amount of taxes that you owe.

When you make an offer in compromise, the IRS will want to see your income and assets. Your offer generally needs to be everything you have minus living essentials.

If the IRS accepts your offer, you won’t have to pay the rest of your tax balance.

This option can be much cheaper and faster than bankruptcy, but the rules are different. Talk to a tax attorney to see if this is a good option for you.

If you have other debts, talk to a bankruptcy lawyer about whether you should make an offer in compromise, file for bankruptcy, or both.

If you have other debts…

If you have other debts, it’s important to take those into consideration.

First, an alternative way of resolving your tax debt may not be the best option when you’re still going to have to file bankruptcy for other debts.

Second, paying the IRS before or without paying other creditors could affect your rights to file for bankruptcy.

If you have other debts, don’t do anything until you talk to a bankruptcy lawyer.

What about state taxes?

State income taxes generally follow the same rules as IRS income taxes.

State property taxes generally won’t be dischargeable. That’s because unpaid state taxes usually result in a lien on your home which make them a priority debt.

Can the IRS take my tax refund if I filed Chapter 13?

When you have tax debt, the IRS generally keeps all of your tax refunds until you pay it off.

The process changes in Chapter 13 bankruptcy. In many cases, your bankruptcy plan will say the IRS has to send your tax refund to the bankruptcy trustee.

Your tax refund is usually part of your disposable income and will go toward your bankruptcy payments.

You may be able to keep your tax refund during bankruptcy if you either 1) show that it’s for essential living expenses or 2) have a payment plan that will cover all or nearly all of your outstanding debt.

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