Are Individual Federal Income Taxes Dischargeable in Bankruptcy?

The answer is, it depends.  Generally, federal income taxes that are due and owing are non-dischargeable in bankruptcy, meaning that even if the bankruptcy eliminates a person’s other secured or unsecured debt, the tax debt he or she has will remain.  In very limited circumstances, outstanding federal income taxes can be discharged in bankruptcy.  However, if the taxes a person owes cannot be discharged through a bankruptcy and he or she cannot pay them in full in a timely manner, the person may be able to enter into a payment plan with the IRS or else resolve the outstanding debt by way of an offer in compromise.


This article primarily focuses on tax debt and bankruptcy.  However, payment of tax debt can be easily addressed if a person enters into a payment plan with the IRS, wherein the person agrees to pay a certain monthly payment on the full balance owing.  Sometimes this option also allows a person to reduce or eliminate any penalties or interest associated therewith.  Notably, even though a person is in a payment plan, his or her future tax refunds, if any, can be automatically applied towards the existing balance.  If he or she fails to comply with the terms of the repayment plan, fees and penalties might accrue so it is important to remain current.


Another option that a person can use to manage his or her tax liabilities is an offer and compromise.  This option gives a person the option to settle his or her tax liability for less than what is owed.  The person must be able to demonstrate a hardship to qualify for this option, such as loss of job or other family hardship.  The person must submit an application and offer that should be either a lump sum offer or a payment plan.  Under this option, any future refunds are also applied to the balance of the tax debt.


The third option to address income tax liabilities may be a chapter seven bankruptcy.  Certain tax delinquencies are dischargeable in individual bankruptcy.  Individual debtors who qualify can file for bankruptcy protection under chapter 7 of the United States Bankruptcy Code in order to discharge their income tax debt.  Generally speaking, tax liabilities cannot be discharged in bankruptcy.  However, if certain criteria are met, the tax can be discharged.  In order to be dischargeable, the taxes must be related to a person’s income and the taxes cannot be related to: unfiled tax returns, tax returns filed late after two years before the bankruptcy petition was filed; taxes associated with fraudulent returns; and taxes that the debtor willfully tried to evade from the IRS.


Further various sections of the Bankruptcy Code provide guidelines and requirements for when federal income taxes may be subject to discharge.


Section 507(a)(8)(A)(i) provides that if a person’s taxes became due three years or longer from the date he or she wants to file a bankruptcy petition, he or she may be able to discharge those past-due taxes.  Since the usual date taxes become due is April 15th of each year, the debtor would just add three years to that date the taxes became due in order to determine the earliest date he or she could file the bankruptcy petition and discharge the tax debt.  However, if the debtor has applied for an extension, the extension date would be the beginning of the three years (for example, October 15th).


Section 523(a)(1)(b)(ii) provides that the tax returns related to the debt a person is trying to discharge must have been filed two years or more before filing the petition for bankruptcy relief.


If a person has previously elected an offer in compromise, the time frames above do not apply.  However simply entering into a payment plan does not prevent the tax debt from being dischargeable per the above rules.  Even if a person discharges the taxes, that does not mean that any potential tax lien would be discharged.  On occasion, after the debtor is discharged from bankruptcy, the IRS may release tax liens when the taxes have been discharged and the debtor does not have significant assets to attach a lien to.


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