When you file bankruptcy the automatic stay stops the IRS (at least temporarily) from collecting on tax debts. However, not all taxes are treated the same in bankruptcy. How bankruptcy affects your taxes depends on the type of your tax debt and if you are filing a Chapter 7 or a Chapter 13 bankruptcy. Read on to learn more about how bankruptcy can help you with your tax debts.
The Automatic Stay
The moment you file bankruptcy an automatic stay is created. The automatic stay stops most creditors, including the IRS, from initiating or continuing any collection activities against you. If any creditor wishes to collect on its debts outside of bankruptcy, it must first ask the court’s permission for relief from the stay in order to proceed.
The automatic stay ends when your case is closed after a discharge, dismissed without a discharge, or if the court lifts the stay at the request of a creditor.
To learn more, see the articles in our Bankruptcy's Automatic Stay area.
Can I Wipe Out Tax Debts in Bankruptcy?
Certain tax debts are dischargeable through bankruptcy while others are not. Usually, you can discharge older income tax obligations where a return was due at least three years ago, you actually filed the return over two years ago, the IRS assessed the tax at least 240 days ago, and you did not commit any fraud or tax evasion.
There are a few other exceptions but if the tax does not meet the criteria above, it is considered a priority debt and cannot be discharged in bankruptcy.
What if My Tax Debt Is Non-Dischargeable?
A bankruptcy can still help you with your tax debts even if they cannot be wiped out. How bankruptcy affects your tax obligations depends on whether you file a Chapter 7 or Chapter 13 bankruptcy.
A Chapter 7 bankruptcy wipes out your dischargeable tax debts. However, if you have priority taxes that cannot be wiped out, Chapter 7 will only provide you with temporary relief from IRS collectors while the automatic stay is in effect. Usually, a Chapter 7 case will be completed after a few months and the IRS will be free to pursue you again.
In a Chapter 13 bankruptcy, you can pay off your priority tax debts through your repayment plan over a three to five year period. As long as you continue to make your bankruptcy payments and your case is active, the automatic stay will prohibit the IRS from collecting the tax debt outside of bankruptcy. As an added benefit, most penalties you incurred will not be considered part of the priority tax debt and you will not incur any further penalties during the bankruptcy.
To learn more about what bankruptcy can and cannot do, check out Nolo's Bankruptcy Information Center.