Tax Debt Discharge in Bankruptcy: Chapter 7 & 13 Explained

It is very rare to receive a complete discharge of tax debt in bankruptcy. The requirements depend on the type of bankruptcy you are filing and the circumstances surrounding the taxes you owe. First, if you are filing a Chapter 13 bankruptcy, some percentage of the taxes will have to be paid as you reorganize your finances. Only those individuals filing for a Chapter 7 liquidation will have a shot at absolute tax discharge, and the discharge is conditional on the following criteria.

Priority Debts

It is important to understand how debts are prioritized in a bankruptcy case. Any unsecured debt, such as debt on a credit card that was issued without collateral, will be the lowest priority. It is very rare for these debts to be repaid in a bankruptcy case at all. Secured debts, such as mortgages or loans against an automobile, take priority. They are repaid in the order of seniority of the liens. Finally, tax debts are the highest priority. Both federal and state taxes are priority debts that will be repaid even before mortgage debts. Therefore, getting a discharge of these debts is very challenging. It is possible, though, if the tax is not a priority tax.

Priority Taxes

Priority taxes are those that have been incurred over the past three years of filing. This three-year time frame is calculated based on the day the taxes were due to be filed and the day you officially declared bankruptcy. Further, if a tax was assessed within 240 days before you filed for bankruptcy, even if it was not filed before the bankruptcy occurred, it is a priority debt. Priority taxes are not dischargeable; you will be required to pay 100 percent of them. Regardless of your financial situation, the IRS or state government will not discharge this amount, and you will have to determine a payment schedule in order to meet the obligation.

Dischargeable Taxes

Taxes that were filed and assessed prior to three years in advance of your bankruptcy filing could be discharged in part or in full. However, it is still challenging to convince a judge to order this discharge. You must prove you will not be able to pay the taxes while maintaining an acceptable standard of living. Typically, this judgment is made only if you have undergone an emergency, such as an illness or disability, that will affect your ability to earn a living and make payments on the debt for an indeterminate amount of time in the future. 

Unpaid or Avoided Taxes

If there is evidence you made attempts to avoid, evade or fraudulently file your tax returns in the past, you will not be able to discharge the tax in any situation. For example, if you failed to file a return for five years and then declared bankruptcy, you will be on the hook for the entire tax obligation you failed to file, in full, with no hope of discharge. For this and many other reasons, it is essential to file your tax returns and make efforts to pay even if you are having financial difficulties.