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  • Robert Nath

Taxes and Bankruptcy

Updated: Mar 14, 2022

Are taxes dischargeable in bankruptcy?

Potentially, yes. The starting rule is that the tax has to be one measured by “income or gross receipts.” So that includes federal income taxes, but not payroll taxes. There are many other rules that govern the discharge of taxes.

How does a Chapter 7 bankruptcy work with respect to taxes?

If your taxes are dischargeable, and you file for Chapter 7, then the bankruptcy court will normally issue a general “discharge.” This is the piece of paper that officially wipes out your “dischargeable” debts, including taxes if they are in fact dischargeable. The IRS as a creditor gets a copy of this discharge. It then assigns an agent to determine if it agrees that your taxes are in fact and law discharged. In most cases, the agency will agree. The agent then goes into the IRS’ internal Master File for your account, adjusts the liability down to zero for the tax periods at issue, and that ends the story. The IRS does NOT send you any notice, though you can ask the agency for an “ account transcript” that will show the zero balance.

When is the “means testing” law applicable with respect to taxes?

The major bankruptcy revisions that went into effect in 2005, enacted a “means testing” provision. As a result, people who can pay something toward their back debts (including taxes if these are owed) will now be required to do so. Before the new law, this was not generally the rule. Means testing applies only in cases of “primarily consumer debt.” The term “consumer debt” generally means credit card debt but includes other categories of debt as well, but NOT taxes. So the new laws will apply where you have mostly credit card debt but you also owe taxes.

Does the bankruptcy law stop the IRS from collecting taxes?

Generally, yes, at least for a while. If you file for bankruptcy protection, the IRS cannot seize assets or take a number of other enforcement actions. But it can file a notice of tax lien, issue a “statutory notice of deficiency,” or audit your tax return. When the bankruptcy is over, it can (and does) revisit your accounts to determine whether you have taxes that were not discharged, and could be paid.

How do Chapter 11 and Chapter 13 work?

These are “reorganizations,” meaning you don’t liquidate your assets. Instead you propose a plan to pay some or all of your debts over time. Some debts are “secured,” others have “priority,” and others are “unsecured.” Chapter 11 is generally for businesses, though individuals can also use it. Chapter 13 is general for wage earners.

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