Tax Debt – Filing for Bankruptcy in 2021

With more and more people free-lancing and the gig economy in full swing, it’s becoming more common for people to owe the IRS for back taxes. And unpaid taxes can add up to a huge financial burden, especially on top of all your other expenses. If you’re feeling overwhelmed by your financial situation, you may be considering bankruptcy. Bankruptcy is a good way to clear unsecured debt, but what about tax debt? This post explores the question of what happens with tax debt when you file for bankruptcy.

Automatic Stay

The moment that you file for bankruptcy, whether it is Chapter 7 (most commonly) or Chapter 13, all your creditors must stop harassing you for payment. That includes the IRS. So no more threatening letters, phone calls, etc. The automatic stay also applies to property. The IRS can’t touch your more valuable assets. So no matter what stage the IRS collection effort is in, the automatic stay stops it completely. But remember, this is just a pause. And as you’ll see, knowing when to file for bankruptcy is especially important if you’re trying to eliminate unpaid taxes as well as other debts.

Conditions for Tax Debt to be Discharged

As you probably already know, IRS rules and regulations can be like an impenetrable maze. There is a regulation for pretty much everything. So, it should be no surprise that there are specific rules for bankruptcy discharge. And you should expect that the IRS will object to eliminating your tax debt if it can find any reason to do so. The main bankruptcy discharge rules have to do with time.

Income Taxes

Chapter 7 bankruptcy only discharges income tax debt. Your 1040 taxes are definitely income taxes, but other taxes aren’t. For instance, property taxes and trust fund taxes are definitely not income taxes. So the kind of taxes you owe the IRS makes all the difference. If you do owe unpaid income taxes, then you’ve cleared the first hurdle.

Taxes Filed for Last 2 Years

You have to have filed your taxes for at least the last 2 years (if you were required to file). At the time you file for bankruptcy, the IRS needs to have your tax filings for the previous 2 tax years, and that applies even if you filed those taxes on time. If you didn’t file and the IRS prepared substitute returns to determine what you owed, those do not count as taxpayer-filed returns.

Tax Debt Must Be at Least 3 Years Old

Your income tax debt must be at least three years old. And it’s crucial to remember that Tax Day is not always April 15. Some years, it could be the 16th, 17th, or even 18th. Last year (2020) it was July 15 because of the pandemic. IRS lawyers have been known to object to discharge over one or two days. So, make sure you file the petition on the correct day, or else you will have to start over.

240 Day Rule

Your tax assessment can’t be more than 8 months old, or must not have been assessed yet. If the IRS has not assessed the debt within the last 240 days, the income tax debt is not dischargeable. It’s almost impossible to tell if the IRS has assessed the debt or not, because this process is an internal accounting tool. But generally, if you’ve not received a bill which breaks down the amount due by tax years, it’s probably not assessed the debt yet.

Burr Law Helps with Complexities

At Burr Law, our professionals have years of experience dealing with bankruptcy law. We understand the complicated IRS rules around bankruptcy, and will work with them to make sure your tax debt is included in your bankruptcy. Don’t leave something this important to chance.