Tax Debt in Chapter 7 Bankruptcy

Believe it or not, many Americans are just now beginning to take a deep breath, somewhat convinced they’ve survived the recession. It’s still a cautious breath, but a collective one around the nation. Unfortunately, many are now beginning to feel the weight of financial burdens too – even though we’re officially out of the recession. One reason those burdens are feeling so heavy has to do with tax debt. What many may not be aware of, however, is that debt owed to the IRS  can indeed be discharged in a Chapter 7 bankruptcy case. Sometimes.

Tax Debt

Anyone who’s ever struggled with revolving credit, such as credit cards, knows full well the frustration of seeing the balance increase, month after month, due to late fees and interest being tacked on to even more interest. The same thing is true with debt owed to the IRS. When your budget is already overwhelming, it only worsens your overall financial outlook. While the IRS will work with you on payment plans, interest continues to run at about 58%!

Chapter 7 Bankruptcy

Chapter 7 bankruptcy is a type of bankruptcy in which most unsecured debt is discharged in three months without a wage garnishment. Because of our strong exemption laws, virtually all assets are retained as exempt when a Chapter 7 bankruptcy case is filed.

Because it feels as though a tax debt takes on a life of its own, it can quickly impact other areas of a debtor’s finances. Before long, you could be facing garnishment or a lien could be attached to your home if you owe back taxes to the federal government. In addition, your efforts to get the tax man off your back could result in letting other debts go into collections, making your overall financial picture worse. If your income remains more or less the same you may never be able to satisfy your tax debt.

Tax Debt Discharge Requirements

Federal income tax debt can be discharged in a chapter 7 if all of the following requirements are met:

  • Tax debt is for personal income taxes – taxes other than person income taxes, such as payroll taxes, cannot be discharged in bankruptcy under any circumstances.
  • The debt is at least three years old – the tax return from which the debt stems must have been due at least three years prior to filing bankruptcy. All valid extensions are also used when calculating the three year period. For example, you disclosed taxes in a tax return in 2011 for which extensions to file the return expired on October 15, 2011, you could not discharge the debt through bankruptcy until after October 15, 2014.
  • You pass the 240 day rule – the tax debt must have been assessed by the tax authority at least 240 days prior to filing bankruptcy. This time limit may be extended if there was an offer in compromise between the taxing authority and you or if you had previously filed for bankruptcy.
  • You filed a tax return – you must have actually filed a tax return for the debt in question at least two years prior to including it in a bankruptcy petition.
  • You did not commit fraud or willful evasion – the tax return on which the debt is based cannot fraudulent of frivolous and you cannot have committed an intentional act of tax evasion in the return.

If your tax debt meets all of the above-requirements you should be able to discharge the debt in a chapter 7 bankruptcy. The various time frames included in the requirements can often be confusing.

If you’re wondering about your specific situation, I invite you to contact my office. With more than thirty years as an experienced Texas bankruptcy attorney, I have helped guide countless families to financial relief via bankruptcy.

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