One of the most common misconceptions about bankruptcy is that you cannot discharge and wipe-out your IRS tax debts. We are not sure where this rumor started, but it is important to know that it is not true.
You can discharge IRS taxes, penalties, and interest using bankruptcy (from an email dated August 2018):
This is [John & Jane Doe] giving you an update. You and [our tax attorney] helped us with our bankruptcy case several years ago when we owed the IRS several million dollars… the IRS debt was mostly dismissed and we have completed our installment plan and now owe no back taxes to the IRS. This is a huge relief and has changed our lives and we want to thank you for your help in a situation that was uncertain at best.
John & Jane Doe
In addition, bankruptcy allows you to immediately stop the IRS from collection efforts and can even completely remove an existing IRS lien.
Tax Bankruptcy Discharge Rules
There are specific rules that need to be followed in order to have a tax debt discharged in your bankruptcy. The rules for discharging tax debt are as follows:
- The tax debt must be 3 years old,
- The tax return must have been filed two years before you file bankruptcy, and
- The IRS must assess the tax debt 8 months (240 days) before you file for bankruptcy.
If you meet all of the rules above, then your tax debt is generally dischargeable in Chapter 7, 11, and 13 of the bankruptcy code under 11 U.S.C. § 523. However, calculating the dates for each of the rules above can be tricky and hiring an experienced bankruptcy attorney will help ensure that appropriate deadlines are met.
It is important to note that filing fraudulent returns or willfully evading taxes could give the IRS the ability to argue that your IRS debt should not be discharged. However, merely failing to pay your taxes is insufficient to trigger this exception due to the case Dalton v. Internal Revenue Service, 77 F.3d 1297, 1301 (10th Cir. 1996).
Bankruptcy Stops IRS Collection, Levy and Federal Tax Liens
If the IRS is taking action to collect, then filing bankruptcy provides instant IRS tax debt relief. The bankruptcy code has a provision called the automatic stay under 11 U.S.C. § 362 that protects you and your assets from collection, levy, and federal tax liens the moment your case is filed.
The IRS will not be able to take your wages, liquidate your bank account, or start new collection actions once your bankruptcy case is filed.
In Chapter 7 bankruptcy, the IRS will be stopped from collecting a prior tax debt until your discharge is entered, approximately 3 months after your case is filed. This will give you time to work out a solution for handling any tax debt that may not be discharged in the bankruptcy.
Alternatively, a Chapter 13 bankruptcy will handle all of your tax debt. Your debt will either be discharged or paid completely over the 3-5 years of your Chapter 13 Plan.
Remove Existing IRS Liens with Bankruptcy
Each type of bankruptcy will result in a different outcome and treatment of federal tax liens. Let’s take a look.
Chapter 13 and Tax Liens
Chapter 13 bankruptcy allows you to pay the lien over 3-5 years, which results in the lien being removed at the end of your payment plan.
The amount you have to pay into the bankruptcy to have your lien removed is determined by the value of the equity you have in your assets at the time your case is filed. You may not have to pay the full amount of the lien in your Chapter 13 bankruptcy if your assets are valued less than lien. For bankruptcy purposes, the value of your assets is based on liquidation or garage sale value, which is often much less than buying or replacing an asset.
Chapter 7 and Tax Liens
Chapter 7 bankruptcy does not remove a tax lien. However, Chapter 7 bankruptcy can result in the tax lien being valued based on the equity in your assets (value minus loans) and keeps the IRS from attaching the lien to any property you acquire after your case is filed.
In addition, if the value of the property in your bankruptcy case securing the lien is considered low enough by the IRS, then the IRS may agree to release the lien after bankruptcy, upon your written request, or accept a payment to resolve the matter.
Take Control of Your Tax Debt with Bankruptcy
You can take back control of your life from the IRS. Bankruptcy stops the IRS and discharges taxes or forces the IRS into a 3-5 year payment plan.
If you think bankruptcy may be an option to handle your tax situation, then speaking to the bankruptcy attorneys at Cohen & Cohen as soon as possible will help to get you on track to filing bankruptcy and stopping the IRS from taking further action.
About the Author: Robertson Cohen
Rob Cohen is a Managing Partner of Cohen & Cohen, P.C., serving clients in Colorado and Wyoming. He’s a Chapter 7 Bankruptcy Panel Trustee, certified mediator, and has administered over 8,000 Chapter 7 bankruptcy estates.