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How Does Bankruptcy Affect Federal Tax Debt?

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How Does Bankruptcy Affect Federal Tax Debt?

Written by Charles Newland on . Posted in Bankruptcy

A law book and gavel, bankruptcyWhen filing for Chapter 7 or Chapter 13 bankruptcy, federal debt may not be automatically discharged. Most tax debts are difficult to eliminate, and complicated bankruptcy laws are often difficult to understand without a bankruptcy attorney who understands federal laws.

Chapter 7 Bankruptcy

Chapter 7 bankruptcy, also referred to as “liquidation bankruptcy” or “straight bankruptcy”, allows the filer to discharge most if not all of his/her unsecured debts. These include: credit card debt; medical expenses; unpaid utility bills; wage garnishments; auto repossession; and some delinquent taxes. When Chapter 7 bankruptcy is filed through an Illinois bankruptcy attorney, a tax debt can be discharged only if the following conditions apply:

  • The tax debt must apply to federal income taxes. Property taxes, payroll taxes, tax fines and penalties, and tax liens can not be discharged in bankruptcy.
  • A tax return must have been filed for the tax debt at least two years prior to filing for bankruptcy, and the tax year of the liability must be at least three years old.
  • The tax liability must have been assessed by the IRS at least 240 days before filing for bankruptcy.
  • The filer did not attempt to evade paying taxes and did not file a fraudulent tax return.

If the tax debt is not eligible for discharge, the filer may be able to enter into an installment agreement to settle the debt. If the filer is being audited by the Internal Revenue Service(IRS), bankruptcy will not stop the audit, but it will suspend collection actions while the case is pending.

Chapter 13 Bankruptcy

Unlike Chapter 7 bankruptcy that eliminates unsecured debt, Chapter 13 bankruptcy allows the filer to pay tax debt back over time. This type of  “reorganization bankruptcy” sets up a manageable payment plan that’s typically structured over a  three to five years. To qualify, the filer must have some type of income with sufficient wages to make payments. The following conditions apply:

  • The filer will be responsible for paying priority or non-dischargeable tax debt off through a structured repayment plan agreement.
  • The non-priority, unsecured tax debt will be eligible for discharge at the end of the repayment period for priority tax debt.

When filing Chapter 13 bankruptcy through a bankruptcy attorney, the filer may also be able to save his/her home from foreclosure, eliminate a second or third mortgage, and stop harassment from creditors.

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