How Bankruptcy Impacts Federal Tax Debt: Discharge vs Non-Discharge

Quick overview

Bankruptcy can erase qualifying federal income tax debts, but the rules are narrow and technical. Whether taxes disappear in a Chapter 7 liquidation or are paid through a Chapter 13 plan depends on timing, the type of tax, and whether the IRS has a tax lien. Understanding these distinctions matters—discharge does not always mean the IRS will lose collection rights against property that secures the tax debt.

This article explains the legal tests that determine dischargeability, how liens and installment agreements interact with bankruptcy, practical next steps, and common pitfalls I see in practice.

Background: why tax debt is treated differently

U.S. bankruptcy law treats tax debts differently because Congress balanced taxpayers’ need for a fresh start with protecting government revenue. The Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005 tightened many rules and clarified timing tests for tax discharge. Federal agencies also maintain guidance: the IRS explains how bankruptcy affects tax assessments, liens, and collection activity (see IRS: Bankruptcy and the IRS) and the federal courts provide the basic framework for bankruptcy procedure (see U.S. Courts: Bankruptcy).

Authoritative references (useful to review):

• IRS — Bankruptcy and the IRS: https://www.irs.gov/businesses/small-businesses-self-employed/bankruptcy-and-the-irs (IRS guidance, current as of 2025).
• U.S. Courts — Bankruptcy information: https://www.uscourts.gov/services-forms/bankruptcy (procedural overview).

The four core tests for dischargeability (the “3–2–240” rule)

For most federal income taxes to be dischargeable in bankruptcy the following must be true at the time you file:

1. The tax return was due at least 3 years before the bankruptcy filing date (for typical April 15 returns, the due date is the tax year’s filing due date, including extensions).
2. The tax return was actually filed at least 2 years before the bankruptcy filing date.
3. The tax must have been assessed by the IRS more than 240 days before you file for bankruptcy.
4. The tax must be an income tax (not trust fund or most payroll taxes), and the return cannot be fraudulent or willfully false.

These are statutory requirements rooted in the Internal Revenue Code and Bankruptcy Code as interpreted by courts after BAPCPA. See the IRS bankruptcy page for the agency’s practical checklist (IRS, 2025).

Note: the assessment date matters because in many cases the IRS assesses tax after processing a return or following an audit. If the assessment occurred within the 240-day window, the tax is generally non-dischargeable.

Common exceptions and traps

• Payroll taxes and trust fund taxes (e.g., withheld income and FICA payroll taxes a business collects from employees) are generally non-dischargeable.
• Fraud or a fraudulent tax return makes the tax non-dischargeable. Courts treat fraudulent returns and willful evasion as exceptions.
• Income tax attributable to fraud penalties or civil fraud penalties are not dischargeable.
• If you filed an offer in compromise or otherwise negotiated with the IRS, the treatment in bankruptcy changes and needs careful handling.

Liens vs. discharge: discharge doesn’t always clear liens

A discharge removes personal liability for the taxes, but it does not automatically remove a federal tax lien against property. If the IRS filed a lien before bankruptcy, that secured claim can often survive the discharge and remains attached to the property until it is paid or otherwise released. In practice I’ve seen clients eliminate personal liability for a tax debt, only to discover the lien still clouds title to a home.

• For more on liens and how they interact with bankruptcy see our guide: Bankruptcy and Tax Liens.

Chapter 7 vs Chapter 13: practical differences for tax debts

• Chapter 7 (liquidation): If taxes meet the discharge rules they may be wiped out when the court issues a discharge. Exceptions and liens still matter. Chapter 7 is generally faster, but many tax debts that fail the timing tests will survive.
• Chapter 13 (repayment plan): Chapter 13 allows you to repay certain priority debts over a 3–5 year plan. Some tax debts that are non-dischargeable in Chapter 7 might be manageable in Chapter 13 by including them in a plan—though priority tax claims must typically be paid in full. Chapter 13 may also prevent the IRS from enforcing collection while you keep up with plan payments.

See our related piece explaining the bankruptcy code chapter differences: Chapter 7 Bankruptcy Explained and Chapter 13 Bankruptcy Explained.

Interaction with IRS installment agreements and collection activity

Filing bankruptcy will usually terminate existing IRS installment agreements (they are not enforceable against the bankruptcy estate unless the court allows them), and the automatic stay halts collection while the bankruptcy case is active. But the IRS can petition the bankruptcy court to lift the stay to continue collection for secured taxes or other exceptions. If you are in an installment agreement, consider the impact of filing—sometimes renegotiating with the IRS outside bankruptcy or using a streamlined installment agreement is a better option.

Our guide on installment agreements explains when bankruptcy may be preferable versus negotiating with the IRS: How Bankruptcy Interacts with IRS Installment Agreements.

Practical checklist before you file (in my practice)

• Confirm the date your tax return was due and the date you actually filed it. Keep copies of return filing confirmation or certified mail receipts.
• Check the IRS account transcript to confirm assessment dates and amounts. You can get this from the IRS online account or request transcripts by mail — these dates drive dischargeability.
• Determine whether the IRS filed a Notice of Federal Tax Lien (NFTL) and when — a lien filing changes outcomes for secured property.
• Ask whether any taxes are trust fund or payroll taxes; those are rarely dischargeable.
• Talk to a bankruptcy attorney who understands tax law. In my practice I work with bankruptcy attorneys to run the timing and lien analysis before recommending filing.

Common mistakes I see

• Assuming all tax debt is dischargeable. Many clients expect bankruptcy to clear everything; only certain income taxes qualify.
• Relying on the calendar rather than transcripts. Dates on the IRS transcript are what courts look at, not your recollection.
• Overlooking state income tax consequences. State tax discharge rules differ; verify with a state tax professional.

Real-world examples (anonymized practice cases)

• A client owed $14,000 in federal income tax and qualified for Chapter 7 discharge because returns were timely filed more than two years before filing and the assessment was older than 240 days. The debt was discharged, but the client later paid off a small lien to clear title on a house.
• Another client had unpaid payroll taxes for a small company. Bankruptcy did not discharge those trust fund taxes; the client remained personally liable and faced potential penalties.

Steps after discharge — what to watch for

• Request a tax account transcript to confirm the balance shows zero or reflects any allowed tax.
• If a lien remains, consider a lien subordination, release, or discharge of the lien through the IRS (procedures exist but require forms and fees).
• Be cautious about filing returns late after bankruptcy—reopening a tax year or filing an amended return can sometimes change the tax picture.

Frequently asked questions (short answers)

• Will bankruptcy stop wage garnishment for taxes? Typically the automatic stay stops garnishments, but if the IRS has statutory exceptions or the stay is lifted, garnishments may resume.
• Are penalties dischargeable? Civil penalties tied directly to tax liability may be discharged if the underlying tax is dischargeable; fraud penalties generally are not.
• Does filing bankruptcy make the IRS remove a lien? No. A discharge eliminates personal liability but lien removal usually requires a separate IRS action or payment.

Resources and further reading

• IRS: Bankruptcy and the IRS — https://www.irs.gov/businesses/small-businesses-self-employed/bankruptcy-and-the-irs (official IRS guidance, 2025)
• U.S. Courts: Bankruptcy — https://www.uscourts.gov/services-forms/bankruptcy
• FinHelp related articles: Discharge of Tax Debt in Bankruptcy, Bankruptcy and Tax Liens, How Bankruptcy Interacts with IRS Installment Agreements

Professional disclaimer

This article is educational and does not constitute legal or tax advice. Tax and bankruptcy outcomes depend on specific facts — consult a qualified bankruptcy attorney and tax professional to analyze your situation before acting.

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Author credentials: CPA and CFP® with 15+ years’ experience advising clients on tax and bankruptcy matters.