How Bankruptcy Affects Tax Liens and Collection Options

How does bankruptcy affect tax liens and collection options?

Bankruptcy changes the rules for how the IRS and state tax authorities can collect, but it does not automatically erase every tax problem. Two separate concepts are at work: the personal obligation to pay a tax (which the bankruptcy court may discharge) and a tax lien (a statutory claim against property that secures unpaid taxes). The automatic stay stops many collection actions immediately, but liens often continue to attach to property until released, paid, or otherwise resolved.

Why this matters: a discharged tax debt means you no longer owe the government personally, but a surviving lien can still block sales or refinancing of real estate and other titled assets.

Sources: IRS guidance on bankruptcy and tax debt explains these distinctions and the conditions for discharge (see IRS: Bankruptcy and Tax Debt).

Key rules and timelines you must know (the “3‑2‑240” test)

For many federal income taxes to be dischargeable in bankruptcy, they generally must meet several timing and conduct tests frequently summarized as the 3‑2‑240 test:

• 3 years: The return’s due date (including extensions) must be at least three years before the bankruptcy filing date.
• 2 years: The tax return must have been filed at least two years before the bankruptcy filing (some exceptions exist for late-filed returns that are later accepted).
• 240 days: The tax must have been assessed at least 240 days before the bankruptcy filing (this period can be tolled during IRS collection actions or while an offer in compromise is pending).
• No fraud or willful tax evasion: Taxes arising from fraudulent returns or willful evasion generally cannot be discharged.

These rules are complex and fact-specific; the IRS publishes a plain-language overview at at their Bankruptcy and Tax Debt pages (IRS.gov).

Automatic stay: immediate relief, but not always permanent

When you file a bankruptcy petition, the bankruptcy code imposes an automatic stay that halts most collection activity — levies, garnishments, lawsuits, and many foreclosures — giving you breathing room to organize a repayment plan or seek discharge. The automatic stay applies to tax collection actions in many cases, but there are important exceptions:

• The IRS can ask the bankruptcy court for relief from the stay to continue collection in certain circumstances.
• Certain post‑filing collection actions tied to continuing tax liabilities may continue.
• The stay does not automatically remove a recorded tax lien; it only prevents new enforcement steps while the stay is in effect.

In my practice I’ve seen clients buy six to eight weeks of realtime relief to negotiate with the IRS or allow the bankruptcy trustee to resolve priority claims. But relief from the stay can be granted to the IRS if it shows cause.

Reference: See the Consumer Financial Protection Bureau and IRS guidance for details on stay exceptions.

Liens vs. liability: discharge doesn’t always equal lien removal

• Discharge of tax liability: If a tax debt is dischargeable under the bankruptcy tests, the court will remove your personal legal obligation to pay that portion of the tax debt.
• Tax lien: A federal tax lien is statutory (arises under the Internal Revenue Code) and generally remains attached to the taxpayer’s property until the lien is formally released or satisfied — even after discharge of the taxpayer’s personal liability.

Practical effect: After discharge you may not owe the tax personally, but the lien can still prevent the sale or refinance of real property. In many cases the IRS will remain a secured creditor to the extent of the lien.

There are limited ways a lien can be addressed in bankruptcy:

• Lien avoidance: Bankruptcy code allows avoidance of certain judicial liens that impair exemptions (11 U.S.C. §522(f)), but statutory tax liens generally are not avoidable under that provision.
• Lien stripping in Chapter 13/11: Under specific circumstances, junior liens can be stripped or crammed down in a Chapter 13 plan, but statutory tax liens present higher hurdles than ordinary mortgage or judgment liens.
• Post‑discharge lien actions: The IRS can continue to enforce an existing tax lien after discharge unless the lien is released.

For practical guidance on plan-based strategies, see our explanation of Chapter 13 bankruptcy and how bankruptcy interacts with IRS installment agreements.

Internal resources:

• Discharge of Tax Debt in Bankruptcy: https://finhelp.io/glossary/discharge-of-tax-debt-in-bankruptcy/
• How Bankruptcy Interacts with IRS Installment Agreements: https://finhelp.io/glossary/how-bankruptcy-interacts-with-irs-installment-agreements/

Chapter 7 vs. Chapter 13: different outcomes for liens and collection

• Chapter 7 (liquidation): The trustee may sell non‑exempt assets to pay secured and unsecured creditors. A tax lien will remain attached to property; if the trustee abandons the property because it’s exempt or has negative equity, you may keep the property but the lien stays in place. Dischargeable taxes under the 3‑2‑240 test can remove personal liability, but not necessarily the lien.

• Chapter 13 (reorganization): You keep property while repaying debts through a 3–5 year repayment plan. Chapter 13 can be used to: pay priority tax claims over time; include taxes in the plan to reduce immediate enforcement; and in some cases subordinate or strip unsecured portions of liens. Chapter 13 allows more control over lien‑related issues but requires strict plan compliance.

In practice I recommend Chapter 13 when a client has valuable secured property (a home or business assets) and needs a structured way to pay priority tax claims while stopping foreclosure or levy.

Payroll taxes, fraud, and other non‑dischargeable tax debts

Not all tax debts are eligible for discharge. Common non‑dischargeable categories include:

• Recent income taxes that fail the timing tests.
• Trust fund taxes and certain payroll taxes (the trust fund recovery penalties are typically non‑dischargeable).
• Taxes arising from fraud or willful evasion.

If your tax debt is non‑dischargeable, bankruptcy may still provide temporary collection relief (via the automatic stay) and a forum to negotiate — but it will not permanently eliminate the obligation.

IRS collection tools and administrative options after bankruptcy

Even during or after bankruptcy, taxpayers can pursue administrative remedies with the IRS:

• Request lien subordination, lien discharge, or lien withdrawal in qualifying situations (see IRS procedures on lien relief).
• Negotiate an Offer in Compromise (OIC) to settle tax liabilities for less than the full amount — though liens often survive unless the IRS takes specific action.
• Enter or modify an installment agreement; note that filing bankruptcy usually terminates an existing installment agreement, but Chapter 13 can incorporate payment terms.

The IRS’s Fresh Start and lien relief publications explain criteria and forms for lien subordination, discharge, and withdrawal — but these are discretionary and require full compliance with filing and payment requirements.

Practical steps checklist (what I do with clients)

1. Inventory tax debts: list tax types, assessment dates, filing dates, and amounts.
2. Run the 3‑2‑240 test for each income tax item to assess dischargeability.
3. Check for liens recorded on property via county records or the IRS public lien search.
4. Decide Chapter 7 vs. Chapter 13 based on assets, exemptions, and ability to pay.
5. If filing, disclose tax refunds and pending filings; consider delaying filing until returns are submitted if it helps meet discharge tests.
6. In Chapter 13, propose a plan that addresses priority tax claims and lien treatment; in Chapter 7, coordinate with the trustee about potential lien impacts.
7. Pursue administrative remedies with the IRS (lien subordination, OIC, lien withdrawal) as a follow‑up.

In my experience, getting the timing right on filing and ensuring returns are filed before a bankruptcy petition makes a measurable difference in whether income taxes are dischargeable.

Common mistakes and misconceptions

• Assuming bankruptcy will remove tax liens automatically: discharge cleans personal liability in eligible cases but often does not wipe out secured tax liens.
• Failing to file late tax returns before bankruptcy: unfiled returns can defeat discharge eligibility.
• Relying solely on bankruptcy for payroll or fraud‑related taxes: many of these debts are non‑dischargeable.

Frequently asked questions (short answers)

Q: Will bankruptcy remove my tax lien?
A: Generally no — liens usually survive unless the IRS releases or the lien is otherwise avoided under narrow bankruptcy rules.

Q: Can I stop the IRS from seizing my house during bankruptcy?
A: The automatic stay will halt most seizures while the stay is in place. In Chapter 13, the plan can preserve the house if you meet plan obligations.

Q: Can unpaid payroll taxes be wiped out in bankruptcy?
A: Typically not. Trust fund taxes and many payroll‑related liabilities are non‑dischargeable.

Where to get authoritative guidance

• IRS — Bankruptcy and tax debt: https://www.irs.gov/businesses/small-businesses-self-employed/bankruptcy-and-tax-debt
• Consumer Financial Protection Bureau — information on bankruptcy protections and the automatic stay

For practical site guidance, see our related articles on Discharge of Tax Debt in Bankruptcy and How Bankruptcy Interacts with IRS Installment Agreements.

Professional disclaimer

This article is educational and based on general rules current as of 2025. It is not legal or tax advice for your specific situation. In my practice as a CPA and CFP®, I recommend consulting a bankruptcy attorney or a qualified tax professional before deciding to file bankruptcy or take action on tax liens.