Managing Tax Debt During Bankruptcy: What Debts Can Be Discharged?

Quick overview

Bankruptcy can discharge some tax debts, but not all. The courts apply specific timing, filing and conduct tests before treating an income tax as dischargeable. Understanding these rules — and the difference between Chapter 7 and Chapter 13 — lets you choose the strategy most likely to remove eligible tax debt while protecting assets.

(Author’s note: In my 15+ years advising clients on tax and bankruptcy issues, careful timing and complete tax records are the two factors that most often determine whether tax debt becomes dischargeable.)

Sources consulted for this article include the IRS (see Bankruptcy guidance at irs.gov), the U.S. Courts and the Consumer Financial Protection Bureau (CFPB). This guidance is current through 2025.

How do courts decide whether a tax debt is dischargeable?

To discharge an income tax in bankruptcy, the debt generally must satisfy a set of statutory tests found in the Bankruptcy Code and interpreted by courts. Practically, there are three timing tests and several conduct-related limits you must meet:

• Age of the tax return (the “three‑year rule”): the return’s due date must be at least three years before you file for bankruptcy.
• Return filing (the “two‑year rule”): you must have filed the tax return at least two years before the bankruptcy filing date.
• Assessment timing (the “240‑day rule”): the IRS must have assessed the tax at least 240 days before you file.
• No fraud or willful tax‑evasion: tax debts caused by fraudulent returns, a willful attempt to evade tax, or certain types of criminal tax conduct are not dischargeable.

If the tax meets the timing tests and was filed honestly, the tax and related interest and non‑fraud penalties are often dischargeable in a Chapter 7 bankruptcy. See the IRS bankruptcy page and U.S. Courts materials for the legal basis (IRS; U.S. Courts).

Note: Extensions can affect the due date used in the three‑year test. Always confirm dates using your IRS account transcripts or tax return copies.

Which tax debts are typically NOT dischargeable?

Some tax liabilities are almost always non‑dischargeable:

• Trust fund or payroll “trust” taxes (e.g., withheld income and payroll taxes employers are required to hold and pay to the IRS). These are treated as fiduciary liabilities and usually survive bankruptcy.
• Recent income taxes that fail the timing tests above (i.e., returns due or filed within the look‑back windows).
• Taxes assessed within the 240‑day window before filing (with limited exceptions where the IRS was barred from collection).
• Taxes tied to fraud, false returns, or willful evasion (courts will deny discharge in these cases).

Payroll trust taxes deserve special mention: even if a small-business owner files bankruptcy, the IRS can still pursue the employer personally for withheld employment taxes. See IRS guidance on employment taxes (irs.gov).

Chapter 7 vs. Chapter 13: how each handles tax debt

• Chapter 7 (liquidation): If your income taxes meet the dischargeability tests, Chapter 7 can wipe out qualifying income tax debts and the interest and penalties tied to them. However, tax liens that attached to property before the bankruptcy generally survive the discharge and continue to encumber any real property. For more on liens, see How Bankruptcy Affects Tax Liens and Collection Options.

• Chapter 13 (repayment plan): Chapter 13 does not automatically discharge the same set of taxes as Chapter 7, but it often provides more flexible ways to manage tax debt. You repay certain priority tax debts through a 3–5‑year plan. At the end of a successful Chapter 13 plan, some unpaid, unsecured taxes (that would otherwise be nondischargeable in Chapter 7) may be discharged. Chapter 13 is frequently used to stretch payments for recent tax debts or stop aggressive collection while retaining assets. For an overview, see Chapter 13 Bankruptcy Explained.

In my practice, self‑employed clients who owe trust fund taxes usually cannot discharge those teacher‑made payroll debts under either chapter, but Chapter 13 can sometimes buy time to pay them off over a plan.

Practical checklist: what to gather and confirm before filing

1. Copies of federal and state tax returns for the prior 3–6 tax years.
2. IRS account transcripts (to confirm assessment dates and balance history).
3. Proof of filing dates (mailed return receipts, e‑file confirmations, or certified transcripts).
4. Notices of tax assessments, liens, levies, or collection notices.
5. Employer payroll records if any payroll/withholding taxes are at issue.
6. A list of all creditors and amounts — include all tax agencies.

Bring these documents to your bankruptcy attorney or a tax professional. Missing or incomplete records are a common reason courts deny discharges.

Action steps and strategy tips

• Verify dates with IRS transcripts before you file. The 240‑day assessment rule and the three‑ and two‑year timing tests are date‑sensitive; mistakes cost you eligibility.
• If you haven’t filed required returns, file them now. Courts routinely refuse discharge if required returns are missing. The IRS uses failure‑to‑file as a red flag and it can lead to nondischargeability.
• If you suspect fraud allegations or willful evasion, consult both a bankruptcy attorney and a tax attorney. These situations often require adversary proceedings and factual defenses.
• Consider Chapter 13 when you need to keep property (home, car) or when recent taxes won’t meet Chapter 7 timing tests. Chapter 13’s plan can include negotiated payments to the IRS and often stops levies and garnishments.
• Watch liens. Even when taxes are discharged, liens secured before filing generally remain attached to property unless separately avoided through bankruptcy procedures.

Common misconceptions

• “Bankruptcy wipes out all taxes.” False. Only certain taxes that meet strict timing and filing tests can be discharged.
• “Penalties and interest are always safe to discharge.” Not always. Penalties tied to non‑dischargeable taxes or fraud may survive.
• “If I file Chapter 7 I’ll automatically get rid of tax liens.” No. Discharge eliminates personal liability for the tax, but liens remain on real property unless you take additional steps.

Short case example (anonymized)

A self‑employed client owed several years of income tax for 2014–2018. Returns for 2014–2016 were filed and assessed more than 240 days before bankruptcy; the 2017 and 2018 debts were more recent. We filed Chapter 7 and were able to discharge the 2014–2016 income taxes (and related interest and penalties) because they met the timing and filing tests, while 2017–2018 remained payable. The client cleared older debt and kept essential household goods, then negotiated an installment agreement for the remaining tax years with the IRS.

This outcome is typical when taxpayers keep complete records and file returns promptly.

Frequently asked questions

• Which tax years can I discharge? Generally, older income tax years that meet the three‑year, two‑year and 240‑day tests; confirm with IRS transcripts.
• Can payroll (trust) taxes be discharged? Typically no. Trust fund and many payroll taxes survive bankruptcy.
• Will bankruptcy stop IRS collection immediately? Filing an automatic stay usually halts most collection actions (levies, garnishments), but some tax actions and collection of trust fund taxes may continue; work with counsel and the IRS.

Where to get help

• Consult a bankruptcy attorney experienced with tax issues. Bankruptcy courts and local bar associations can provide referrals.
• Work with a CPA or tax attorney to obtain transcripts and prepare any late returns before filing. The IRS can provide account transcripts online (see IRS tools at irs.gov).
• For consumer‑facing guidance, the CFPB has clear materials on bankruptcy basics (consumerfinance.gov).

For related reading on our site, see these helpful pages:

• Impact of Bankruptcy on Different Types of Tax Debt: https://finhelp.io/glossary/impact-of-bankruptcy-on-different-types-of-tax-debt/
• How Bankruptcy Affects Tax Liens and Collection Options: https://finhelp.io/glossary/how-bankruptcy-affects-tax-liens-and-collection-options/
• Chapter 13 Bankruptcy Explained: https://finhelp.io/glossary/chapter-13-bankruptcy-explained/

Professional disclaimer: This article is educational and does not constitute legal or tax advice. Bankruptcy and tax outcomes depend on specific facts and current law. Consult a qualified bankruptcy attorney and a tax professional before making decisions.

Authoritative sources: IRS bankruptcy guidance (irs.gov), U.S. Courts bankruptcy resources (uscourts.gov), and the Consumer Financial Protection Bureau (consumerfinance.gov).