Overview

Bankruptcy can provide a fresh start by discharging qualifying debts, and that sometimes includes federal (and state) income taxes. However, unlike unsecured consumer debts such as credit cards, tax liabilities are subject to specific statutory tests. Meeting these tests is not automatic — timing, the type of tax, and taxpayer conduct are decisive. This article explains which tax debts may be dischargeable, the key timing rules, how liens and refunds are affected, and practical steps to take before filing.

Note: This is informational and not legal advice. Consult a bankruptcy attorney for case-specific guidance (see sources: IRS Pub. 908; U.S. Courts).

Which tax debts are potentially dischargeable?

Most commonly discharged: income taxes (individual or corporate) that meet the bankruptcy code’s timing and conduct exceptions. Generally not dischargeable:

  • Trust fund taxes (withheld payroll taxes) and recent payroll taxes
  • Tax debts based on fraud, willful evasion, or false returns
  • Penalties arising from fraud or willful evasion
  • Certain penalties and interest in some cases

Authoritative guidance: the IRS explains discharge rules in Publication 908 (Tax Guide for Bankruptcy) and the bankruptcy code sets priority and discharge exceptions (see IRS Pub. 908; 11 U.S.C. §507(a)(8)).

The four timing and conduct tests (simple checklist)

To be dischargeable in Chapter 7 or Chapter 13, an income tax debt generally must meet all four tests below:

  1. Type of tax: The debt is for income tax (federal or state), not payroll/trust-fund taxes or certain penalties. (IRS Pub. 908.)
  2. Three-year rule: The tax return was due (including extensions) at least three years before the bankruptcy filing date.
  3. Two-year rule: The tax return was actually filed at least two years before the bankruptcy filing date.
  4. 240-day assessment rule: The tax must have been assessed by the IRS at least 240 days before the bankruptcy filing (this can be tolled by certain events, like offer-in-compromise or bankruptcy stays).

If any of these conditions fail, the tax is likely nondischargeable. Fraud, false returns, or willful evasion will exclude discharge regardless of timing.

Chapter differences: Chapter 7 vs Chapter 13

  • Chapter 7 (liquidation): If the tax qualifies under the tests above it can be discharged at the end of the case. However, tax liens that attached to property before filing generally survive the bankruptcy and remain attached to the property unless the lien is avoided or the property is sold free and clear.

  • Chapter 13 (repayment plan): Non-dischargeable taxes remain payable and are usually paid through the Chapter 13 plan as unsecured or priority claims; qualifying taxes may be discharged at the completion of the plan, but Chapter 13 can be used to catch up recent taxes over the life of the plan (3–5 years).

For more on when bankruptcy can stop IRS actions and how liens behave, see our guide on When Bankruptcy Can Stop IRS Collection Actions.

How tax liens and refunds are affected

  • Liens: Filing bankruptcy does not automatically remove an IRS tax lien. A tax lien is a property right that survives discharge. If the lien secured property you own, the IRS still has a right to that property even after the underlying tax is discharged. In some cases the lien can be avoided or stripped in Chapter 13 (if certain conditions are met), or the lien will fall off when the statute of limitations on collection expires.

  • Refunds: If you are due a refund for a tax year before the bankruptcy filing, the refund may become property of the bankruptcy estate and could be used to pay creditors. Refunds for tax years after filing are the debtor’s and not estate property.

For details on liens, refunds, and priorities, consult our related article: How Bankruptcy Affects Tax Debts, Liens, and Refunds.

Practical examples (realistic scenarios)

Example 1 — Dischargeable income tax

  • Return due (with extension): April 15, 2019 (extended to Oct. 15, 2019)
  • Return filed: Oct. 1, 2019
  • Tax assessed: March 2020
  • Bankruptcy filing: Nov. 2023

Outcome: Return was due/extended date more than three years prior and filed more than two years before the bankruptcy filing; assessment is more than 240 days old. If no fraud or willful evasion, the tax may be dischargeable.

Example 2 — Non-dischargeable payroll tax

  • Employer failed to remit withheld employee taxes in 2022
  • Bankruptcy filed in 2024

Outcome: Trust fund payroll taxes are generally nondischargeable; the business and responsible officers may remain personally liable.

These examples are illustrative. Dates, extensions, and tolling events (offers in compromise, collection stays) change the analysis.

Steps to take before filing bankruptcy (practical checklist)

  1. Gather complete tax records for the last 3–6 years, including returns, extension requests, assessments (Notice of Deficiency, CP notices), and correspondence with the IRS or state tax authorities.
  2. Confirm filing dates (date return was actually filed) and whether extensions were requested and granted. The due date for the three-year rule includes extensions.
  3. Check the assessment date on IRS notices — determine whether the 240-day rule applies or whether tolling events delay assessment.
  4. Ask whether any penalties are flagged for fraud or willful evasion — such findings generally prevent discharge.
  5. Consult a bankruptcy attorney and, if needed, a tax professional. An attorney helps with strategy (Chapter 7 vs 13) and whether the tax lien can be dealt with in the case.

In our practice at FinHelp, clients who compile complete tax files before meeting an attorney avoid costly surprises about nondischargeable taxes and preserved liens.

Alternatives and complementary strategies

  • Offer in Compromise (OIC): Negotiating an OIC with the IRS can be an alternative to bankruptcy for resolving tax debt, but pending OICs can affect bankruptcy timing. See our explainer When to Consider Bankruptcy vs IRS Debt Relief Options.

  • Installment agreements: For many taxpayers, an installment agreement avoids bankruptcy and yields manageable monthly payments.

  • Innocent spouse relief and penalty abatement: These administrative remedies can reduce liability in qualifying cases; they should be explored before filing if applicable.

Common mistakes to avoid

  • Filing bankruptcy before confirming the tax return was actually filed — failing the two-year rule is common and costly.
  • Assuming all taxes are dischargeable — payroll taxes and fraud-related taxes are usually nondischargeable.
  • Ignoring liens: discharge of the tax does not always remove the lien from property.

Frequently asked questions (brief)

Q: Can I discharge state income taxes in bankruptcy?
A: Yes, state income taxes can meet the same discharge tests as federal income taxes (timing and conduct rules) and may be dischargeable if they meet the four tests.

Q: Will bankruptcy stop an IRS levy or wage garnishment?
A: The automatic stay triggered by a bankruptcy filing typically halts most collection actions, including levies and garnishments, immediately (U.S. Courts). However, special rules apply to criminal proceedings and certain tax enforcement actions.

Q: Do tax penalties go away in bankruptcy?
A: Penalties tied to nondischargeable taxes (fraud penalties, trust-fund penalties) remain. Some ordinary interest and penalty may be discharged with a qualifying income tax.

Sources and further reading

Final word

Bankruptcy can discharge certain income tax liabilities, but strict timing, return-filing, and conduct rules mean many tax debts remain enforceable. Before filing, collect your tax records, confirm due dates and filing dates, check for liens and tolling events, and consult a bankruptcy attorney. Thoughtful timing and professional guidance often determine whether a tax debt survives the bankruptcy process.

Professional disclaimer: This article is educational and not a substitute for legal or tax advice. For personalized advice, contact a licensed bankruptcy attorney and a tax professional.