Background

Bankruptcy is a federal legal process that lets individuals or businesses seek relief from overwhelming debt. For income tax debts, the Bankruptcy Code and IRS rules set narrow conditions for discharge; other tax obligations (for example, payroll trust fund taxes) are typically non‑dischargeable. In my practice guiding clients through tax‑related bankruptcy cases, missing one critical date or lacking a filed return has been the single biggest reason tax debt wasn’t wiped out.

How discharge rules differ: Chapter 7 vs Chapter 13

  • Chapter 7 (liquidation): Some federal and state income taxes can be discharged if all qualifying tests are met. The IRS summarizes these rules under its “Bankruptcy and Taxes” guidance (see IRS.gov).
  • Chapter 13 (repayment plan): You keep assets and repay creditors through a court‑approved 3–5 year plan. Many tax debts are repaid through the plan; some older taxes may be partially discharged at completion.

When an income tax debt is dischargeable

To have income taxes discharged in bankruptcy (commonly cited tests):

  1. The tax return due date (including extensions) was at least three years before the bankruptcy filing.
  2. The tax return was actually filed at least two years before the bankruptcy filing.
  3. The tax was assessed by the IRS at least 240 days before filing (exceptions exist, e.g., stays or pending collection due to offer‑in‑compromise).
  4. The return was not fraudulent and you didn’t willfully evade taxes.

These tests are strict: if any fail, the tax is generally non‑dischargeable. See IRS guidance for details: https://www.irs.gov/businesses/small-businesses-self-employed/bankruptcy-and-taxes

Taxes that usually cannot be discharged

  • Trust‑fund payroll taxes (employee portion withheld by employer) and related penalties.
  • Recent income taxes that fail the timing tests above.
  • Fraudulent or willfully evaded taxes.
    Note: State tax rules vary—some states follow the federal timing tests for dischargeable income taxes, others treat state taxes differently.

What happens to tax liens and collection actions

  • A federal tax lien may survive a bankruptcy discharge. Bankruptcy can discharge the underlying tax liability, but a lien recorded against property usually remains unless the lien is avoided, paid, or released. (See FinHelp’s guide to tax liens: https://finhelp.io/glossary/understanding-tax-liens-how-theyre-placed-released-and-challenged/).
  • Filing bankruptcy triggers an automatic stay that generally halts most IRS collections while the case is active. However, certain actions (like continuing to hold a secured lien) may be permitted.

Differences for state taxes

State tax treatment differs by jurisdiction. Some states allow discharge of older income taxes under federal‑style tests while others classify certain state tax claims as priority debts payable in full through Chapter 13. Always check state tax authority rules and consult a local bankruptcy attorney.

Real‑world examples (illustrative)

  • Individual: An filer with unpaid 2017 income tax filed Chapter 7 in 2021. Because the 2017 return had been filed more than two years earlier, the assessment was older than 240 days, and there was no fraud, the tax debt qualified for discharge.
  • Small business: Payroll (trust‑fund) taxes owed for withholding were non‑dischargeable. The owner still had to repay those amounts even after completing Chapter 13.

Practical steps and professional strategies

  1. Gather records — get transcripts for the years in question from the IRS (Account Transcript and Return Transcript).
  2. Confirm dates — check return filing dates, assessment dates, and any collection holds.
  3. Consider Chapter selection — if timing tests fail for Chapter 7, Chapter 13 can provide an orderly repayment plan and stop collections.
  4. Explore alternatives — Offers in Compromise, installment agreements, or penalty abatements may be better in some cases. (See FinHelp’s comparison: https://finhelp.io/glossary/when-to-consider-bankruptcy-for-tax-debt-chapter-7-vs-chapter-13-effects-/).
  5. Work with specialists — use a bankruptcy attorney and a tax professional to run dates and model outcomes; in my experience coordinated planning reduces surprises at the 341 meeting or from the IRS.

Common misconceptions

  • Myth: All taxes can be erased in bankruptcy.
    Reality: Only certain income taxes that meet strict timing and conduct tests may be discharged; many taxes persist.
  • Myth: A discharge automatically removes tax liens.
    Reality: Liens often survive unless separately addressed.

What to expect after bankruptcy

  • If income taxes are discharged, the IRS will generally update its records, but a lien may still cloud title until released.
  • Discharged tax debts no longer appear as collectible debts, but the IRS may still offset refunds for nondischarged years.

Key resources

  • IRS: Bankruptcy and Taxes (IRS.gov) — official rules and timing tests.
  • Consumer Financial Protection Bureau: information on bankruptcy basics.

Disclaimer

This article is educational only and not legal or tax advice. Rules are nuanced and state‑specific; consult a qualified bankruptcy attorney and a tax adviser for guidance tailored to your situation.

Further reading on FinHelp

If you’re evaluating bankruptcy to address taxes, collect the IRS transcripts and consult a bankruptcy attorney experienced with tax claims before filing.