Overview

Bankruptcy and tax relief overlap, but they are not the same. Bankruptcy (Chapter 7 or Chapter 13) is a federal court process that can eliminate or restructure qualifying tax debt. Tax relief options—like an Installment Agreement or an Offer in Compromise (OIC)—are negotiated directly with the IRS and may avoid the consequences of filing bankruptcy.

In my practice I’ve seen both outcomes: Chapter 7 discharge that erased years-old income taxes for a client who met the rules, and Chapter 13 plans that blended tax payments into an affordable 3–5 year repayment schedule. Which path is right depends on the tax type, the age of the debt, whether returns were filed, and whether the IRS has assessed the tax.

How bankruptcy can reduce or restructure tax debt

  • Chapter 7: Can discharge qualifying income tax debts entirely if they meet strict tests (timing, assessment, and no fraud). Discharge does not remove tax liens attached to property.
  • Chapter 13: Allows you to include tax claims in a court-approved 3–5 year repayment plan, which can reduce interest and penalties and re-schedule payments you otherwise could not make.

Key legal tests for discharging income taxes (commonly called the “tax discharge rules”):

  1. The tax return’s due date (including extensions) was at least three years before the bankruptcy filing date. (IRS guidance)
  2. The tax return was actually filed at least two years before filing bankruptcy. (IRS guidance)
  3. The tax was assessed by the IRS at least 240 days before the bankruptcy filing (with some exceptions for tolling). (IRS guidance)
  4. The return was not fraudulent and you did not willfully try to evade tax.

These rules apply mainly to federal income taxes. Many other tax obligations—like recent income taxes, trust fund (payroll) taxes, certain excise taxes, and some penalties—are generally nondischargeable. Also, a tax lien can survive and stay attached to real property even if the underlying tax debt is discharged. (Sources: IRS; U.S. Courts)

Sources and further reading from official agencies:

Chapter 7 vs Chapter 13: practical differences

  • Chapter 7 (liquidation): Faster (months); discharges qualifying unsecured debts, including some older income taxes that meet the tests. Not suitable if you have nonexempt assets you want to protect or if tax liens attach to property you must keep.
  • Chapter 13 (reorganization): 3–5 year plan; better when you want to keep property and need to repay some taxes over time. Chapter 13 can reduce monthly payments and allow the inclusion of priority tax claims in the plan.

Note: Even if income taxes are dischargeable in Chapter 7, secured tax liens generally remain unless separately addressed (for example, via lien avoidance or by paying the lien as part of a plan).

Who typically qualifies

  • Older federal income tax debts where returns were timely filed (or filed later but more than two years before filing bankruptcy) often qualify for discharge.
  • Taxpayers with unfiled returns, recent assessments, or any fraud or willful evasion generally will not qualify for discharge.

For details on eligibility and timing, see the IRS guidance on bankruptcy and taxes (link above).

Alternatives and how they compare

  • Offer in Compromise (OIC): Settles the tax for less than the full amount based on doubt as to collectibility or effective tax administration. May be an alternative if you have assets a bankruptcy would not protect. See FinHelp’s guidance on Offers in Compromise: When to Use an Offer in Compromise vs Bankruptcy: Decision Framework.
  • Installment Agreement: Monthly payments directly to the IRS; avoids bankruptcy’s public record and court costs.
  • Currently Not Collectible (CNC) status: Temporarily pauses collections if you have no ability to pay.

Compare these options with our related guide: How Bankruptcy Affects Federal and State Tax Debts.

Practical tips if you’re considering bankruptcy for tax debt

  • Gather records: filed tax returns, IRS notices, assessments, and proof of payments. Courts and trustees will review these documents.
  • Don’t assume all tax debt is dischargeable—especially payroll (trust fund) taxes and recent assessments.
  • File missing returns early if you can; some discharges require the returns to have been filed.
  • Talk to a bankruptcy attorney and a tax professional together. They can assess dischargeability, lien risks, and whether an OIC or installment plan is better.

In my experience, collecting complete tax transcripts from the IRS before filing uncovers simple fixes (e.g., a misapplied payment) that can prevent unnecessary bankruptcy filings.

Common misconceptions

  • “All tax debt can be wiped out in bankruptcy.” False—only certain older income taxes may be discharged.
  • “Filing bankruptcy automatically stops IRS liens.” False—tax liens can survive bankruptcy unless the lien is properly avoided or paid.
  • “Filing bankruptcy lets me ignore unfiled returns.” False—you generally must file required returns (commonly four years’ worth is cited) before certain discharges are possible.

Short FAQs

  • Can recent tax debt be discharged? No—recent income taxes usually fail the timing tests and are nondischargeable.
  • Will bankruptcy stop wage garnishments for tax debt? Filing bankruptcy triggers an automatic stay that usually halts garnishments immediately, but exemptions and exceptions apply.
  • Do state taxes follow federal rules? States vary. Some state income taxes are dischargeable under federal bankruptcy rules; check both state tax law and federal bankruptcy law.

Real-world example (anonymized)

A client I advised lost income and fell behind on three years of federal income taxes. Their returns were filed on time for the earlier years, and the taxes were assessed more than 240 days before filing. We filed Chapter 7 and the qualifying income taxes were discharged; however, a state tax lien on a small rental property remained and required separate negotiation.

Professional disclaimer

This article is educational and does not constitute legal or tax advice. Tax and bankruptcy outcomes depend on facts and local law; consult a qualified bankruptcy attorney and tax professional licensed in your state for advice tailored to your situation.

Authoritative sources

(Content current as of 2025.)