Introduction

Bankruptcy is a legal tool that can provide a fresh start, but its interaction with taxes is complex. Which tax debts you can shed, whether a tax lien will stay attached to your property, and whether a tax refund is safe depend on timing, tax type, and the chapter under which you file. This article explains the key rules, practical workarounds I use in client cases, and the actions you should take before filing.

Quick roadmap

  • When income taxes are dischargeable: the ‘‘three‑year, two‑year, 240‑day’’ framework.
  • Which taxes are nondischargeable (payroll/trust fund, certain penalties, fraud).
  • Why tax liens usually survive bankruptcy and when they can be removed or subordinated.
  • How tax refunds can become property of the bankruptcy estate and how to protect them.

Authoritative sources

I use these sources routinely in case intake and legal coordination; see the IRS and U.S. Courts pages for official guidance.

How income tax debts can be discharged

Not all income tax debts are dischargeable. Courts and the Bankruptcy Code apply a practical multi‑part test that most guides summarize as the “three‑year, two‑year, 240‑day” rules plus an honesty requirement. Generally, to discharge a federal income tax in Chapter 7 or Chapter 13:

  1. The tax return was due (including extensions) at least three years before the bankruptcy filing date. (The period counts from the original due date.)
  2. The tax return was actually filed at least two years before the bankruptcy filing date. (If you filed later, the return often won’t qualify.)
  3. The tax was assessed by the IRS at least 240 days before the bankruptcy filing, unless collection was stayed by a pending offer in compromise or IRS administrative action.
  4. The return was not fraudulent and the taxpayer did not willfully evade tax.

If all four conditions are met, the underlying tax liability may be discharged. See the IRS guidance on bankruptcy and taxes for the official explanation and examples. (IRS, Bankruptcy: https://www.irs.gov/businesses/small-businesses-self-employed/bankruptcy)

Practical note from my practice: small timing differences matter. For example, a return filed late by a couple of weeks can change discharge eligibility. Before filing bankruptcy I always run a timeline for each tax year (due date, filing date, assessment date) to see which years may survive.

Tax types that are nearly always nondischargeable

Certain taxes and related liabilities are generally not dischargeable in bankruptcy:

  • Trust fund taxes (the employer’s withheld income and payroll taxes that were held in trust for employees). The government treats these as trust obligations and will pursue collection from responsible persons. See IRS pages on employment taxes.
  • Payroll taxes (the employer portion and trust fund portion) are rarely dischargeable.
  • Tax debts arising from fraud, willful evasion, or fraudulent returns.
  • Many penalties tied to nondischargeable taxes or willful misconduct.

If you owe payroll or trust fund taxes, bankruptcy will not erase the liability for responsible persons; a repayment plan or negotiating with the IRS may be the realistic route.

How bankruptcy affects tax liens

A critical distinction: bankruptcy discharge relieves your personal liability for tax debt but does not automatically remove a tax lien on property. Important points:

  • A federal tax lien recorded before your bankruptcy filing generally survives the bankruptcy and continues to encumber the property until the IRS releases the lien. The lien attaches to the property, not the personal obligation, and discharge does not erase that encumbrance.
  • The bankruptcy estate and trustee can sometimes sell property free of certain liens, but the IRS lien will usually attach to sale proceeds unless the trustee pays the IRS or the lien is dealt with in the plan.
  • In Chapter 13, you can often structure a repayment plan to pay priority tax claims over time; Chapter 13 can also allow ‘lien stripping’ in specific situations (for example, avoiding wholly unsecured junior liens under 11 U.S.C. § 506(d) or via exemption‑based avoidance under 11 U.S.C. § 522(f)).

For more detail on practical lien options (withdrawal, subordination, discharge of property), see our guide: How Bankruptcy Affects Tax Liens and Collection Options. (Internal link: https://finhelp.io/glossary/how-bankruptcy-affects-tax-liens-and-collection-options/)

Refunds, offsets, and the bankruptcy estate

A tax refund due to you at the time you file for bankruptcy usually becomes property of the bankruptcy estate under 11 U.S.C. § 541. Consequences:

  • The bankruptcy trustee can take the refund and use it to pay unsecured creditors unless you have an exemption that covers the refund amount.
  • If your return was filed but the refund was not yet issued on the filing date, it is generally estate property.
  • If the refund is for a tax year after the bankruptcy filing (post‑petition), the debtor often keeps that refund unless the plan or trustee asserts an interest.
  • The IRS also participates in refund offsets through the Treasury Offset Program for certain debts (e.g., past‑due federal payments, state debts, child support). An offset can occur outside of bankruptcy; if your refund is offset before the trustee has a chance to claim it, you may receive nothing.

If you expect a refund and are planning bankruptcy, timing the filing and discussing exemptions with counsel can sometimes protect some or all of the refund. See our article on refund timing and installment agreements: How an Installment Agreement Can Affect Future Tax Refunds and Credits (internal link: https://finhelp.io/glossary/how-an-installment-agreement-can-affect-future-tax-refunds-and-credits/).

Practical filing differences: Chapter 7 vs. Chapter 13

  • Chapter 7: The trustee gathers nonexempt property for distribution to creditors. Refunds due at filing are usually administered by the trustee. Discharge removes personal liability for qualifying taxes but not liens.
  • Chapter 13: You propose a repayment plan (usually 3–5 years). Chapter 13 is commonly used to catch up secured debts, pay priority taxes over time, and in some cases cure tax liens through the plan. Nondischargeable tax debts generally must be paid through the plan.

Common mistakes and how to avoid them

  • Filing bankruptcy before you file late tax returns: Unfiled returns commonly block discharge of the underlying tax. Prepare and file missing returns before filing bankruptcy when possible.
  • Ignoring payroll/trust fund taxes: These are personal liabilities for responsible managers; bankruptcy won’t save you.
  • Assuming discharge removes tax liens: A lien stays attached unless you take affirmative steps (pay, subordination, or lien avoidance where legally available).
  • Not claiming exemptions for refunds: In many states you have exemptions that can protect a refund if properly claimed on your bankruptcy schedules.

Strategies I use with clients

  1. Build a year‑by‑year tax timeline (due date, filing date, assessment date, payments): this determines which tax years are dischargeable.
  2. File missing returns promptly before bankruptcy if dischargeability is a goal.
  3. If payroll/trust fund taxes are involved, identify the responsible parties and evaluate payment plans or offers in compromise with the IRS.
  4. If you are expecting a refund, explore applicable exemptions and the timing of filing; sometimes delaying bankruptcy until after you receive a refund (if safe) preserves that money.
  5. Coordinate bankruptcy counsel with a tax practitioner — the overlap of tax procedure and bankruptcy law is technical and fact specific.

Additional resources and interlinks

When to seek professional help

If you have more than a simple tax return history, seek both a bankruptcy attorney and a tax professional. In my 15+ years advising clients I’ve seen small omissions create big consequences — a fired‑off return or a missed assessment date can change whether a tax is dischargeable. Use the IRS and U.S. Courts pages above for background, but get case‑specific advice.

Professional disclaimer

This article is educational and does not constitute legal or tax advice. Bankruptcy and tax outcomes depend on the precise facts and applicable law; consult a qualified bankruptcy attorney and a tax professional before making filing decisions.

References