How does bankruptcy affect different types of tax debt?
Bankruptcy can provide meaningful relief for selected tax liabilities, but it does not erase all tax obligations. Which taxes survive bankruptcy — and which can be discharged — depends on four main variables: the tax type (income, payroll, property, etc.), the bankruptcy chapter you file under, the timing of assessment and filing, and whether there was fraud or tax evasion. This article explains those rules, practical steps to protect your interests, and real-world considerations I’ve seen in practice.
Which tax debts are commonly dischargeable?
The most commonly discharged taxes in consumer bankruptcy are certain older federal and state income taxes. To be dischargeable, income taxes normally must meet all of these tests (commonly taught in bankruptcy practice and summarized by the U.S. Courts and IRS):
- The tax is for a prior year income tax (not payroll, trust-fund, or certain penalties).
- The tax return was due at least three years before the bankruptcy filing date (this includes extensions in many contexts).
- The tax return was actually filed at least two years before the bankruptcy filing date.
- The tax assessment occurred at least 240 days before the bankruptcy filing (this period can be extended by criminal proceedings or offer-in-compromise negotiations).
- There was no fraud or willful tax evasion related to the return.
These rules come from federal bankruptcy law and are summarized by the IRS and U.S. Courts (see IRS guidance on bankruptcy and discharge of tax debts and U.S. Courts resources on dischargeability) (IRS, U.S. Courts).
Note: The precise legal tests are found in 11 U.S.C. § 523 and related case law. If one of these timing or conduct tests fails, the tax debt usually survives the bankruptcy.
Which tax debts are generally NOT dischargeable?
Some tax-related liabilities are rarely — if ever — discharged in bankruptcy:
- Payroll taxes (including the employer portion and, importantly, trust‑fund taxes withheld from employees’ wages). These are given special status because employers collect them on behalf of employees.
- Trust Fund Recovery Penalties (TFRP) assessed against responsible officers for withheld payroll taxes.
- Recent income taxes that do not meet the timing rules above.
- Fraudulent tax liabilities and liabilities for willful evasion of taxes.
- Certain large tax penalties and taxes related to fraud or criminal tax prosecutions.
The IRS treats trust fund and payroll taxes differently from ordinary income taxes; bankruptcy relief for these obligations is limited (IRS; U.S. Courts).
How Chapter 7, Chapter 13, and Chapter 11 differ for tax debts
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Chapter 7 (liquidation): Nonpriority unsecured debts may be discharged after the bankruptcy process, including qualifying older income taxes that meet the discharge tests. Chapter 7 does not typically eliminate tax liens on real estate — the lien remains unless separately avoided. See the article on Discharge of Tax Debt in Bankruptcy for deeper coverage.
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Chapter 13 (repayment plan): Chapter 13 lets filers pay nondischargeable taxes over time within a 3–5 year court‑approved plan. Secured tax claims or priority taxes (like certain payroll taxes) may be payable in full in the plan. Chapter 13 can stop IRS collection actions and let you catch up while protecting property such as a home. For more on plan mechanics, see Chapter 13 Bankruptcy Explained.
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Chapter 11 (reorganization, mostly businesses): Businesses often use Chapter 11 to restructure operations and pay priority tax claims over time. Chapter 11 can be useful when restructuring payroll tax obligations and preserving business value.
In my practice, I’ve seen Chapter 13 used strategically when a homeowner needs time to pay recent tax liabilities without losing the house, while Chapter 7 is often the better path for filers whose qualifying older income taxes can be discharged quickly.
Tax liens, refunds, and the bankruptcy estate
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Tax liens: A tax lien recorded before bankruptcy typically survives a discharge of the underlying tax debt — the lien remains attached to the property unless the lien is avoided in bankruptcy or redeemed by the estate (U.S. Courts). Bankruptcy may change priority and cure defaults, but a lien’s existence is a distinct legal issue from discharge of the tax itself. See our article on How Bankruptcy Affects Tax Liens and Collection Options.
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Tax refunds: Refunds due for pre‑petition tax years can become property of the bankruptcy estate. The chapter and timing determine whether the trustee or the filer keeps the refund. Under Chapter 13, an expected refund might be part of plan calculations.
Timing and documentation — the practical gatekeepers
Documentation and precise dates matter more in tax‑bankruptcy matters than in many other areas of consumer bankruptcy. The three‑year and two‑year rules depend on filing due dates, actual filing dates, and assessment dates. Common documentation that helps the bankruptcy process:
- Copies of tax returns filed and proof of filing (IRS transcripts can confirm filing and assessment dates).
- Notices of tax assessment and collection activity from the IRS or state tax authority.
- Records showing whether the IRS assessed penalties for fraud or civil fraud investigations.
Order IRS transcripts early (IRS online account or by Form 4506-T where applicable) to confirm assessment dates; I often advise clients to secure transcripts before filing so there are no surprises at the 341 meeting of creditors (IRS).
Typical examples and outcomes (anonymized)
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Example A — Discharged income tax (Chapter 7): A filer had a 2016 federal income tax assessed and filed the return timely. In 2020 they filed Chapter 7. The debt met the three‑year and two‑year tests and there was no fraud. The trustee administered the estate and the income tax was discharged under §523.
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Example B — Payroll tax not discharged (business): A small corporation faced an unpaid trust fund balance for withheld payroll taxes. Bankruptcy alone could not discharge the trust fund portion; responsible officers remained personally liable unless specific IRS remedies applied.
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Example C — Chapter 13 catch-up: A homeowner with a recent 2-year-old tax assessment used Chapter 13 to include the tax in a 60‑month repayment plan, stopping collections and avoiding foreclosure while catching up the liability.
These are representative scenarios — each case depends on facts, dates, and the presence or absence of fraud.
Steps to take if you have tax debt and are considering bankruptcy
- Gather tax returns and IRS transcripts for the past 3–6 years.
- Get a current account transcript from the IRS to confirm assessment dates and amounts (IRS).
- Consult both a bankruptcy attorney and a tax professional (CPA or tax attorney). I routinely work with both in complex cases to align filings and timing.
- Consider alternatives before filing (installment agreements, offer-in-compromise, currently not collectible status) — bankruptcy is powerful but not always the optimal first step (CFPB).
- File only after you understand how liens, refunds, and exemptions apply in your state.
Common mistakes to avoid
- Assuming all tax debts are dischargeable: Payroll and trust‑fund taxes are major exceptions.
- Filing bankruptcy without having filed required tax returns: Unfiled returns can block dischargeability and trigger audits or adversary proceedings.
- Not checking lien records: Tax liens reduce the protective value of bankruptcy for real property.
When to consult a professional
Always consult a bankruptcy attorney experienced with tax issues and a tax professional who understands bankruptcy timing rules. In my practice, early coordination between the tax preparer and bankruptcy counsel reduces surprises at the 341 meeting and avoids missed deadlines.
Useful internal resources
- Discharge rules and explanation: Discharge of Tax Debt in Bankruptcy
- Tax liens and collection: How Bankruptcy Affects Tax Liens and Collection Options
- Chapter 13 mechanics: Chapter 13 Bankruptcy Explained
Authoritative sources and further reading
- Internal Revenue Service — bankruptcy and tax guidance (see IRS resources on bankruptcy and tax debt). (IRS: https://www.irs.gov)
- U.S. Courts — dischargeability of tax debts and bankruptcy basics. (U.S. Courts: https://www.uscourts.gov)
- Consumer Financial Protection Bureau — consumer options for dealing with tax debt and alternatives to bankruptcy. (CFPB: https://www.consumerfinance.gov)
Professional disclaimer
This article is educational and does not create an attorney‑client or taxpayer‑advisor relationship. Use this information to prepare questions for a licensed bankruptcy attorney and tax professional who can give individualized advice. Laws and procedures vary by jurisdiction and may have changed since publication.
If you want, I can summarize the discharge tests into a printable checklist or review your dates (return due date, filing date, assessment date) and show whether those taxes likely meet the discharge rules.
