Overview

Filing bankruptcy affects tax debt in two major ways: it can (1) temporarily stop most collection actions through the automatic stay, and (2) potentially discharge some tax liabilities if they meet strict criteria. However, not all tax debts are created equal. Understanding which taxes survive a bankruptcy filing, which can be wiped out, and how bankruptcy interacts with other IRS programs is essential to avoid surprises.

Sources: IRS Publication 908, “Bankruptcy Tax Guide” (see IRS.gov) and U.S. Courts guidance on tax debts in bankruptcy.

How the Automatic Stay Changes Collections

When you file for bankruptcy, the court issues an “automatic stay” that immediately stops many collection activities: wage garnishments, levies on bank accounts, and most phone calls from collectors. This gives you breathing room to organize claims and negotiate a plan.

Important limits:

  • The automatic stay stops new collection actions, but it doesn’t erase tax liens already attached to property; liens generally survive bankruptcy and remain on the title until paid or otherwise resolved (U.S. Courts).
  • The IRS can ask the bankruptcy court to lift the stay in limited circumstances.

If the immediate goal is to stop a levy or wage garnishment, bankruptcy can be effective. If the goal is to remove a lien or discharge a recent tax debt, additional conditions must be met.

Which Tax Debts Can Be Discharged?

Federal income tax debts may be discharged, but only if four main tests are met (commonly summarized as the 3‑year, 2‑year, 240‑day, and fraud tests):

  1. Age of the tax return (the “3‑year” rule). The tax return must have been due (including extensions) at least three years before the bankruptcy filing date. (IRS Publication 908)
  2. Return filing rule (the “2‑year” rule). The tax return must have been filed at least two years before the bankruptcy filing date.
  3. Assessment timing (the “240‑day” rule). The tax must have been assessed by the IRS at least 240 days before the bankruptcy filing, or the period for collection must not have been suspended.
  4. No fraud or willful evasion. If the IRS proves fraud or a false return, the tax is not dischargeable.

Example: If you file bankruptcy on January 1, 2025, a tax return due April 15, 2021 (for tax year 2020) would generally meet the 3‑year test. But if the return wasn’t filed until later than two years before filing, it fails the 2‑year test.

Caveats: State and local income taxes follow different rules; check state law or consult a tax attorney.

(See IRS Publication 908 for official tests.)

Chapter 7 vs Chapter 13: Practical Differences

  • Chapter 7 (liquidation): If the above tests are satisfied, qualifying federal income taxes can be discharged relatively quickly. Chapter 7 is often faster, but it won’t stop liens from surviving.

  • Chapter 13 (repayment plan): Chapter 13 lets debtors repay some taxes through a 3–5 year plan. Some taxes that would be nondischargeable in Chapter 7 may still be addressed in Chapter 13 as part of the plan’s priority treatment. In some cases, timing concerns (for example, the 240‑day rule) can be managed through a Chapter 13 plan to achieve better outcomes than Chapter 7.

Choosing the right chapter should be done with a bankruptcy attorney and a tax professional who understand how both chapters treat tax claims.

Taxes That Generally Survive Bankruptcy

  • Payroll taxes and trust‑fund taxes (including employer withholding and Trust Fund Recovery Penalty) are usually nondischargeable. The IRS aggressively enforces collection for withheld payroll taxes.
  • Recent income taxes that fail the timing rules.
  • Fraudulent or false returns, and penalties relating to fraud.
  • Certain excise and trust taxes.

Because these liabilities frequently survive bankruptcy, many filers must negotiate settlements or payment plans with the IRS after bankruptcy. See the section on offers in compromise below.

Tax Liens, Secured Claims, and Property

Bankruptcy does not automatically remove federal tax liens. A lien attaches to property and can prevent sale or refinance until the lien is satisfied or released. Options include:

  • Paying the lien in full.
  • Seeking a lien subordination, discharge, or release from the IRS (rare and fact‑specific).
  • Selling the asset and using proceeds to pay the lien or asking the bankruptcy court to strip or avoid a lien in limited circumstances (e.g., lien avoidance against wholly unsecured junior liens in Chapter 13).

If your primary goal is to sell a home or car free of an IRS lien, consult an attorney early; bankruptcy alone rarely removes tax liens without a plan to address the lien.

How Bankruptcy Affects Offers in Compromise and Other IRS Programs

Bankruptcy can affect your ability to enter certain IRS programs:

  • Offers in Compromise (OIC): The IRS may consider pending or recent bankruptcy filings when evaluating an OIC. If you are in bankruptcy or recently discharged, the IRS may delay or decline an OIC until the bankruptcy estate is closed and tax claims are resolved. See FinHelp article on When Bankruptcy Affects Your Ability to Enter an Offer in Compromise for details and timing considerations.

  • Installment Agreements: After bankruptcy, you can often negotiate a fresh installment agreement with the IRS for nondischargeable taxes; bankruptcy may improve your negotiating position by temporarily stopping collections.

  • Penalty abatement and innocent spouse relief: These administrative remedies remain available but require separate applications and documentation.

When considering non‑bankruptcy relief, coordinate timing: some tax resolution tools are less effective or unavailable while a bankruptcy case is open.

Practical Steps to Take Before Filing

  1. Get all unfiled returns current. A timely‑filed return is a precondition for discharge on many income taxes. Prepare returns even if you can’t pay the tax due. (IRS guidance)
  2. Document dates of assessment and notices from the IRS so you can test timing rules.
  3. Consult both a bankruptcy attorney and a CPA (or enrolled agent) before filing. In my practice I’ve seen clients lose discharge eligibility by filing before meeting the 2‑year or 240‑day thresholds.
  4. If a levy or garnishment is imminent, an emergency bankruptcy filing can stop collection actions—but evaluate longer‑term effects first.

After Bankruptcy: Managing Remaining Tax Debt

If taxes survive the bankruptcy, you still have options:

  • Installment Agreement: The IRS offers streamlined and long‑term agreements based on your ability to pay.
  • Offer in Compromise: Possible if you can show doubt as to collectibility or extraordinary circumstances, but the IRS will weigh recent bankruptcy filings carefully.
  • Currently Not Collectible (CNC) status: If payments would create extreme hardship, the IRS can temporarily suspend collection.

Coordinate these options with a tax pro—post‑bankruptcy timing and documentation matter.

Real‑World Examples (Lessons Learned)

  • Jane: After filing Chapter 7, she avoided repayment of older income taxes that met the timing tests, giving her a fresh start. She remained responsible for recent taxes and payroll obligations the IRS could still collect.

  • Mark: Because he hadn’t filed returns for the most recent year, his bankruptcy did not discharge those recent taxes. Filing the missing return before bankruptcy—when possible—can change outcomes.

These examples highlight a recurring theme: accurate filing history and assessment dates often determine the bankruptcy result more than the dollar amount owed.

Common Mistakes to Avoid

  • Filing bankruptcy without filing missing tax returns.
  • Assuming payroll taxes will be discharged.
  • Believing bankruptcy automatically removes tax liens.
  • Entering an Offer in Compromise while your bankruptcy case is open without legal advice.

Quick FAQ (Short Answers)

Q: Will bankruptcy stop the IRS from collecting taxes?
A: It stops many collection actions temporarily (automatic stay), but nondischargeable taxes and liens often survive.

Q: Can I discharge recent tax debt in Chapter 13?
A: Chapter 13 can reorganize and pay some tax debts through a plan, but discharge still depends on timing rules and the plan’s terms.

Q: What about state income taxes?
A: State tax rules vary; always check state law or consult a tax professional.

Professional Tip

In my practice, the most effective strategy is to map every tax year: due date, filing date, assessment date, and collection activity. This calendar often reveals whether bankruptcy will help, or if alternatives like an installment agreement or OIC make more sense.

Sources and Further Reading

  • IRS Publication 908, Bankruptcy Tax Guide (see IRS.gov)
  • IRS, “Understanding Tax Debt” (IRS.gov)
  • U.S. Courts, information on “Bankruptcy Basics” and tax debt treatment

For a deeper look at how bankruptcy timing affects offers in compromise, see our article: When Bankruptcy Affects Your Ability to Enter an Offer in Compromise. To learn when bankruptcy can pause or stop IRS actions, read: When Bankruptcy Can Stop IRS Collection Actions. For a general introduction to bankruptcy and tax debt, see: Can Bankruptcy Help With Tax Debt? What You Need to Know.

Disclaimer

This article is educational only and does not constitute legal or tax advice. Bankruptcy and tax law are fact‑specific; consult a qualified bankruptcy attorney and a tax professional to analyze your situation.