When Bankruptcy Can and Cannot Eliminate Tax Debt

Overview

Bankruptcy can give taxpayers real relief — but it’s not a universal eraser. Under U.S. bankruptcy law, some federal income taxes may be discharged, while other tax debts (and many tax-related penalties and liens) survive a bankruptcy filing. The difference turns on the type of tax, when the tax was assessed, whether the required returns were filed, and whether fraud or willful evasion is involved. See the IRS guidance on how bankruptcy affects tax debts (https://www.irs.gov/businesses/small-businesses-self-employed/understanding-the-impact-of-bankruptcy-on-tax-debts) and the U.S. Courts overview of bankruptcy basics (https://www.uscourts.gov/services-forms/bankruptcy).

This article explains the legal tests used to determine dischargeability, compares Chapter 7 and Chapter 13 outcomes, lists taxes that are almost never dischargeable, describes practical steps to protect your position, and points to alternatives to bankruptcy.

The three core dischargeability tests (and why they matter)

To discharge an income tax in bankruptcy, courts normally apply three timing and filing tests measured as of your bankruptcy filing date:

1. Return due more than three years before the bankruptcy filing. The tax return’s due date (including extensions) must be at least three years prior to the date you file bankruptcy. (This is often called the “three-year rule”).
2. Tax return filed at least two years before filing. You must have filed the tax return for the year in question at least two years before you file bankruptcy (the “two-year rule”).
3. Tax assessed at least 240 days before the bankruptcy filing. The IRS assessment date is the date the IRS records the liability; it must be at least 240 days before you file. Certain events (like an offer-in-compromise pending) can toll that period; consult counsel for specific situations.

If all three tests are satisfied and the return was not fraudulent and the liability does not arise from tax evasion or willful misconduct, the income tax debt is typically eligible for discharge in Chapter 7 and may be discharged in Chapter 13 at the end of a repayment plan. These rules are explained by the IRS and interpreted via bankruptcy code and case law (see IRS guidance linked above).

Important: the tests are technical. For example, a return filed late may be considered “filed” only when the IRS receives it, and tax assessments can be delayed by audits, collections activity, or offers-in-compromise.

Taxes commonly eligible for discharge (when rules are met)

• Individual federal income taxes that meet the timing and filing requirements described above. If you filed a timely return (or the IRS has recorded the return as filed), and the assessment and filing dates are old enough, those older income taxes can be discharged.
• Associated penalties and interest that are part of the dischargeable tax debt may be discharged as well. However, some penalties tied to fraud or willful evasion are not dischargeable.

Taxes that are typically not dischargeable

• Payroll taxes and trust-fund withholding liabilities (trust fund recovery penalty): amounts the employer withheld from employees (Social Security, Medicare, federal income withholding) are rarely dischargeable; the IRS treats them as trust-fund liabilities and pursues collection aggressively.
• Recent income taxes that fail the timing tests (returns due within three years, filed within two years, or assessed within 240 days) are nondischargeable.
• Taxes resulting from fraud, false returns, or willful evasion are not dischargeable.
• Some tax penalties tied to fraud or criminal activity.

Also note: tax liens are property interests. A bankruptcy discharge may eliminate a taxpayer’s personal liability for an income tax, but liens recorded against real property often remain attached to the property until the lien is released or paid. The lien itself may survive the bankruptcy even when the underlying debt is discharged, so checking lien status after bankruptcy is essential (see https://finhelp.io/glossary/how-bankruptcy-affects-federal-tax-debt-and-liens/).

Chapter 7 vs Chapter 13 — how outcomes differ

• Chapter 7 (liquidation): If the tax debt qualifies under the timing and non-fraud tests, Chapter 7 commonly discharges the individual income tax liability. Chapter 7 triggers an automatic stay that halts most collection actions while the case proceeds. However, liens usually survive, and the IRS can still enforce liens against property unless the lien is avoided or stripped through specific legal procedures.

• Chapter 13 (repayment plan): Chapter 13 gives you a 3–5 year plan to pay certain debts. Qualifying taxes may be paid through the plan or, in some cases, discharged after completion of the plan. Chapter 13 can be useful to: (a) avoid immediate liquidation, (b) cure priority tax arrears over time, and (c) strip junior liens in limited circumstances. But nondischargeable taxes (like recent income taxes or trust-fund liabilities) must be paid in full outside of the plan.

For practical comparisons and examples, see FinHelp’s related articles on “Managing Tax Debt During Bankruptcy: What Debts Can Be Discharged?” (https://finhelp.io/glossary/managing-tax-debt-during-bankruptcy-what-debts-can-be-discharged/) and “How Bankruptcy Affects Federal Tax Debt and Liens” (https://finhelp.io/glossary/how-bankruptcy-affects-federal-tax-debt-and-liens/).

Common real-world issues and examples

• Example 1: Older, filed returns. A taxpayer owed income taxes for 2017 and 2018. Returns were filed on time and the IRS assessed the taxes in 2018 and 2019. Filing Chapter 7 in 2023 made those taxes dischargeable because they met the three-year and two-year tests, and assessments were over 240 days old.

• Example 2: Recent assessments. A taxpayer who filed in 2023 for taxes due in 2021 and was assessed in 2024 filed bankruptcy later in 2024. Because the assessment occurred less than 240 days before filing, the debt was nondischargeable.

• Example 3: Trust-fund liability. A small-business owner withheld employee income taxes but did not remit them. These trust-fund taxes are not dischargeable and the owner remained personally liable after bankruptcy.

(These examples are illustrative. Outcomes depend on specific dates and facts.)

Procedural notes: filings, adversary proceedings, and IRS positions

• The automatic stay: Filing bankruptcy immediately stays most IRS collection actions, including levies and garnishments, giving breathing room while you organize claims.
• Adversary proceedings: The IRS (or a creditor) can file an adversary proceeding to challenge the dischargeability of a tax debt (for instance, if fraud or willful evasion is alleged). Likewise, a debtor may file requests in the bankruptcy case to determine whether a debt is dischargeable.
• Proof of claim and priority claims: The IRS typically files a proof of claim in bankruptcy; taxes that qualify as priority unsecured claims are treated differently than general unsecured claims (11 U.S.C. §507(a)(8)).

Practical checklist before you file bankruptcy

1. Gather tax returns (filed and unfiled), IRS notices, transcripts, and proof of payment. 2. Confirm filing and assessment dates with IRS transcripts (get a tax transcript at https://www.irs.gov/individuals/get-transcript). 3. Determine whether any tax debt is a trust-fund or payroll liability. 4. Check for liens recorded against property (county recorder or state filing office). 5. Talk to a bankruptcy attorney who handles tax issues and, if needed, a CPA to reconstruct the timeline.

If returns are missing, filing the returns now may start the clock for the two-year rule but won’t retroactively change dates. Some debtors file missing returns before bankruptcy to improve the chance that those taxes will be treated as dischargeable, but timing and strategy depend on facts.

Alternatives and supplements to bankruptcy

Bankruptcy is one option but not always the best one for tax debt:

• Offer in Compromise (OIC): The IRS may accept less than full payment if you cannot pay and certain criteria are met (see IRS Offer in Compromise program).
• Installment agreement: Spread payments over time to resolve tax debt outside bankruptcy.
• Currently Not Collectible (CNC) status: If you lack ability to pay, the IRS may temporarily suspend collection.

Discuss these options with a tax professional — sometimes combining approaches (e.g., filing returns, negotiating with the IRS, then filing bankruptcy) produces the best result.

Practical tips and professional perspective

• File missing returns sooner rather than later. Unfiled returns almost always prevent discharge of the associated taxes.
• Keep clear records. Bankruptcies over tax debts often turn on dates and documentation.
• Don’t assume discharge eliminates liens. If you have a lien on your home, verify its status after bankruptcy and work with counsel to release or address it.
• Get professional help early. In my practice, early document gathering and targeted counsel usually saves time and avoids unnecessary adversary proceedings.

Where to find authoritative guidance

• IRS: “Understanding the Impact of Bankruptcy on Tax Debts” — https://www.irs.gov/businesses/small-businesses-self-employed/understanding-the-impact-of-bankruptcy-on-tax-debts
• U.S. Courts: “Bankruptcy Basics” — https://www.uscourts.gov/services-forms/bankruptcy
• For reader-friendly guidance and examples on FinHelp, see: “Managing Tax Debt During Bankruptcy: What Debts Can Be Discharged?” (https://finhelp.io/glossary/managing-tax-debt-during-bankruptcy-what-debts-can-be-discharged/) and “How Bankruptcy Affects Federal Tax Debt and Liens” (https://finhelp.io/glossary/how-bankruptcy-affects-federal-tax-debt-and-liens/).

Final takeaway

Bankruptcy can discharge some older, properly filed federal income-tax liabilities, but many tax-related obligations — especially recent assessments, payroll/trust-fund taxes, and fraud-based obligations — are not dischargeable. The details are highly technical; prepare your records, confirm timing with IRS transcripts, and consult a bankruptcy attorney and CPA to evaluate whether bankruptcy will accomplish your goals.

Professional disclaimer: This article is for educational purposes only and does not constitute legal, tax, or financial advice. For advice tailored to your situation, consult a licensed bankruptcy attorney and tax professional.