Background

Bankruptcy exists to give honest debtors a fresh start while treating creditors fairly. For tax debts, bankruptcy law and the Internal Revenue Service intersect in complex ways: some older income-tax liabilities can be discharged under Chapters 7 or 13, while other tax types and priority claims survive. The U.S. Courts and the IRS provide the legal framework and practical rules that determine what is dischargeable (U.S. Courts; IRS).

How it works — the core rules

Discharging tax debt in bankruptcy generally requires meeting several tests under federal law. In practice the IRS and bankruptcy courts apply these widely cited timing and conduct rules:

  • Age of the tax return (the “three‑year rule”): the tax return must have been due (including extensions) at least three years before you file bankruptcy.
  • Timely filing (the “two‑year rule”): the tax return itself must have been filed at least two years before the bankruptcy filing date.
  • Assessment timing (the “240‑day rule”): the tax must have been assessed at least 240 days before filing (exceptions exist for stays, offers in compromise, and certain administrative delays).
  • No fraud or willful tax evasion: returns that were fraudulent or where the filer willfully attempted to evade tax are not dischargeable.

These are summarized and explained by the IRS (see “Bankruptcy and the IRS”) and the U.S. Courts (see “Bankruptcy basics”). If a debt fails any one of these tests it is usually non‑dischargeable.

Chapter 7 vs Chapter 13 — practical differences

  • Chapter 7: If you qualify for Chapter 7 and the taxes meet the discharge tests above, the eligible income taxes can be wiped out as part of the discharge. Note: tax liens generally survive a Chapter 7 discharge — the IRS may still have a lien on property even after the underlying tax is discharged.
  • Chapter 13: You keep property but pay creditors through a 3–5 year plan. Priority tax claims and recent taxes are often repaid in full or given special treatment; older qualifying tax debts may be allowed as unsecured claims and can be discharged at the end of the plan.

Important tax types that are usually non‑dischargeable

  • Payroll (trust fund) taxes and penalties tied to payroll withholding (often enforced under 26 U.S.C. §6672) are typically nondischargeable. (IRS: Trust Fund Recovery Penalty)
  • Taxes resulting from fraudulent returns or those where there was willful evasion are not dischargeable.
  • Civil and criminal tax penalties for tax crimes, and many trust‑fund and employment taxes, survive bankruptcy.

How bankruptcy interacts with IRS collections

  • Automatic stay: Filing bankruptcy usually triggers an automatic stay that temporarily halts most IRS collection actions (levies, garnishments) while the case is active. However, the stay does not forgive the debt.
  • Liens: A discharge eliminates personal liability for eligible taxes but does not automatically remove a valid federal tax lien against property — you may need to request lien relief or seek lien discharge separately.

Eligibility — checklist to review before filing

  • Were the tax returns filed on time (including extensions)?
  • Were the returns filed more than two years before filing bankruptcy?
  • Was the tax assessed more than 240 days before filing?
  • Is the tax an income tax (not trust‑fund or payroll)?
  • Is there any allegation of fraud or willful evasion?

If you answer “no” to one or more items, that tax liability is likely not dischargeable.

Real‑world examples (illustrative)

  • Older income taxes: I once advised a client whose properly filed 2015 and 2016 income taxes had been assessed years earlier. Because those returns met the timing tests and there was no fraud, the Chapter 7 discharge eliminated the unpaid income tax balances. The client still faced a tax lien on a rental property and needed a separate process to clear title.
  • Business owner with payroll taxes: A small business owner who fell behind on payroll withholding discovered that those trust‑fund taxes could not be eliminated in bankruptcy; they remained collection priorities and required direct negotiation with the IRS.

Professional tips and strategies

  • Get professional help early: A bankruptcy attorney and a tax professional can review the timing rules, inspect IRS transcripts, and advise whether filing will produce a discharge or simply delay collection.
  • Pull IRS transcripts: Ask the IRS for account transcripts to confirm assessment dates and enforcement actions before filing.
  • Consider alternatives: Offers in compromise, installment agreements, or currently not collectible status may be better than bankruptcy in some cases — see our guide on When to Use an Offer in Compromise vs Bankruptcy: Decision Framework.
  • Remember liens and collateral: If the IRS has recorded a tax lien, bankruptcy discharge of the underlying liability usually won’t clear the lien automatically. Address title and lien release separately.

Common mistakes and misconceptions

  • “All tax debt is dischargeable”: False — many taxes are protected from discharge by statute.
  • “Bankruptcy removes liens”: False — liens can survive discharge and still encumber property.
  • “Filing bankruptcy fixes unfiled returns”: You generally must have filed required returns to qualify for discharge of income taxes.

When bankruptcy may be the right move

Bankruptcy can be appropriate when:

  • qualifying income taxes meet the discharge tests and the debtor has limited nonexempt assets (Chapter 7), or
  • a Chapter 13 plan can reorganize tax debts and stop aggressive collection while repaying priority claims over time.

But bankruptcy is not a one‑size‑fits‑all solution. Compare bankruptcy outcomes to non‑bankruptcy options (offers in compromise, installment agreements) to choose the best path. See our deeper discussion in When Bankruptcy Can (and Cannot) Eliminate Tax Debt.

FAQ — short answers

  • Will bankruptcy erase IRS penalties? Possibly for qualifying income taxes, but not for penalties tied to nondischargeable taxes (like trust‑fund taxes) or fraud.
  • Does filing bankruptcy stop wage garnishments by the IRS? Usually yes while the automatic stay is in effect, but the stay’s protection and exceptions should be confirmed with counsel.
  • How long does bankruptcy affect my credit? A Chapter 7 or Chapter 13 filing can remain on credit reports for 7–10 years.

Authoritative sources

Professional disclaimer

This article is educational only and does not constitute legal or tax advice. Laws and IRS procedures change; consult a qualified bankruptcy attorney or tax advisor who can analyze your specific records and IRS transcripts before making decisions.