Can You Wipe Out Personal Income Taxes in Bankruptcy and How Does That Work?
Many people assume that taxes can never be discharged in bankruptcy. While it’s true that most tax debts are harder to eliminate than credit cards or medical bills, some personal income taxes can be wiped out in bankruptcy, but only if very specific rules are met. Understanding how this works can help individuals make informed financial decisions when dealing with overwhelming tax debt.
The Basics: Bankruptcy and Tax Debt
Personal income tax debt is handled differently depending on the type of bankruptcy filed. The two most common forms for individuals are Chapter 7 and Chapter 13. Chapter 7 can potentially eliminate qualifying tax debts entirely, while Chapter 13 usually involves a repayment plan where some or all of the tax debt is paid over time.
Not all taxes are eligible for discharge. Payroll taxes, trust fund taxes, and tax penalties tied to fraud generally cannot be eliminated. However, older federal and state income taxes may qualify if certain conditions are met.
The Key Rules for Discharging Income Taxes
For personal income taxes to be discharged in a Chapter 7 bankruptcy, the debt must pass several tests, often referred to as timing and conduct rules:
- The Three-Year Rule
The tax return must have been due (including extensions) at least three years before filing for bankruptcy. - The Two-Year Rule
The tax return must have been filed at least two years before the bankruptcy filing. Late-filed returns can still qualify, but only if they meet this requirement. - The 240-Day Rule
The tax must have been assessed by the IRS at least 240 days before filing. If the IRS recently adjusted or audited the tax, the clock may reset. - No Fraud or Willful Evasion
If the IRS determines that the taxpayer committed fraud or intentionally tried to evade paying taxes, the debt cannot be discharged.
If all of these conditions are met, the qualifying income tax debt may be completely eliminated in Chapter 7 bankruptcy.
What About Chapter 13 Bankruptcy?
In Chapter 13, tax debts are treated differently. Some income taxes may still be dischargeable at the end of the repayment plan, but priority tax debts, usually newer taxes, must be paid in full over three to five years. Chapter 13 can be useful for people who don’t qualify for Chapter 7 or who need time to catch up on taxes without facing aggressive collection actions.
Liens and Other Limitations
Even if income taxes are discharged, tax liens may survive bankruptcy. This means the IRS could still have a claim against property that was owned before the bankruptcy was filed, although they would no longer be able to pursue personal collection.
Final Thoughts
Wiping out personal income taxes in bankruptcy is possible, but it depends heavily on timing, compliance, and the type of bankruptcy filed. Because the rules are strict and technical, many people benefit from speaking with a qualified bankruptcy or tax professional before filing. With the right circumstances, bankruptcy can offer meaningful relief from older income tax debts and provide a fresh financial start. If you are looking for a financial fresh start, call Hoglund Law today for a free consultation at 651-789-5052.
