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Bankruptcy and tax debt, part 2: Chapter 7 vs. Chapter 13

In part one of this post, we introduced the subject of bankruptcy and tax debt. We used a Texas case to illustrate the point that a bankruptcy filing does not necessarily stop the IRS from trying to collect back taxes from you.

In this part of the post, let's look more specifically at how the two main types of consumer bankruptcy - Chapter 7 and Chapter 13 - apply to tax debt.

 First of all, let's take note of some of the limitations on the use of bankruptcy to address tax debt.

  • Business taxes: Bankruptcy can't be used to get rid of business tax debt, such as unpaid payroll taxes. It is only possible for personal income taxes.
  • Eligibility for installment agreement or OIC: If you are in the midst of bankruptcy proceedings, you will not be eligible for two of the main means for resolving tax debt: an installment agreement or an offer in compromise (OIC).
  • Federal tax liens - If the IRS has already filed a valid notice of federal tax lien, tax debt becomes a secured debt. When that happens, tax debt cannot be eliminated in bankruptcy.
  • Timing - There are limitations on the amount of time that must have passed since the taxes should have been filed (three years from the bankruptcy filing date) and since they were assessed (240 days since the filing date). (There are also various exceptions that can extend these dates.)

These are definitely significant limitations on using bankruptcy to discharge tax debt. But it still may be possible to use bankruptcy to get relief from that debt. A knowledgeable tax attorney can guide you through the process.

As a consumer, it would be preferable for you to seek bankruptcy relief through Chapter 7. A successful Chapter 7 filing allows for the discharge of many debts. But there is a financial means test for Chapter 7, and sometimes a Chapter 7 filing has to be converted into Chapter 13.

A Chapter 13 bankruptcy involves working out a debt repayment plan. But it can still be an effective strategy in certain cases for keeping tax penalties and interest from mounting. Again, this is worth discussing with a skilled tax lawyer.

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