Bankruptcy & IRS Tax: Types, Requirements, Debt Discharge

Bankruptcy is a legal process designed to help individuals and businesses struggling with overwhelming debt to get a fresh financial start. When facing financial hardships, individuals often find themselves grappling with unpaid taxes owed to the Internal Revenue Service (IRS). This article aims to delve into the complexities of bankruptcy and its interaction with IRS tax, exploring the types of bankruptcy, eligibility requirements, and the process of discharging tax debts.

Types of Bankruptcy:

There are several types of bankruptcy under the United States Bankruptcy Code, but the two most common for individuals are Chapter 7 and Chapter 13.

1. Chapter 7 Bankruptcy:Chapter 7, often referred to as “liquidation bankruptcy,” involves the sale of a debtor’s non-exempt assets to pay off creditors. This process typically lasts a few months and is available to individuals, married couples, corporations, and partnerships.In the context of IRS tax, Chapter 7 can discharge certain tax debts, but specific criteria must be met. Generally, income taxes are dischargeable if they meet the following conditions:
   • The taxes are income-based.
   • The tax return was due at least three years ago.
   • The tax return was filed at least two years ago.
   • The tax assessment is at least 240 days old.
2. Chapter 13 Bankruptcy:Chapter 13 is a reorganization bankruptcy that allows individuals with a regular income to create a plan to repay all or part of their debts over three to five years. This type of bankruptcy is particularly useful for those with non-exempt assets they want to keep.In a Chapter 13 bankruptcy, IRS tax debts can be included in the repayment plan. While the full amount of tax debt must be repaid, the advantage is that it can be done over an extended period, potentially with reduced interest.

Requirements for Bankruptcy Filing:

Regardless of the type of bankruptcy, certain eligibility requirements must be met:

1. Means Test:The means test evaluates an individual’s income and expenses to determine whether they qualify for Chapter 7 bankruptcy. If an individual’s income is below the state median, they are typically eligible for Chapter 7. Otherwise, they may be required to file for Chapter 13.
2. Credit Counseling:Before filing for bankruptcy, individuals are required to undergo credit counseling from an approved agency. This counseling helps assess the individual’s financial situation and explore alternatives to bankruptcy.
3. Tax Filings:Individuals must have filed their income tax returns for the previous four years before filing for bankruptcy. Failure to do so may result in ineligibility for certain types of bankruptcy.

Discharging IRS Tax Debts:

While bankruptcy can provide relief from certain tax debts, not all tax obligations are dischargeable. Non-dischargeable tax debts may include:

1. Recent Income Taxes:Income taxes from the most recent tax year are generally not dischargeable in bankruptcy.
2. Fraudulent or Evasion-Related Taxes:Tax debts related to fraudulent activities or tax evasion are usually not dischargeable.
3. Trust Fund Taxes:Taxes withheld from employees’ wages for Social Security and income taxes are considered trust fund taxes and are generally not dischargeable in bankruptcy.

Bankruptcy can be a lifeline for individuals drowning in debt, providing a chance for a fresh start. When dealing with IRS tax debts, understanding the nuances of the bankruptcy process is crucial. While certain tax debts can be discharged, eligibility requirements and considerations must be carefully evaluated. Seeking professional advice from bankruptcy attorneys and tax professionals can help individuals navigate the complexities of bankruptcy and make informed decisions about their financial future. In conclusion, the intersection of bankruptcy and IRS tax is a complex terrain, and individuals considering this path should proceed with caution and seek expert guidance to ensure the best possible outcome for their financial situation.