If you’ve fallen behind with the IRS, declaring bankruptcy may or may not wipe out your IRS tax debt.
First, the good news. The moment you file bankruptcy, an automatic stay is created to stop most creditors–including the IRS–from continuing any collection activities against you. This means that the IRS can’t levy your bank account, can’t garnish your paycheck, etc, until the bankruptcy case is completed.
Now the bad news. This automatic stay only provides temporary relief. Usually a Chapter 7 bankruptcy case will be completed after a few months. After that, the IRS is free to pursue you again,and resume their collection activity, including levying your bank account or paycheck.
4 Requirements to wipe out your IRS Tax Debt via bankruptcy
There are cases where your income tax debt can be discharged permanently via bankruptcy, specifically where these conditions are met:
(a) the return’s filing deadline was due at least three years ago, and
(b) you actually filed the return over two years ago, and
(c) the IRS assessed the tax at least 240 days (or 8 months) ago, and
(d) you did not commit any fraud or tax evasion along the way.
If the total tax you owe–or any part of the balance due–does not meet the criteria above, it’s considered a ‘priority’ debt. Priority tax debt cannot be discharged in bankruptcy.
The sad tale of Jim and Mary
Jim and Mary Jenkins (not their real names) prepared their 2009 tax return back in 2010, and filed it without paying the $3,000 balance due. The next year, on their 2010 tax return, the tax due would have been another $3,000, but they decided to ‘stay low’ and not file the return in fear of IRS collection actions that might result. Then their financial hardship snowballed, and they did not file returns for either 2011 or 2012. However, the IRS took action in May of 2013 and filed ‘substitute for returns”, assessing $9,000 in additional tax due liability for those two years, based solely on Jim’s reported W-2 income, married filing single status, and no deductions. (Ouch!)
The Jenkins filed for Chapter 7 bankruptcy protection in October 2013, gaining peace of mind in knowing they would benefit from an automatic stay on IRS collection efforts. Unfortunately, that ‘protection’ was short-lived. Their 2009 return qualified for discharge, however, their 2010 return (never filed) did not, nor did the 2011 and 2012 returns due to their recent assessment dates. By early 2014, an IRS revenue officer resumed his efforts to collect $12,000 in back taxes plus interest and non-filing penalties in excess of $4,000. When they contacted their attorney, he stated “that is the IRS’s decision; I had nothing to do with it.”
The Jenkins subsequently sued their bankruptcy attorney for malpractice.
ANCHOR ON THIS: Bankruptcy laws can provide powerful protection for consumers who fall behind on IRS and other debts. However, when considering bankruptcy, ask your attorney to obtain transcripts from the IRS and perform a thorough Bankruptcy Discharge Analysis before proceeding. Knowing in advance whether bankruptcy will discharge your income tax debt is important in helping you make an informed decision regarding the tax aspect of your bankruptcy case.