Can IRS Debt Be Discharged in Chapter 7 Bankruptcy?
Opening the mailbox to find an IRS notice can induce sheer dread—primarily if back taxes are owed, and there are no funds to pay.
The anxiety only mounts as interest and penalties tally up. Before long, the debt has snowballed into five or even six figures. And the collections letters and calls from IRS agents keep coming.
Bankruptcy may seem like the only way out. But can filing for Chapter 7 bankruptcy really wipe the tax debt clean?
The short answer is maybe. It depends on the types of taxes owed and when they were assessed.
This comprehensive guide will walk through the following:
- The key factors that determine IRS debt dischargeability in Chapter 7
- The most common IRS debts that can and cannot be discharged
- Steps to take if the IRS objects to an attempt to discharge taxes
- Alternatives if the tax debt doesn't qualify for Chapter 7 discharge
Why IRS debt is hard to discharge in Chapter 7
Filing for Chapter 7 bankruptcy immediately stops most collection actions—from harassing creditor calls to wage garnishment.
The court appoints a trustee who gathers up and sells nonexempt assets. The proceeds then go toward paying off as much debt as possible.
Once that's done, the remaining unsecured debt like personal loans and credit cards goes away.
There is a fresh start with a clean slate.
But trying to discharge tax debt through bankruptcy isn't so straightforward—bankruptcy law treats taxes much differently than other unsecured debt like credit cards or medical bills.
For starters, certain taxes cannot be discharged at all in Chapter 7 (or any other bankruptcy type).
Taxes that cannot be discharged in Chapter 7
Only specific types of taxes have a shot of being canceled in bankruptcy. If the IRS debt falls into any of the below categories, there is no luck:
Federal Income Taxes Less Than 3 Years Old - The most recent income tax bills are ineligible for discharge if those returns were filed within the past two years. For example, 2021 taxes filed in early 2022 could only be discharged by filing for Chapter 7 bankruptcy in 2024 or later.
Unfiled Tax Returns - A return must have been filed for the tax years in question to have any chance at tax debt discharge—simply failing to file returns makes those taxes non-dischargeable.
Fraudulent Returns - If false or fraudulent returns were willfully filed, any tax debt from those years could not be discharged.
Taxes Tied to Late Returns - If returns are filed more than two years late, the tax debt for those years is not dischargeable.
Payroll Taxes - Withheld income taxes and the employee's share of Social Security and Medicare taxes cannot be discharged. This includes any penalties and interest.
As you can see, the list of nondischargeable taxes is pretty long. But that doesn't mean you should abandon hope altogether.
Taxes eligible for Chapter 7 discharge
While the tax code makes discharge challenging, it's still possible under the right circumstances.
The following types of IRS debt have the potential to go away in Chapter 7:
Income Taxes More Than 3 Years Old - Federal income taxes from returns filed more than two years ago can be discharged. For example, taxes from 2018 and prior returns filed in 2019 or earlier may qualify.
Old Employment Taxes - Certain old payroll taxes from more than three years ago can be discharged—penalties related to late payments of those taxes can also go away.
Some Trust Fund Taxes - If trust fund taxes were not willfully failed to be collected/paid as a person responsible for withholding (e.g., an employer), those taxes may qualify for discharge.
Civil Penalties - Penalties not related to tax fraud or willful evasion may be dischargeable after three years—this includes failure-to-pay penalties and penalties for filing returns late.
State/Local Taxes - State income taxes and other state/local taxes like sales tax or unemployment taxes can also qualify for discharge under the 3-year time frame.
The lesson here is the older the tax debt, the better chance it can be eliminated in Chapter 7 bankruptcy. Just be sure the debt doesn't fall into one of the exclusion categories.
Now it's time to walk through what happens when attempting to discharge taxes in bankruptcy.
The IRS objection process
Simply listing the IRS debt on Chapter 7 bankruptcy schedules doesn't automatically discharge it. Here are the steps in the IRS objection process:
File Bankruptcy - The bankruptcy petition will list all debts to be discharged, including any eligible IRS debt. Make sure to accurately disclose any IRS tax debt on the schedules and forms.
IRS Can Object - The court notifies the IRS, who then has 60 days to review returns and file an objection if they believe the taxes are not dischargeable.
Prove Dischargeability - If the IRS objects, the burden falls on the filer to file an adversary proceeding and prove to the court that the tax debt qualifies for discharge under bankruptcy law—this adversarial legal process can be complicated. So if the IRS disagrees, the back taxes can be discharged, and an experienced bankruptcy attorney must be worked with.
They'll request the discharge if the taxes fall within the time limits and categories outlined above. If the IRS still objects, the attorney can provide the legal and tax expertise to build a strong case for discharge in court.
Alternatives if the taxes don't qualify for Chapter 7 discharge
If the tax debt cannot be discharged in Chapter 7, all hope is not lost. There are a few potential options:
File Chapter 13 Instead - Chapter 13 bankruptcy does allow certain non-dischargeable taxes, like income taxes under three years old, to be paid over 3-5 years through a court-approved repayment plan.
Request an Offer in Compromise - One may qualify to settle the tax debt for less than the total amount owed based on finances—this requires strict eligibility.
Get Placed on Uncollectible Status - If unable to pay is proven, the IRS may deem the account currently not collectible. This pauses enforcement but doesn't discharge the debt.
Work Out an Installment Plan - Based on the ability to pay, the IRS may approve reducing monthly tax payments over several years.
While wiping IRS debt clean through Chapter 7 bankruptcy has significant hurdles, it can work for eligible older tax bills.
Understanding the complex rules is the crucial first step to developing a viable tax debt reduction strategy.
Discharging tax debt in Chapter 7 bankruptcy is difficult, but federal income taxes over three years old can be filed on time.
Certain very old employer payroll taxes may also qualify. But more recent income taxes, unfiled returns, and fraudulently filed returns cannot be discharged.
If the taxes fall into a dischargeable category, be prepared for the IRS to object. Work with an experienced bankruptcy attorney to request the discharge and, if needed, argue the case in court.
If the IRS debt is ineligible for Chapter 7 discharge, don't panic—other options like Chapter 13 bankruptcy, IRS repayment programs, or settlements may provide much-needed relief.
As stressful as owing back taxes is, there are more options than may be thought.