🛑 IRS Debt and Bankruptcy: Why Filing Might Not Erase Your Tax Bill
From the Desk of Lance Herndon, Former Attorney and IRS Enrolled Agent
As a former attorney and IRS Enrolled Agent, I have witnessed countless mistakes—and a lot of unnecessary frustration—when taxpayers rely on bankruptcy to eliminate tax debt. The truth is, while bankruptcy offers immediate relief from collection actions, it is not a simple button press that discharges all your IRS obligations.
In fact, if your only goal is to solve your tax debt, filing bankruptcy may complicate your situation, leave you still owing the IRS, and cost you valuable time.
3 Critical Rules for Discharging Tax Debt
To successfully discharge (eliminate) an income tax debt in a Chapter 7 or Chapter 13 bankruptcy, the tax year in question must meet three complex criteria related to time. Ignoring these rules is where most taxpayers and even some attorneys go wrong:
- The 3-Year Rule (Due Date): The date the tax return was originally due (including extensions) must be at least three years ago before you file for bankruptcy.
- The 2-Year Rule (Filing Date): The tax return must have been filed by the taxpayer at least two years ago before the date you file for bankruptcy.
- The 240-Day Rule (Assessment Date): The IRS must have assessed the tax debt at least 240 days ago before your bankruptcy filing.
Example: You cannot discharge 2021 tax debt until your filing date meets all three criteria, especially the 3-Year Rule (the return was due April 2022, meaning you generally must wait until at least April 2025). If you filed the return late, the two-year clock starts only on your actual filing date.
Important: Filing Late is Costly
If you failed to file a return at all, the tax debt for that year is not dischargeable in bankruptcy. To make it eligible, you must file the return and then wait the required two-year period.
Why Bankruptcy Might Not Be Your Best Option
If you are dealing with other overwhelming unsecured debt (like credit cards or medical bills), bankruptcy is often necessary. However, if your primary goal is solving an IRS problem, beware of these pitfalls:
1. The Means Test
Following the 2005 Bankruptcy Law changes, you can no longer simply file Chapter 7 to liquidate debt if you have disposable income. The court must run the “means test.” If the test determines you have sufficient income to repay some debts, you may be forced into a Chapter 13 repayment plan, meaning you still must pay your creditors, including the IRS, over a period of 3 to 5 years.
2. Extending the Collection Clock
Filing for bankruptcy triggers a “stay” on the Collection Statute Expiration Date (CSED)—the 10-year limit the IRS has to collect your debt. The clock stops for the entire duration the bankruptcy is pending (often 4-6 months for Chapter 7) plus an additional six months after the bankruptcy is discharged or dismissed. If your tax debt was close to expiring, bankruptcy may have just given the IRS more time to collect.
The Immediate Advantage: Why Bankruptcy Is a Powerful Tool
While you should be wary of bankruptcy as a sole tax solution, it offers instant, powerful relief from collection actions that no other single IRS resolution program provides:
- Automatic Stay: Filing bankruptcy results in an automatic stay on collection actions by all creditors, including the IRS.
- Immediate Levy Release: The IRS must immediately release any existing bank levies or wage garnishments upon being provided with the bankruptcy case number, with no questions asked and no financial statements required.
- Stops Liens: The stay also prevents the IRS from filing a Federal Tax Lien if one has not yet been filed.
- Unfiled Returns: Bankruptcy can force the release of a levy even if you have unfiled tax returns (though you must still file them for the bankruptcy court).
Final Word: Bankruptcy is a complex legal tool that provides temporary relief and potential discharge, but it must be timed perfectly and should only be pursued with a deep understanding of its impact on your tax liability. Don’t let an attorney who is unfamiliar with the nuances of tax law make your IRS problem worse.
If you are considering bankruptcy to solve your IRS debt, contact a qualified tax resolution expert—a former attorney and Enrolled Agent—to review your options first.