With the economic downturn, continuing high levels of unemployment and the housing crisis, it's no surprise that a lot of people are dealing with debt problems. When you sit down to consider filing for bankruptcy, you may have a lot of questions. You've probably heard, for example, that there are some kinds of debt that bankruptcy won't get rid of: child support, alimony, student loans and taxes, for example.

The truth is that, while these kinds of debt are very hard to discharge through either Chapter 7 or Chapter 13 bankruptcy, there are exceptions. For example, under the 2005 bankruptcy law, student loans can still be discharged in limited cases by going to trial to prove "undue hardship."

Federal tax debts were also made harder to discharge by the 2005 bankruptcy law, but in a few cases, they can still be released in Chapter 7 and Chapter 13. Some taxes are never dischargeable, such as payroll taxes, an IRC §6672 trust fund tax penalty, most state sales taxes and certain excise taxes.

There Are Alternatives to Bankruptcy That Can Resolve IRS Tax Debts

For most people, the best option for handling federal tax debts will be the IRS's debt negotiation and settlement process. The IRS works with taxpayers to resolve tax debts through innocent spouse relief, installment agreements, offers in compromise and agreements to reduce penalties.

If the IRS debt negotiation process doesn't resolve the situation, you may have some tax debts that are eligible for bankruptcy discharge. Your own situation may have aspects that can't be covered in a blog post, so you should check with a bankruptcy attorney before making any decisions.

Some Federal Tax Debts Are Dischargeable in Bankruptcy

Federal bankruptcy law sets up a mechanical formula for determining whether IRS tax debts can be discharged. The general rules are:

  • The tax debt must be at least three years old. The IRS goes on the date the tax return generating the liability was filed, including extensions. If you didn't file a return and the IRS is billing you based on a "substitute for return" it filed on your behalf, however, that doesn't count. There are other things that may have happened that can also extend that three-year period as well, such as having filed a prior bankruptcy or having received a tax assistance order. The facts in your particular case will determine whether your tax debt is considered old enough.
  • 240 days must have elapsed between the date of the final IRS assessment and your bankruptcy petition. Here again, certain situations can cause that requirement to be longer, such as adjustments due to an audit or an amended return, or because you agreed to an offer in compromise.
  • The tax debt must have been filed more than two years before you file for bankruptcy. Again, there are specific rules for what qualifies, including the rule that a "substitute for return" doesn't count for this purpose.
  • You can't have intentionally tried to evade paying your taxes or filed a fraudulent return.

If you have a federal tax debt that meets the criteria of all four of these rules, you can discharge it through bankruptcy. Check with a bankruptcy lawyer to make sure.

If your tax debt meets the criteria in the first, second and fourth rules but not the third, it is not dischargeable, but will be reclassified from "priority debts" to "non-priority debts."

Related Resource:

"Discharging Taxes in Bankruptcy" (The American Chronicle, August, 2010)