IRS Collections and Bankruptcy

When to Consider Bankruptcy to Help with IRS Tax Issues

Taxpayers often believe that their IRS tax lien is not dischargeable in bankruptcy. This is partially true and partially false.

  • Payroll and trust fund recovery taxes are not dischargeable in bankruptcy. Full stop. There is nothing your IRS lawyer or bankruptcy lawyer can do about this (as of the date this article was written, laws are certainly always subject to change).
  • Income taxes can be discharged by filing bankruptcy under certain conditions.

When Can Income Taxes Owed Be Discharged in Bankruptcy?

Income taxes owed to the IRS may be discharged by filing bankruptcy, if all three of the below conditions can be satisfied:

  1. The due date of the tax return in question is three years old or older;
  2. The tax return (for owed taxes that one is seeking to discharge) has been filed with the IRS for at least two years; and
  3. The IRS has assessed the tax for at least eight months (240 days).

If the above three criteria are met at the time you file bankruptcy, applicable income taxes owed can be discharged.

Bankruptcy is an especially attractive option when the taxpayer, in addition to having taxes that can be eliminated through declaring bankruptcy, has other significant debts for which bankruptcy would provide significant debt relief.

Then, after bankruptcy, the tax lawyer has a much easier job of only having to resolve the most recent three years of tax obligations.

Impact of Bankruptcy on IRS Tax Collections Statute of Limitations

While the taxpayer will be relieved that the “automatic stay” issued after filing for bankruptcy, puts an immediate pause on IRS collections efforts, it also pauses the IRS collections statute of limitations.

Not only does bankruptcy pause the statute of limitations, it tacks on an additional six months to when the IRS collections statute of limitations would have ended. So if the taxpayer files for chapter 7 bankruptcy, that process may only take four months. When the taxpayer comes out of bankruptcy, it would extend the IRS collections statute of limitations for 10 months (4 months in bankruptcy + 6 months statutory tack-on) for those taxes that were unable to be discharged in the bankruptcy proceeding.

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