Other taxes, such as fraud penalties or payroll taxes, cannot be eliminated through bankruptcy. Many people are surprised to learn that bankruptcy can end back taxes. As a general rule, income taxes older than 3 years can be eliminated. And while you must have filed your returns and not committed fraud, bankruptcy can be a powerful way to deal with the IRS.
In bankruptcy jargon, taxes are often treated as “unliquidable priority debt.” This means that bankruptcy will not eliminate them and that repaying the debt takes precedence over the claims of other creditors. Even so, there are times when taxes can be considered a “taxable debt” that can be eliminated by filing for bankruptcy. Yes, you can file for bankruptcy to resolve back taxes, but not for all your tax debts. Each chapter has a different set of requirements and processes.
Chapter 7 is often a “saving grace” for anyone who is going overboard with insolvency, as it completely eliminates all taxable past tax debts. This strategy is used for those who cannot pay their income tax debt; however, it is more difficult to obtain approval than in the other chapters of bankruptcy. The IRS Fresh Start Program allows taxpayers to pay off their debts by making monthly payments for six years. The IRS has some specific rules about when your tax assessment was done before you filed for bankruptcy, commonly known as the “240-day rule.” You can cancel (eliminate) income tax debts if you meet the requirements, limitations, and restrictions listed below.
The IRS can initiate collection actions and will not have to wait for you to receive the final forgiveness. With respect to the third requirement, a late return will not count as a return for the purpose of obtaining a waiver. In addition, the rules on previously unfiled tax returns are not uniform and more recent obligations cannot be resolved. The IRS may be willing to establish a plan that allows a delinquent taxpayer to pay their debts in installments.
During the pay period, the taxpayer must file returns on time and pay any new income taxes that are due. Finally, there is an exception in a Chapter 13 bankruptcy that will allow the IRS to collect the balances due if you did not receive notification of the bankruptcy filing in time to file a claim to protect your interests. If you can't pay your tax debt with an installment plan, you may be able to use the IRS “compromise offer” program. Also know that different judicial jurisdictions may have other rules for eliminating tax liability in the event of bankruptcy.
Generally, you can't eliminate your income tax liability by filing for Chapter 7 bankruptcy, but there is an exception.