Filing Bankruptcy on Tax Debt? What You Need to Know

Can IRS Debt Be Discharged in Bankruptcy?

Bankruptcy can eliminate certain tax debts. But it depends on the type of tax debt and how long you’ve owed it. 

If your tax debt qualifies for discharge in Chapter 7, you may be able to eliminate it entirely. If it doesn’t, Chapter 13 can help you set up a manageable repayment plan while keeping the IRS off your back.

In general, only income tax debt qualifies for discharge. Even then, the IRS has strict rules about which debts can be erased.

Requirements for Discharging IRS Tax Debt in Chapter 7

The IRS is very big on rules. There is a regulation for pretty much everything. So, it should be no surprise that there are specific rules for bankruptcy discharge. It’s important to understand if your debt qualifies for discharge because the IRS can and will object to your discharge if it has any reason to do so.

Here’s what you need to know about discharging IRS tax debt in Chapter 7 bankruptcy:

• Chapter 7 bankruptcy only discharges income tax debt. Beyond that, the parameters are not very well defined. For example, 1040 taxes are definitely federal income taxes. But property taxes, trust fund taxes, and sales taxes are definitely not income taxes. To ensure that Chapter 7 can erase your tax debts, you'll need to know what kind of taxes you owe.

• You must have filed your tax returns for the past two years if you're required to file. Your tax returns for the debt you want to discharge must have been on file for at least two years at the time you file for bankruptcy. The two-year waiting period applies even if the returns were filed on time. If you don’t file your taxes, the IRS may prepare a substitute return and use it to calculate what you owe. Substitute returns don’t count as taxpayer-filed returns. This is sometimes referred to as the two-year rule.

• The income tax debt must be at least three years old. Note that Tax Day is not always April 15. Some years, it's April 16, 17, or even 18. IRS lawyers have been known to object to a discharge over a difference of one or two days. So, make sure you file the petition on the correct day or else you'll have to start over. This is sometimes referred to as the three-year rule..

• Your tax assessment can't be more than eight months old. If the IRS has not assessed the debt within the last 240 days, the income tax debt is not dischargeable. This is referred to as the 240-day rule. It’s almost impossible to tell if the IRS has assessed the debt or not because this is done internally. But generally, if the taxpayer has not received a bill that breaks down the amount due by tax years, the IRS has probably not assessed the debt.

• You must not have committed fraud or willful evasion. If the IRS believes you intentionally avoided paying taxes or submitted a fraudulent return, the debt won’t be erased in bankruptcy.

If your tax debt meets all these criteria, it can usually be wiped out in Chapter 7.

If your tax debt doesn’t qualify for discharge in Chapter 7, Chapter 13 might still give you some debt relief. It can stop IRS collection efforts and set up a repayment plan that fits your budget. 

Even if a bankruptcy filing doesn’t wipe out your tax debt, it may still give you relief by putting IRS collections on pause. Read on to learn how.

How Bankruptcy Stops IRS Collections

Filing for bankruptcy puts an immediate stop to IRS collection efforts thanks to the automatic stay. 

🛑 The automatic stay is a legal protection that goes into effect as soon as you file your bankruptcy petition. It stops most creditors, including the IRS, from trying to collect while your case is open. 

If you’ve been dealing with IRS warning letters, a wage garnishment, or a bank account levy, the automatic stay can give you breathing room to figure out your next steps

When the automatic stay is in place, the IRS can’t:

❌ Garnish your wages or freeze your bank account

❌ Send new collection letters or make collection calls

❌ File a new tax lien against your personal property

If the IRS is already taking aggressive collection actions, filing for bankruptcy may still help by putting an immediate stop to them. That’s true even if your tax debt isn’t dischargeable yet.

What If My Tax Debt Isn’t Dischargeable Yet?

If your tax debt doesn’t qualify for discharge in Chapter 7, you still have options. You can:

• Set up an IRS payment plan: Spread payments out over time to avoid aggressive collection actions. The IRS offers several different types of payment plans.

• Apply for an offer in compromise: Try to settle your debt for less than you owe if you qualify.

• Wait until your tax debt becomes dischargeable: If your debt is close to meeting the bankruptcy requirements, waiting might be the best move.

Each of these options has pros and cons, so it’s important to weigh what works best for your situation. Here’s more information about each option.

Set Up an IRS Payment Plan

The IRS offers payment plans that let you pay your tax debt over time. Interest and penalties will continue to add up until the balance is paid, but a payment plan can help you avoid more serious collection actions like wage garnishment or bank levies.

IRS payment plans fall into two main categories:

• Short-term payment plans: If you owe less than $100,000 and can pay off your balance within 180 days, you don’t need a formal installment agreement. There are no setup fees, and you can pay online, by check, or by debit/credit card.

• Long-term payment plans: If you owe $50,000 or less and need more than 180 days to pay, you’ll need a formal installment agreement. This requires an application and a setup fee, which varies based on your payment method.

Long-term payment plans include guaranteed, streamlined, and partial payment installment agreements. Each has different eligibility requirements and repayment terms.

Guaranteed Installment Agreements

This is the easiest plan to qualify for, and approval is guaranteed if you meet these requirements:

• You owe $10,000 or less (excluding penalties and interest).

• You haven’t entered into an installment agreement in the last five years.

• You can pay off the full balance within 36 months.

• You agree to stay current on future tax filings and payments.

If you qualify, you can apply online, by mail, by phone, or in person.

Streamlined Installment Agreements

If you owe more than $10,000 but less than $50,000, you may qualify for a streamlined installment agreement. In a streamlined agreement:

• You must pay off the balance within 72 months (six years).

• If you owe more than $25,000, you need to set up automatic payments (direct debit or payroll deduction).

• You don’t have to provide detailed financial disclosures to the IRS.

If your total balance (including penalties and interest) is over $50,000, you may need to pay it down before applying.

Partial Payment Installment Agreements

If you can’t afford full payments, a Partial Payment Installment Agreement (PPIA) may allow you to pay a lower monthly amount. In a PPIA:

• The IRS reviews your finances every two years and may adjust your payments if your income increases.

• This plan lasts until the IRS collection period (typically 10 years) expires.

• You must provide detailed financial information to qualify.

How To Apply for an IRS Payment Plan

You can apply online if you owe less than $50,000. If you owe more, you’ll need to submit IRS Form 9465. You may also need to submit a financial disclosure form. The IRS charges setup fees, which vary based on income level and payment method but can cost as much as $178.

If you’re considering a payment plan, it’s a good idea to compare options and choose the one that best fits your budget.

Apply for an Offer in Compromise

If you can’t afford to pay your full tax debt, you may be able to settle with the IRS for less through an Offer in Compromise (OIC).

This is a debt settlement agreement where the IRS agrees to accept a reduced amount as full payment. But qualifying isn’t easy. The IRS only approves OICs when it believes there’s no realistic way to collect the full amount from you.

Who Qualifies for an Offer in Compromise?

The IRS will only consider an OIC for one of three reasons:

• Doubt as to liability: You can prove there was an error in how your tax debt was assessed.

• Doubt as to collectibility: You don’t have enough income or assets to reasonably pay your full tax debt.

• Effective tax administration: Even if you technically could pay, doing so would create an exceptional financial hardship (such as a serious medical condition or disability).

For most people, “doubt as to collectibility” is the best argument for an OIC. To qualify, you must prove that the IRS has no reasonable chance of collecting the full debt from you, either as a lump sum or through a payment plan.

OIC Eligibility Requirements

Even if you meet one of the three reasons above, the IRS won’t even consider your OIC if any of the following apply:

• You haven’t filed all required income tax returns for previous years.

• You’re currently in an open bankruptcy case.

• You’re being audited by the IRS.

• You haven’t made the required estimated tax payments for the current year.

• The IRS hasn’t officially billed you for the tax debt yet.

If none of these apply, you can check your eligibility using the IRS Offer in Compromise Pre-Qualifier Tool online.

How the IRS Calculates an Offer in Compromise

The IRS doesn’t just let you name your own settlement amount. They use a strict formula to decide whether to accept your offer. This calculation is based on:

• Your monthly income after necessary living expenses

• The value of your assets (like home equity, savings, and investments)

• The amount the IRS believes it could collect from you over time

If your financial situation suggests that you could reasonably pay your tax debt through an installment plan, the IRS is likely to reject your OIC and direct you toward a payment plan instead.

How Much Do You Have to Pay in an Offer in Compromise?

When you submit an OIC, you must offer an amount equal to your "reasonable collection potential.” That’s the amount the IRS calculates you can afford to pay.

There are two ways to pay off an accepted OIC:

• Lump-sum cash offer: You pay 20% of the offer amount upfront, with the rest due within five months.

• Periodic payment offer: You make monthly payments for up to 24 months until the agreed-upon amount is paid.

You also have to pay a $205 application fee, unless you qualify for a low-income exemption based on federal poverty guidelines.

What Happens After You Apply for an OIC?

The IRS can take up to two years to review your offer. If they don’t decide within that time, your OIC is automatically accepted.

While your OIC is under review, the IRS won’t garnish your wages or seize your assets, but existing tax liens stay in place

💡 The IRS rejects about 60% of OICs, usually because they believe the taxpayer can afford to pay more. If rejected, you can appeal within 30 days.

What Happens After Your OIC Is Accepted?

If your offer is accepted, you must:

• Pay the agreed amount on time.

• File and pay your taxes on time for the next five years.

• Give up any tax refunds for the year your OIC was accepted.

If you don’t follow these terms, the IRS can cancel your OIC and reinstate your full tax debt.

Wait Until Your Tax Debt Becomes Dischargeable

If your tax debt almost meets the IRS’s waiting period rules for bankruptcy, holding off on filing could make a big difference. Once your tax debt qualifies, Chapter 7 bankruptcy may be able to erase it completely, saving you from having to pay it back.

⌛ The IRS has strict timing rules for discharging tax debt, based on when your taxes were due, when you filed your return, and when the IRS officially recorded the debt. If you file too soon, your tax debt might not qualify, and you’ll still owe it after bankruptcy.

If you’re unsure whether your tax debt meets the rules, you can request your tax transcripts from the IRS to check the key dates. If your debt is close to qualifying, waiting a little longer before filing could be the difference between keeping and erasing the debt.

If your tax debt doesn’t qualify for discharge and you can’t afford to wait, Chapter 13 bankruptcy might offer another solution. It won’t erase your tax debt, but it can stop IRS collection efforts and give you more time to pay through a structured repayment plan. Here’s how it works.

Does Chapter 13 Bankruptcy Help With Tax Debt?

Yes! Chapter 13 bankruptcy can be a powerful tool for managing tax debt, especially if your taxes don’t qualify for discharge in Chapter 7. 

Instead of wiping out the debt completely, Chapter 13 lets you repay what you owe over time through a court-approved repayment plan. Plans usually last 3–5 years.

💡 Chapter 13 is also called reorganization bankruptcy because it allows you to get a fresh start by repaying debts over time.

How Chapter 13 Bankruptcy Helps With Tax Debt

Your tax debt is divided into two categories in Chapter 13 bankruptcy:

• Priority tax debt, including most recent income taxes and other taxes that don’t qualify for discharge in Chapter 7

• Non-priority tax debt, including any tax debt that meets the requirements for discharge (like the three-year, two-year, and 240-day rules)

You must pay priority tax debts in full through your repayment plan. Non-priority tax debts are treated like other unsecured debts. You may not have to pay the full amount or may be able to get them wiped out.

Regardless of how your debts are treated, Chapter 13 provides several benefits if you owe the IRS:

• Stops IRS collections: The automatic stay prevents wage garnishments, bank levies, and collection calls while your case is active.

• Spreads payments over time: Instead of facing an immediate lump-sum payment, you can repay tax debt in smaller, manageable installments.

• May reduce penalties and interest: While the IRS still charges some interest, Chapter 13 can reduce or eliminate penalties on tax debt.

• Prevents new tax liens: Once your repayment plan is in place, the IRS can’t file new tax liens against you.

Is Chapter 13 Better Than Chapter 7 for Tax Debt?

Many filers choose Chapter 13 over Chapter 7 when:

✔️ Their tax debt can’t be discharged in Chapter 7. ✔️They need more time to pay without IRS collection pressure. ✔️ They have other debts, like mortgage arrears or car loans, that they need to catch up on.

Chapter 13 requires a long-term repayment commitment. Some people choose Chapter 7 or an IRS payment plan instead if they qualify for a quicker resolution.

If you’re unsure whether Chapter 13 is the right choice, consider consulting a bankruptcy attorney to review your options. Upsolve can connect you with a local bankruptcy lawyer for a free consultation.

How Does Bankruptcy Affect Your Tax Refund?

Filing for bankruptcy can impact your tax refund, but whether you get to keep it depends on a few things, including which type of bankruptcy you file.

👉 Most people who file Chapter 7 bankruptcy get to keep their tax refunds. But this depends on what bankruptcy exemptions you claim and how you use the money. If your refund isn’t protected by an exemption and you still have it when you file, the trustee may use it to pay creditors.

👉 In Chapter 13 bankruptcy, tax refunds you receive during your repayment plan are usually included in the estate and may go toward your debt payments. Some filers adjust their tax withholding to avoid large refunds while they’re in Chapter 13.

If you’re expecting a refund and considering bankruptcy, planning ahead can help you keep as much of it as possible. 

💡 You can learn more in our article: What Happens to Your Tax Refund in Bankruptcy? 

How Does Bankruptcy Affect Your Future Tax Returns?

Filing for bankruptcy doesn’t mean you can skip filing taxes. After a Chapter 7 discharge, you’ll still need to file your tax returns like usual. 

If any of your debts were wiped out in bankruptcy, you might get a Form 1099-C (Cancellation of Debt). But debts discharged in bankruptcy usually aren’t considered taxable income, so you typically don’t owe taxes on them.

If you had unpaid taxes before filing, your future refunds could still be affected. For example, if the IRS was applying your refunds to old tax debt, that won’t change after bankruptcy. Moving forward, staying on top of tax filings and payments can help you avoid new tax issues down the road.

FAQs About Tax Debt and Bankruptcy

Tax debt and bankruptcy can be complicated, and the rules aren’t always straightforward. Here are answers to some common questions that may help clarify what happens to IRS debt when you file for bankruptcy.

Can Other Types of Tax Debt Be Wiped Out in Bankruptcy?

Not all tax debt qualifies for discharge in bankruptcy. Only unpaid income taxes may be erased. 

Other types of tax debt, like payroll taxes, trust fund taxes, and most property taxes, can’t be eliminated in Chapter 7.

• Payroll and trust fund taxes: These are taxes employers withhold from employee paychecks. Since the IRS considers this money to belong to employees, not the employer, it can’t be discharged.

• Property taxes: While some older property taxes might be dischargeable, most are treated as secured debts, meaning they stay attached to the property.

• Tax penalties: Some penalties related to dischargeable tax debt may also be erased, but not always. Interest on non-dischargeable tax debt usually remains.

If you have these types of tax debt, Chapter 13 bankruptcy might help by setting up a manageable repayment plan while stopping IRS collection efforts.

Are State Income Taxes Treated the Same as Federal Taxes in Bankruptcy?

In most cases, state income taxes follow the same bankruptcy rules as federal income taxes. They can be discharged in Chapter 7 if they meet the three-year, two-year, and 240-day rules. If they don’t qualify for discharge, Chapter 13 can help by setting up a repayment plan.

However, if your state has placed a tax lien on your property before you file, that lien will remain even if the underlying debt is erased. Since state taxing authorities have their own collection policies, it’s a good idea to check how your state handles tax debt in bankruptcy.

Can I Discharge Tax Debt If I’m Self-Employed?

Yes, but the same rules apply. If you owe income taxes and meet the timing requirements, bankruptcy may erase the debt. 

What Happens to a Federal Tax Lien in Bankruptcy?

If the IRS placed a federal tax lien on your property before you filed, bankruptcy won’t remove it. The lien will stay attached to your real estate or other assets until the debt is paid or settled.

Will Bankruptcy Clear Fraud Penalties or Tax Evasion Charges?

No. If the IRS determines you committed tax fraud or willful evasion, bankruptcy won’t erase the debt. The same applies to fraud penalties assessed by the IRS.

What Happens to My Tax Debt at the Meeting of Creditors?

At your meeting of creditors, the bankruptcy trustee and IRS representative (if present) may review your tax debt. If the IRS wants to challenge your discharge, they could object before the bankruptcy court finalizes your case.

Let's Summarize...

Owing past-due income taxes can be overwhelming, especially as interest and penalties add up. Even a small tax debt can quickly become unmanageable. The good news is that Chapter 7 bankruptcy can erase certain income tax debts, but only if they meet strict IRS rules. If your tax debt doesn’t qualify, Chapter 13 may still help by giving you time to pay it off while stopping IRS collection efforts. 

Exploring your options can help you find the best path toward financial relief. If you want some legal advice regarding your case, you can set up a free consultation with a qualified bankruptcy attorney. If you have a simple Chapter 7 case, you may be eligible to use Upsolve’s free filing tool to file without an attorney.