Does Bankruptcy Clear Tax Debt?

The rules that determine if your tax debt can be discharged

For income tax debt to be dischargeable in bankruptcy, it must satisfy five stringent requirements, often called the “discharge rules.” All five conditions must be met—failing even one means the tax debt survives bankruptcy.

The three-year rule

• The tax debt must be from a tax return that was originally due at least three years before you file for bankruptcy. This countdown begins from the return’s due date, including any extensions you properly requested. For example, if you’re considering bankruptcy in 2025, only taxes from returns due in 2022 or earlier would satisfy this requirement.

• It’s important to note that extensions affect this calculation. If you filed for an extension on your 2020 tax return, moving the due date from April 15, 2021, to October 15, 2021, the three-year clock wouldn’t start until October 15, 2021.

The two-year rule

• You must have filed the tax return for the debt in question at least two years before filing for bankruptcy. This rule trips up many people who fell behind on filing returns. Even if the underlying tax year is old enough to satisfy the three-year rule, if you only recently filed the return, you must wait two years from that filing date.

• This requirement becomes particularly complicated with substitute returns. When taxpayers fail to file, the IRS can file a substitute return on their behalf. Taxes assessed from these IRS-prepared returns generally cannot be discharged because the taxpayer never actually filed a return. Courts have consistently held that a substitute for return prepared by the IRS doesn’t constitute a return filed by the taxpayer.

The 240-day rule

• At least 240 days must have passed between the date the IRS assessed the tax and your bankruptcy filing date. Assessment typically occurs when you file your return, but it can happen later if the IRS audits you or discovers additional taxes owed.

• This 240-day period can be extended in certain circumstances. If you previously filed an offer in compromise, submitted a request for innocent spouse relief, or filed a previous bankruptcy petition, these actions suspend the 240-day clock. The suspension period gets added to the required 240 days, potentially pushing back the date when your tax debt becomes dischargeable.

The fraud rule

• You must not have filed a fraudulent return or willfully attempted to evade paying taxes. Tax fraud includes deliberately falsifying information on your return, claiming deductions you know you’re not entitled to, or hiding income. Tax evasion involves actions taken to avoid paying taxes you know you owe, such as hiding assets or using false Social Security numbers.

• These are high bars to meet. The IRS must prove fraud or evasion, which requires showing intentional wrongdoing rather than mere mistakes or negligence. However, if the IRS can demonstrate fraud or evasion, the associated tax debt can never be discharged in bankruptcy, regardless of how old it becomes.

The valid return rule

• You must have filed a valid, proper tax return. This requirement connects closely to the two-year rule but goes further. The return must have been honest and legitimate, filed in good faith, and included all required information. Courts have struggled with what constitutes a “valid return,” particularly regarding late-filed returns.

• Some courts have held that returns filed after the IRS has already taken collection action don’t qualify as valid returns for discharge purposes. This remains an evolving area of bankruptcy law with some disagreement among different court jurisdictions.

Types of tax debt that cannot be discharged

Even in bankruptcy, certain tax-related debts remain non-dischargeable regardless of how old they are or whether they meet the discharge rules.

• Recent income taxes: As explained above, income taxes from the most recent three tax years generally cannot be discharged. Even if you filed for extensions or faced other complications, recent tax debts typically survive bankruptcy.

• Trust fund taxes: Trust fund taxes are amounts you withheld from others but failed to pay to the government. The most common examples are payroll taxes that employers withhold from employee wages and sales taxes that businesses collect from customers. These are considered funds held “in trust” for the government, and bankruptcy law prevents their discharge.

• Tax liens: Tax liens create a secured interest in your property. While bankruptcy can eliminate your personal liability for the underlying tax debt (if it meets the discharge requirements), it cannot eliminate liens that attached to your property before you filed for bankruptcy. This means the IRS retains the right to collect from property that had a lien on it before your bankruptcy filing.

• Property taxes: Property taxes less than one year old before your bankruptcy filing cannot be discharged. Additionally, property taxes on property you didn’t own aren’t dischargeable since they remain attached to the property itself.

• Penalties on non-dischargeable taxes: Penalties and interest that accrued on non-dischargeable tax debts also cannot be discharged. However, penalties on dischargeable taxes may themselves be dischargeable if they meet certain time requirements.

How Chapter 7 bankruptcy handles tax debt

Chapter 7 bankruptcy can completely eliminate qualifying tax debts:

• When you file Chapter 7, an automatic stay immediately stops most IRS collection activities, including wage garnishments, bank levies, and collection calls.

• If your tax debt meets all five discharge requirements, it will be wiped out when you receive your bankruptcy discharge, typically three to four months after filing.

• However, Chapter 7 has limitations for dealing with tax debt. It only helps with dischargeable taxes—non-dischargeable tax debts survive the bankruptcy and become collectible again once your case concludes. If the IRS has placed liens on your property before you file, those liens survive even if the underlying debt is discharged.

• Additionally, Chapter 7 requires you to pass a means test showing your income is below your state’s median or that you lack sufficient disposable income to repay creditors. Not everyone qualifies for Chapter 7 relief.

How Chapter 13 bankruptcy handles tax debt

Chapter 13 bankruptcy offers different advantages for dealing with tax debt, particularly when your taxes don’t meet the discharge requirements.

• Rather than liquidating assets, Chapter 13 creates a court-approved repayment plan lasting three to five years.

• In Chapter 13, priority tax debts—those that don’t meet the discharge requirements—must be paid in full through your repayment plan, but you benefit in several ways. Interest and penalties stop accruing once you file, potentially saving thousands of dollars. You can stretch repayment over three to five years rather than facing aggressive IRS collection tactics. The automatic stay protects you throughout the plan period, preventing wage garnishments and levies as long as you make your plan payments.

• Non-priority tax debts that meet the discharge requirements are treated as general unsecured debts in Chapter 13. You pay them through the plan along with credit cards and medical bills, often receiving only pennies on the dollar. Any remaining balance on these qualifying tax debts receives a discharge when you complete your plan.

• Chapter 13 also provides tools for dealing with tax liens. Through a process called lien stripping or lien cramming (depending on your jurisdiction and circumstances), you may be able to address liens on certain types of property.

Special considerations for different types of taxes

While income taxes receive the most attention in bankruptcy planning, other types of taxes have their own rules.

• Payroll taxes: As mentioned earlier, the employee portion of payroll taxes—amounts withheld from workers’ wages—can never be discharged because they’re trust fund taxes. The employer’s portion of payroll taxes (the employer’s matching contribution) may be dischargeable if it meets the time requirements, though this remains a complex area with different courts reaching different conclusions.

• Self-employment taxes: Self-employment taxes present a hybrid situation. The IRS considers part of self-employment tax to be equivalent to trust fund taxes (representing the employee portion) and part to be employer taxes. Some courts hold that none of the self-employment tax can be discharged, while others allow the employer portion to be discharged if time requirements are met. This variation in court approaches makes self-employment tax discharge particularly unpredictable.

• Sales taxes: Collected sales taxes are trust fund taxes that cannot be discharged. If you operated a business and collected sales tax from customers but failed to remit it to the state, that debt survives bankruptcy.

• State and local income taxes: State and local income taxes follow the same discharge rules as federal income taxes. They must meet the three-year, two-year, and 240-day requirements, and you cannot have engaged in fraud or evasion. Many people facing federal tax problems also owe state taxes from the same years, and both may qualify for discharge together if requirements are met.

The automatic stay and its limitations with tax debt

When you file bankruptcy, the automatic stay immediately stops most collection activities. This powerful tool halts wage garnishments, bank levies, collection letters, and phone calls. However, the automatic stay has important limitations regarding tax matters.

• The IRS can continue certain activities despite the stay, including conducting audits, issuing tax deficiency notices, demanding tax returns, and assessing taxes.

• The IRS can also issue a notice of tax deficiency and demand payment for taxes, though it cannot actually collect without court permission.

• For criminal tax matters, the automatic stay provides no protection. Tax-related criminal prosecutions proceed regardless of bankruptcy filing.

Is bankruptcy right for your tax situation?

Deciding whether to file bankruptcy for tax debt requires careful analysis of multiple factors:

1. Calculate how much of your tax debt would actually be discharged. If most of your tax debt is recent (less than three years old), consists of trust fund taxes, or has liens attached, bankruptcy may provide limited benefit.

2. Consider your other debts. If you’re also struggling with credit cards, medical bills, personal loans, and other unsecured debts, bankruptcy might make sense even if it doesn’t eliminate all your tax debt. The discharge of other debts can free up income to address remaining tax obligations.

3. Evaluate the alternatives. Could you negotiate an offer in compromise or set up an affordable installment agreement? These options avoid bankruptcy’s impact on your credit and public record.

4. Assess your overall financial situation. Do you have significant assets that would be liquidated in Chapter 7? Can you afford Chapter 13 plan payments while keeping up with current expenses and new tax obligations?

5. Consider timing carefully. If your tax debt doesn’t currently meet the discharge requirements but will in six months or a year, waiting might significantly improve the outcome of bankruptcy.

Working with professionals

Both tax law and bankruptcy law are complex, and their intersection creates particular challenges. Most people benefit from professional guidance when considering bankruptcy for tax debt.

• A bankruptcy attorney can evaluate whether your taxes meet discharge requirements, advise on Chapter 7 versus Chapter 13, and represent you throughout the bankruptcy process. Many bankruptcy attorneys, however, have limited tax expertise.

• A tax professional, such as a CPA or enrolled agent experienced in tax resolution, can analyze your tax situation, explore IRS programs, and potentially negotiate settlements. Tax professionals cannot, however, provide bankruptcy legal advice or represent you in bankruptcy court.