How to Handle Tax Debt and IRS Tax Liens in Bankruptcy

Filing for bankruptcy can be a great way to get relief from overwhelming tax debt and IRS tax liens. I know the whole process can seem really confusing and scary, but I promise it’s not as bad as it seems! This article will walk you through everything you need to know about dealing with the IRS and your tax debt when filing for bankruptcy.

The Basics of Tax Debt and Tax Liens

First, let’s go over some of the basics. Tax debt is simply money you owe to the IRS or your state tax agency. This could be from not paying enough taxes throughout the year, underpaying estimated taxes, or not filing a return at all.

A tax lien is when the IRS puts a legal claim on your property as collateral for your tax debt. This gives them the right to seize and sell your property to pay off what you owe if you don’t pay up. Obviously, you want to get rid of tax liens in bankruptcy if possible!

The 240 Day Rule for Tax Debt

One of the most important bankruptcy rules for tax debt is something called the “240 day rule.” Basically, any income tax debt assessed by the IRS more than 240 days before you file for bankruptcy can be discharged, or wiped out[5]. This includes personal income tax as well as trust fund taxes if you had employees.

For example, let’s say you owe $50,000 in back taxes from not filing returns in 2018 and 2019. The IRS assessed this tax debt in November 2020. As long as you file for bankruptcy more than 240 days after November 2020, this tax debt can potentially be discharged in bankruptcy.

If the IRS suspended collection efforts at some point, the 240 day timeframe may be extended[5]. And if you owe other types of taxes like payroll taxes or excise taxes, the rules are a bit different so make sure to consult a tax attorney.

How Tax Liens Are Treated in Bankruptcy

Now let’s talk about tax liens. Unlike tax debt, tax liens are not automatically discharged just by filing for bankruptcy[3]. But that doesn’t mean you can’t get rid of them.

First, any tax lien filed after you file for bankruptcy is automatically invalidated by something called the “automatic stay”[3]. This prevents any creditors, including the IRS, from taking action to collect debts outside of the bankruptcy process.

For tax liens filed before bankruptcy, you have a few options:

• Pay off the tax lien in full through your bankruptcy repayment plan
• Challenge the validity of the lien
• Request the lien be released once the underlying tax debt is discharged

The details get complicated quickly, but a good bankruptcy or tax attorney should be able to help maximize the relief you can get from tax liens[6]. The key is taking action before the tax lien expires – federal tax liens are enforceable for 10 years[3].

Using Chapter 7 Bankruptcy for Tax Debt

Now let’s talk specifics about different bankruptcy chapters. Chapter 7 bankruptcy is where most of your debts are wiped out entirely. Any tax debt meeting the 240 day rule, and any tax liens filed after your bankruptcy case, are usually discharged in Chapter 7[4].

The catch is that you have to pass the Chapter 7 “means test” showing your income is low enough. If it’s too high, you’ll be kicked to a Chapter 13 repayment plan instead. Chapter 7 also requires liquidating some assets to pay creditors, but taxes are at a low priority.

Overall, Chapter 7 gives the quickest and cleanest tax debt relief if you qualify and act fast before tax liens expire. Just make sure to keep filing tax returns and paying ongoing taxes, or the tax debt discharge can be revoked[2].

Using Chapter 13 Bankruptcy for Tax Debt

Chapter 13 bankruptcy involves setting up a 3-5 year repayment plan to pay back creditors, including the IRS. It has more flexibility than Chapter 7, but doesn’t wipe debts out completely.

The good news is there is no means testing, so high income filers qualify. You also get to keep all your assets. The catch is you must complete the entire repayment plan for debts to be discharged.

In Chapter 13, tax liens can often be eliminated for a fraction of the amount owed[6]. And unpaid tax debt can be repaid over time. Interest and penalties may be reduced as well. It takes discipline, but can save you a ton of money vs paying the IRS in full.

Strategies to Reduce Tax Debt in Bankruptcy

To maximize tax relief in bankruptcy, here are some key strategies:

• File bankruptcy as soon as possible after tax assessment to take advantage of the 240 day rule
• File before tax liens expire to increase odds of discharging them
• Consult a tax specialist to help with complex lien issues
• Request an IRS audit reconsideration after bankruptcy to reduce amounts owed
• Negotiate an IRS Offer in Compromise after bankruptcy to settle remaining debts

With some planning and persistence, you can often eliminate or reduce tax debt and liens significantly. It takes some effort, but will be worth it to get the IRS off your back and make a fresh start!

Bankruptcy can seem intimidating, but please don’t wait if you are struggling with overwhelming tax burdens. The tax experts at [insert law firm name] offer a free consultation, so contact us today to discuss your situation!