Does Bankruptcy Get Rid of Tax Debt? Pros and Cons of a Chapter 7 Bankruptcy

Are you struggling with tax debt and facing bankruptcy? You may breathe a sigh of relief to know that you can sometimes eliminate tax debt with bankruptcy. Whether you can avoid paying Uncle Sam depends on a few factors, though.

Eliminating tax debt is possible if you file Chapter 7 bankruptcy. This is one of the more common types of bankruptcy. In 2016, 509,769 people filed for Chapter 7 bankruptcy, according to the United States Courts.

If you’re able to discharge your tax debt in Chapter 7 bankruptcy, it can be completely eliminated. That means you pay nothing. Chapter 7 bankruptcy is designed to allow those with debt, who are unable to pay, a chance to wipe out the debt and start with a clean slate.

Chapter 7 bankruptcy requirements

Not everyone can get rid of tax debt with Chapter 7 bankruptcy. According to Mark Billion, CEO of, you must meet several criteria to qualify.

There’s the 3-2-1 rule for bankruptcy and taxes. The taxes need to have been due three or more years ago, filed more than two years ago, and assessed more than 240 days (one year) ago.”

Says Billion, “There’s the 3-2-1 rule for bankruptcy and taxes. The taxes need to have been due three or more years ago, filed more than two years ago, and assessed more than 240 days (one year) ago.” You also qualify if the taxes have never been assessed.

Dismissal of taxes owed only applies to income taxes. Says Billion, “Remaining financial obligations, like payroll taxes, cannot be discharged in bankruptcy.” In addition, warns Billion, “File your taxes on time. Late-filed returns are often not dischargeable [able to be forgiven].”

If you filed a fraudulent return or otherwise evaded paying your taxes, you don’t qualify for IRS tax debt forgiveness.

How Chapter 7 bankruptcy works

Chapter 7 bankruptcy proceedings start when you file a petition with the bankruptcy court in the area where you live. When you file, you must also provide additional information, including the following:

  • Your assets and liabilities
  • Your current income and expenses
  • An explanation of your current financial situation
  • Current contracts or leases
  • Recently filed tax returns

Fees are also due when you file Chapter 7 bankruptcy. These currently total $335. [source]

Property tax liens and bankruptcy

It’s important to note that, if the IRS recorded a tax lien on your property before the bankruptcy, the lien will remain. You won’t be personally liable to pay the lien, but you’ll need to settle it before you can sell the property. If this occurs, there are steps you can take.

Drawbacks to Chapter 7 bankruptcy for tax forgiveness

While Chapter 7 bankruptcy allows you to start fresh with no debt, the solution has drawbacks. Your credit score will plummet. The bankruptcy stays on your credit report for up to 10 years. [source]

You may also lose important possessions during the procedure. Chapter 7 bankruptcy is known as liquidation bankruptcy. That means that your assets will be sold and your creditors will receive payment from the sale of your property.

Non-exempt items that can be seized during Chapter 7 bankruptcy include credit cards, investments, and valuables such as stamp and coin collections, family heirlooms, a second home or vacation home, and a second vehicle.

The exempt property you can keep includes vehicles (up to a certain value), most clothing, household goods and furniture, appliances, jewelry (up to a certain value), your home and some of its equity, and pensions.

If you don’t wish to part with your property and your tax debt is several years old, Chapter 7 bankruptcy may not be the best idea. There is a 10-year statute of limitations on tax debt. After 10 years, tax debt is usually forgiven by the IRS. If you’re close to forgiveness, it may pay to wait. Filing for bankruptcy extends the statute of limitations.

Alternatives to Chapter 7 bankruptcy for tax payment

Given the drawbacks to bankruptcy, it may be a better idea to find an alternative way to pay off the IRS. The IRS is open to working with you to resolve your tax debt. Read this article for a comprehensive list of tax debt relief strategies.

Uncle Sam offers short and long-term payment plans. You can also try for an offer in compromise, which can reduce your tax debt. Penalty abatement is another option. This eliminates accrued tax penalties.

If you own a home with some equity, a HELOC could also be a good solution. You can generally access 85% of your home’s equity. That money can be used to pay off the IRS. HELOCs are easy to qualify for and generally feature low interest rates.

You might also consider paying off the IRS with a personal loan. With good credit (700+), you can get a competitive interest rate.

Start by getting pre-approved personal loan offers without affecting your credit score.

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Consult with a tax relief company

Owing to the IRS and filing for bankruptcy are two serious financial matters. If you decide to go the bankruptcy route to erase your tax debt, consider seeking professional assistance.

A tax relief company can help you determine the best way to resolve your tax debt.

The best place to start is to first find out if you qualify for tax relief. Then, make sure you review and compare the top tax relief companies side by side to find the best option for you.

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