There are a few common ways of resolving your IRS tax debt.  The most popular are the offer in compromise and the installment agreement.  But, there is an uncommon way that many people believe doesn’t exist: bankruptcy.  Most people have bought into the myth that bankruptcy filings cannot help with tax problems.  I have even run into some bankruptcy lawyers who believe the same thing.  That couldn’t be further from the truth.  Bankruptcy can eliminate income taxes and non-trust fund related taxes.  You can look at it like this – if you are holding the tax and supposed to pay it on behalf of someone else (e.g. the trust fund portion of payroll taxes or sales tax) then you cannot bankrupt it.

Before we dive in to talk about whether bankruptcy may be a possibility for your taxes, let’s talk about why you may consider filing bankruptcy to resolve your tax debt.  The first reason is so you can resolve your tax debt and other debts like medical bills and credit cards all at one time.   You may just want to get someone else to review your tax debt when the IRS is being unreasonable or is simply unwilling to work with you to resolve your debt in a fair way.  You can use a bankruptcy as leverage to get an offer in compromise accepted that may otherwise be rejected by the IRS.  Filing a bankruptcy will have the immediate effect of releasing any lien or levy the IRS has filed against you. The filing of bankruptcy will stop all interest and penalties from accruing against you and it can be a quick means to resolving your tax problems.

The issue of bankruptcy and taxes are simply a question of timing.  That is, your taxes have to meet certain time requirements before they become bankrupt-able.  Here are some general rules to keep in mind: first, the bankruptcy must be filed more than three years after the tax return was due to be filed (including extensions) and if you are a late filer, the bankruptcy must be at least 2 years after the return was actually filed.  The final timing issue is that if the tax due is a result of an IRS examination (or audit) at least 240 days must have passed since the audit was final and the tax was assessed.

So your first step in determining whether you can bankrupt your taxes will be to examine the periods you owe the IRS for and see if they meet the timing requirements.  The next step will be to review the different types of bankruptcy to determine what you will qualify for and if it will have an impact on your tax situation.

While bankruptcy is an option for corporate taxes, today we are going to focus on the personal tax liability and personal bankruptcy options.  So we will be talking about Chapter 7 and Chapter 13 bankruptcies.

Chapter 7 bankruptcy is the most common form of bankruptcy.  It will generally take between 4-6 months and will result in the elimination of your tax liability.  There are two types of Chapter 7 bankruptcy, asset cases and no asset cases, but before we determine what type of case we have, we must qualify for Chapter 7 by having no disposable monthly income after paying some reasonable living expenses.  While the IRS also considers “reasonable living expenses” they do so according to their collection financial standards which are more strict than the bankruptcy allowances.  But, the determination is similar to that used to determine currently not collectible status like we discussed in episode 2.  If you do not have any monthly disposable income you will be a candidate for a Chapter 7 bankruptcy.

Next, we evaluate your assets.  A no asset case means that you have no meaningful equity in any of your assets to satisfy your debts.  If you have no equity in your assets your case will be considered a no asset case and you will emerge from bankruptcy with all of your assets.  There are also exemptions the bankruptcy code allows for including up to $800 in cash on hand, $1,000 of equity in a car, and up to $5,000 of equity in a personal residence and it will typically al...