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Can I discharge my tax debt in bankruptcy?

When filing for bankruptcy, people as a rule take it seriously—they know they are making a decision that will have a big impact on their life, financially and otherwise. Before filing for bankruptcy, it is important to get the answers to basic questions answered. This includes questions about how bankruptcy affects a person’s credit score, spouse, mortgage, job or future employment, eligibility for financial aid, and so on and so forth.

One aspect of bankruptcy that folks may not think to ask about immediately is how bankruptcy will affect their tax liabilities. To begin with, it is important to make it clear from the outset that tax debt discharged in bankruptcy is generally not considered taxable income. That being said, not all types of tax debt may be discharged in bankruptcy. 

Some examples of tax debt that cannot be discharged in bankruptcy include trust fund penalties, fraud assessments, and the trust fund part of payroll tax debts. Taxes that are dischargeable in bankruptcy must be personal income taxes that are a minimum of three years old. Other qualifications apply as well, including that tax returns must have been filed on the debt.

In some cases, debtors may be better off negotiating tax debt. Submitting an “Offer in Compromise” to the IRS is the alternative in cases where it is not possible to wipe out tax debt due to bankruptcy requirements.

This brings up the larger issue of the non-dischargeable character of certain types of debt. While bankruptcy can provide relief on a great many types of debt, it does not wife all debt out without discrimination. Some forms of tax debt may be discharged, but only if certain requirements are met. And in terms of taxable income from discharged debt, it is still good to work it into your tax return for record-keeping, even though it is not taxable income. 

Source: Fox Business, “How Bankruptcy Impacts Your Taxes,” Bonnie Lee, July 25, 2013. 

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