What is an IRS Tax Discharge?

Posted on December 22, 2021

A tax discharge is the cancellation of the tax debt due to bankruptcy. However, there’s a common misconception that filing for bankruptcy discharges all debt. Bankruptcy discharges the most unsecured debts. But thanks to the Bankruptcy Abuse Prevention and Consumer Protection Act, most tax debts are not dischargeable, such as payroll taxes, fraud penalties, recent property taxes, and certain employment taxes. Also, if the IRS recorded a federal tax lien on your property before you filed for bankruptcy, the lien remains.

Chapter 7 bankruptcy is a relatively quick process that only takes a few months. However, it only applies to those with little property and, therefore, insufficient to no equity in a property. Your average monthly income over the past six months also needs to be lower than the median income for your state. Known as “straight bankruptcy,” Chapter 7 liquidates your assets so that you can pay off as much debt as possible. But for tax debt to be dischargeable in Chapter 7 bankruptcy, all of the following conditions must be met:

It must be income tax debt. Under Chapter 7, income taxes are the only type of debt that is dissolvable.
The 240-day rule. The IRS must have assessed your income tax at least 240 days before you filed for bankruptcy.
The 3-year rule. The tax debt must have been due at least three years before filing for bankruptcy.

The taxes will also not be discharged if it’s proven that you’ve filed fraudulent returns or willfully attempted to evade paying taxes. It’s also important to mention that some jurisdictions had additional requirements, such as a history of filing tax returns in a timely manner.

Is Bankruptcy the only option?

Filing for bankruptcy is not a choice to be made lightly. And bankruptcy practitioners should take care in advertising and advising delinquent taxpayers that bankruptcy is a tax relief technique. Remember, bankruptcy does not mean you can escape all your tax debt. Chapter 7 bankruptcy will not help you deal with unfiled tax returns, recently filed tax returns, and trust-type taxes – leaving you with lingering issues. Filing for bankruptcy is not always the best option in many situations, particularly if tax relief is on your mind.

Filing bankruptcy also negatively impacts your credit score. In Chapter 7 bankruptcy, the effect of filing remains on your credit reports for ten years from the filing date. So even if your financial situation improves soon, applying for and acquiring credit over the next decade will prove to be challenging.

We advise consulting a tax relief specialist before filing bankruptcy, especially if you have a tax liability and don’t want to damage your credit.

Contact us at 206-970-4477. Talk with a Tax Resolution Expert today. We’re here to help Seattle business owners with their tax concerns and troubles.