The relationship between tax debt and bankruptcy can raise many potential issues. For starters, it depends on what type of tax debt is involved and what type of bankruptcy.
There is therefore no single answer when it comes to questions of tax debt and bankruptcy.
For consumer bankruptcy, the most common forms are of course Chapter 7 and Chapter 11. Chapter 7 is often referred to as a "liquidation bankruptcy" because it allows for the discharge of many types of debt.
Not all individuals qualify for Chapter 7, however, because it requires a means test. If a debtor's income exceeds a certain level, a Chapter 7 filing is not in order. But a Chapter 11 filing, which generally involves a debt repayment plan, may be.
There are also some important nuances regarding the means test that debtors can benefit from knowing about. In particular, if over 50 percent your total debt is medical debt or business debt, a means test is not necessary and your may be eligible for Chapter 7 after all. In calculating total debt, be sure to include your mortgage and car loans.
Keep in mind, however, that even in a Chapter 7 bankruptcy, business tax debt is not dischargeable. It's true that personal income taxes may be discharged under certain circumstances. But business tax debt is not.
Obviously it's not an ideal situation when you owe taxes and can't afford to pay them. In that situation, though, an offer in compromise may be the right strategy to choose. It can allow a debtor to settle tax debt for less than the full amount that is owed. Of course, just as with a Chapter 7 bankruptcy, there are strict eligibility requirements. But an experienced tax lawyer can help you understand what they are and how they relate to your situation.
Source: "Declaring Bankruptcy," IRS.gov