Bankruptcy rules and regulations – particularly regarding taxes – can be highly dependent on the chapter you file. Both Chapter 7 and Chapter 13 stop collection efforts by the Internal Revenue Service while you're in bankruptcy. Beyond this, however, each chapter treats tax debts differently.
In a Chapter 7 bankruptcy, the trustee takes control of your non-exempt assets and sells them to pay your creditors. Exemptions allow you to protect some of your property. If you have no non-exempt assets so there's nothing to liquidate, some tax debts can be eliminated – those resulting from returns you submitted at least two years before you filed if the returns were due at least three years before. If you have some non-exempt assets, the IRS receives payment before other creditors. If your tax debt isn't discharged, it will still be due after your bankruptcy is over; the IRS can begin trying to collect from you again at that time. Interest and penalties continue to accumulate while you're in bankruptcy.
Chapter 13 is a court-approved plan to pay off your creditors with your disposable income over a period of three to five years. If you owe the IRS, your tax debt is included in the debts paid off through your plan. If you don't pay the tax debt entirely, the remaining balance is typically discharged. Unlike with a Chapter 7 proceeding, penalties and interest stop piling on when you file for Chapter 13 protection.
Read More: Chapter 13 Bankruptcy Explained
- The Law Dictionary: Bankruptcy Impact on Money Owed to the IRS
- Howard S. Levy: Offer in Compromise vs. Bankruptcy – Which Settlement Amount Will Be the Lowest?
- Steven R. Jacob: Bankruptcy
- United States Courts: Chapter 7 – Liquidation Under the Bankruptcy Code
- United States Courts: Chapter 13 – Individual Debt Adjustment
Beverly Bird is a practicing paralegal who has been writing professionally on legal subjects for over 30 years. She specializes in family law and estate law and has mediated family custody issues.