What’s the Difference Between Tax Liens vs. IRS Debt in Bankruptcy?
When facing overwhelming IRS debt, many individuals consider filing for bankruptcy to achieve financial relief. However, not all tax obligations are treated equally in bankruptcy, and it’s important to understand the distinction between IRS debt and tax liens. Each type of tax burden has unique implications in bankruptcy, and consulting with the Los Angeles IRS tax debt lawyers at Wadhwani & Shanfled can help you understand how they differ and make informed decisions about managing your tax obligations.
IRS Debt in Bankruptcy
IRS debt refers to unpaid taxes owed to the Internal Revenue Service (IRS), including income taxes, penalties, and interest. When individuals owe back taxes and struggle to repay them, bankruptcy may offer a way to discharge or restructure those debts. However, not all IRS debt is dischargeable, and specific criteria must be met.
To determine whether IRS debt can be discharged in bankruptcy, the following conditions generally apply:
- Three-Year Rule: The tax return must have been due at least three years before the bankruptcy filing.
- Two-Year Rule: The tax return must have been filed at least two years before the bankruptcy filing.
- 240-Day Rule: The IRS assessment of the tax must have occurred at least 240 days before the bankruptcy filing.
If these conditions are met, certain federal income tax debt may be eligible for discharge in Chapter 7 or Chapter 13 bankruptcy. However, taxes associated with fraud or failure to file a return are typically non-dischargeable, meaning the debtor will remain responsible for those debts even after bankruptcy.
Discharging IRS Debt in Chapter 7 Bankruptcy
Chapter 7 bankruptcy is designed to give individuals a fresh start by discharging certain unsecured debts. Regarding IRS debt, income taxes may be discharged under Chapter 7 if they meet the abovementioned criteria. This means that, upon successfully completing the bankruptcy process, the debtor may no longer be liable for certain past-due taxes.
However, it’s important to note that Chapter 7 only discharges the debt itself, not any associated tax liens (more on this below). Additionally, penalties for late payments and interest related to those taxes are also dischargeable under Chapter 7, assuming the underlying taxes are eligible for discharge.
IRS Debt in Chapter 13 Bankruptcy
In Chapter 13 bankruptcy, debtors enter into a court-approved repayment plan that lasts three to five years. Unlike Chapter 7, which eliminates eligible debts outright, Chapter 13 allows individuals to reorganize and repay their debts over time. While this process doesn’t automatically discharge IRS debt, it can provide significant relief by allowing the debtor to catch up on payments in a structured manner.
In a Chapter 13 case, eligible IRS debt may be treated as unsecured debt and potentially discharged at the end of the repayment period, depending on the debtor’s financial circumstances. However, priority tax debts, including more recent tax obligations, are often required to be paid in full as part of the repayment plan.
What is a Tax Lien?
A tax lien is a legal claim filed by the IRS against a debtor’s property due to unpaid taxes. When the IRS files a lien, it essentially asserts its right to claim the debtor’s property or assets if the tax debt remains unpaid. Tax liens can be placed on real estate, personal property, and financial assets. The purpose of a tax lien is to protect the government’s interest in recovering unpaid taxes.
Unlike IRS debt, which may be discharged in bankruptcy, tax liens are treated differently. While bankruptcy can eliminate the personal obligation to repay the underlying debt, the lien itself remains attached to the debtor’s property. This means that if the debtor sells or transfers the property, the IRS may still be entitled to recover the unpaid taxes through the sale proceeds.
The Impact of a Tax Lien in Bankruptcy
Bankruptcy does not automatically remove a tax lien. In Chapter 7, even if the IRS debt is discharged, the lien will remain in place, and the IRS may still seek to enforce the lien against the debtor’s property. This is because a tax lien is a secured claim, and secured claims are treated differently than unsecured debts in bankruptcy.
For example, if you own a home and a tax lien is placed on it before you file for Chapter 7 bankruptcy, the IRS still has a right to collect on the lien if the property is sold. While the bankruptcy discharge eliminates your personal liability for the debt, the IRS retains its right to pursue repayment through the lien on the property.
In Chapter 13 bankruptcy, tax liens may be addressed through the repayment plan. Depending on the value of the lien and the type of property it’s attached to, the debtor may be able to pay off the lien over the course of the three- to five-year repayment period. However, if the lien is not fully satisfied during the repayment plan, it will remain attached to the property after bankruptcy, similar to Chapter 7.
Tax Lien vs. IRS Debt: Key Differences in Bankruptcy
- Dischargeability: IRS debt can be discharged in Chapter 7 or Chapter 13 bankruptcy if it meets certain criteria. Tax liens, on the other hand, are not discharged and continue to attach to property even after bankruptcy.
- Property Impact: IRS debt discharge removes your personal obligation to repay, while tax liens remain secured against your property. If a property is sold, the IRS can still collect through the lien.
- Treatment in Chapter 13: In Chapter 13, IRS debt can be paid off through a repayment plan, and some of it may be discharged at the end of the case. Tax liens can be addressed in the plan but may still remain on the property if not fully satisfied.
Contact Wadhwani & Shanfeld
Understanding the difference between IRS debt and tax liens in bankruptcy is essential for managing tax obligations effectively. While bankruptcy can offer relief from certain types of tax debt, tax liens are more complex and require a strategic approach. If you’re facing significant tax debt or have tax liens on your property, consulting with an experienced bankruptcy attorney can help you explore your options and protect your assets.
At Wadhwani & Shanfeld, our knowledgeable bankruptcy attorneys can guide you through the process of addressing IRS debt and tax liens. Whether you’re considering Chapter 7 or Chapter 13 bankruptcy, we can provide the legal support you need to achieve financial relief. Contact us today for a consultation and take the first step toward resolving your tax-related challenges.
Sources:
irs.gov/businesses/small-businesses-self-employed/understanding-a-federal-tax-lien#:~:text=A%20lien%20secures%20the%20government’s,or%20have%20an%20interest%20in.
forbes.com/advisor/debt-relief/does-bankruptcy-clear-tax-debt/
