How Can Bankruptcy Affect Your IRS Tax Obligations?
Under Louisiana law, bankruptcy interacts with IRS rules in very specific ways, and understanding those interactions is crucial when determining if bankruptcy is a viable option for dealing with outstanding taxes.
At the Hoke Law Firm, we work with many clients who feel overwhelmed by both debt and tax obligations. While many people understand that bankruptcy can help address certain debts, there's often confusion about how it impacts federal tax liabilities.
Bankruptcy law provides a legal structure to either discharge certain debts or create repayment plans under court supervision. When taxes are involved, however, not all debts are treated equally.
The IRS has its own set of protections and priorities, which means that not every tax debt will be erased or reduced in a bankruptcy case. The key lies in understanding when taxes qualify for discharge and how the type of bankruptcy filing—whether Chapter 7 or Chapter 13—affects those obligations.
How Tax Debt Fits Into Bankruptcy Law
Bankruptcy law classifies debts as secured, unsecured, or priority. Tax debts often fall under the “priority” category, which means they are treated differently from general unsecured debts like credit card bills or personal loans. Priority debts are usually not dischargeable, and they must be paid in full in most bankruptcy plans.
That said, certain older income tax debts may qualify for discharge under bankruptcy law if they meet specific criteria. This is where timing becomes important—when the tax was assessed, when the return was due, and whether it was filed on time all matter.
Under Louisiana bankruptcy proceedings, the court will consider these factors when determining whether the IRS debt can be wiped out or restructured.
The Key Factors That Determine Dischargeability
While every case is unique, bankruptcy law sets out general rules for when income tax debts can be discharged. These rules apply to both federal law and Louisiana bankruptcy cases. A tax debt may be eligible for discharge if:
The tax return was due at least three years before the bankruptcy filing date.
The return was actually filed at least two years before the bankruptcy filing.
The tax was assessed at least 240 days before the filing.
There was no fraud or intentional evasion involved.
If these conditions are met, bankruptcy law may allow the debt to be eliminated. However, payroll taxes, fraud-related taxes, and certain penalties will almost never be discharged.
How Chapter 7 Bankruptcy Impacts IRS Debts
Chapter 7 bankruptcy is often referred to as a “liquidation” bankruptcy because it involves selling non-exempt assets to pay creditors. For those with qualifying older income tax debts, Chapter 7 can completely wipe out those obligations if the eligibility rules are met.
However, IRS tax liens are a separate issue. Even if the underlying tax debt is discharged, an IRS lien filed before bankruptcy will survive the case and remain attached to any property you owned at the time of the filing.
This means that bankruptcy law can relieve you of the personal obligation to pay the tax, but it may not remove the lien unless the IRS releases it voluntarily.
In Louisiana, the same rules apply—if the IRS has secured a lien, bankruptcy will not automatically erase it. This is why we evaluate not only the debt itself but also any IRS enforcement actions that have already taken place.
How Chapter 13 Bankruptcy Impacts IRS Debts
Chapter 13 bankruptcy works differently. Instead of liquidation, it involves creating a court-approved repayment plan that typically lasts three to five years. Under bankruptcy law, priority debts like recent tax obligations must be paid in full during this plan period, but it also provides benefits for dealing with the IRS.
First, Chapter 13 stops IRS collection actions immediately through the automatic stay. Wage garnishments, bank levies, and property seizures must cease as soon as the case is filed.
Second, the repayment plan can spread out tax payments over several years without additional penalties accruing, making it easier for debtors to handle the financial burden.
In Louisiana, many clients find Chapter 13 particularly helpful if they owe both dischargeable and non-dischargeable tax debts. The plan allows them to pay the IRS in an orderly fashion while also addressing other creditors, giving them room to recover financially.
Penalties, Interest, and How Bankruptcy Law Addresses Them
A common question we hear is whether bankruptcy stops the interest and penalties the IRS adds to tax debts. Bankruptcy law treats these charges differently depending on whether the underlying tax debt is dischargeable.
If the tax itself can be discharged, related penalties and interest may also be wiped out. If the tax isn't dischargeable, the interest will likely continue to accrue until the debt is paid in full.
In a Chapter 13 case, however, the interest on certain priority tax debts stops accruing during the repayment period, which can significantly reduce the total amount owed. This is a valuable benefit for those struggling to keep up with aggressive IRS interest rates.
The Automatic Stay and Its Impact on the IRS
One of the most powerful tools in bankruptcy law is the automatic stay. When a bankruptcy case is filed, this court order halts most collection actions immediately. For IRS debts, this means that wage garnishments, bank levies, property seizures, and even some ongoing audits must stop.
However, the automatic stay is not permanent. If a debt is non-dischargeable and not fully addressed through the bankruptcy process, the IRS can resume collection efforts once the case is closed. This is why it's important to address all tax liabilities during the bankruptcy itself.
Common Misunderstandings About Bankruptcy and Taxes
We often meet people who believe bankruptcy law automatically eliminates all tax debts, but this is not the case. Others think filing bankruptcy will trigger additional IRS scrutiny or penalties, which is generally untrue. While the IRS does receive notice of the filing, the process is governed by law and the court, not by IRS discretion.
Another misconception is that you cannot file for bankruptcy if you have unfiled tax returns. In reality, bankruptcy law requires that all tax returns for the past four years be filed before the case can proceed, but you can prepare and file those returns quickly to meet the requirement.
The Benefits and Limits of Bankruptcy Law in Tax Cases
When used strategically, bankruptcy law can give taxpayers breathing room, stop aggressive IRS collection actions, and even discharge certain older income tax debts. However, it isn't a universal solution, and in some cases, an alternative such as an Offer in Compromise or IRS installment agreement may be more appropriate.
In Louisiana, the bankruptcy court will carefully review the type of taxes owed, how old they are, whether returns were filed on time, and whether any fraud or evasion occurred. These factors determine whether relief is possible and what form it can take.
Steps to Take If You Owe the IRS and Are Considering Bankruptcy
If you're facing both overwhelming debt and significant IRS tax liabilities, there are several key steps to take before deciding whether to file for bankruptcy:
Gather all tax records and confirm that all required returns have been filed.
Determine the age of the tax debts and when they were assessed.
Review any IRS liens or pending enforcement actions.
Consult with a bankruptcy attorney familiar with both Louisiana law and federal tax rules.
Evaluate whether Chapter 7, Chapter 13, or a non-bankruptcy IRS resolution is the best option.
By taking these steps, you can avoid mistakes that might limit your options under bankruptcy law and make an informed decision about your next move.
Why We Guide Clients Through Both Bankruptcy and Tax Concerns
At Hoke Law Firm, we have seen firsthand how stressful it's to face the combined pressure of debt and IRS collection actions. We use bankruptcy law as one of several tools to help our clients achieve financial relief. For some, it means discharging older tax debts entirely; for others, it means restructuring payments in a manageable way.
Our approach is to look at the entire financial picture, including assets, liabilities, income, and expenses, along with the specifics of each tax debt. This allows us to determine whether bankruptcy is truly the right choice or if another path would be more effective.
Contact a Bankruptcy Attorney Today
Bankruptcy law offers meaningful relief for certain tax debts, but it isn't an all-or-nothing solution. The dischargeability of IRS obligations depends heavily on the age of the debt, filing history, type of tax, and whether there has been any fraud or evasion.
For Louisiana residents, these rules apply just as they do nationwide, but state exemptions and procedures may also affect the outcome. If you're struggling under the weight of IRS debts, understanding how bankruptcy law interacts with those obligations is the first step toward regaining financial control.
By assessing your tax situation in detail and applying the right legal strategy, you can use bankruptcy to either eliminate or better manage your IRS responsibilities, giving you the opportunity to rebuild your financial future. We’re proud to serve Baton Rouge, Louisiana, as well as the neighboring areas of New Orleans and Lafayette. Call today.