Bankruptcy ✦ Tax Debt
Yes, Bankruptcy Can Wipe Out Tax Debt. Here Is Exactly When.
Income tax owed to the IRS and the Franchise Tax Board is dischargeable in bankruptcy when four timing tests are met, and the difference between meeting them and missing them is often a matter of weeks. North Star Law Firm reads the transcripts, runs the dates, and times the filing. It is the intersection of tax law and bankruptcy law, and it is the work an attorney-CPA was built for.
The Short Answer
Yes. Old income tax goes away in bankruptcy. Recent tax does not.
That is the whole rule, and everything else on this page is detail. If you owe the IRS or the Franchise Tax Board for income tax from a few years ago, you filed the return yourself, and nobody has been fighting about it recently, that debt is treated like a credit card balance: it is wiped out in Chapter 7 and paid pennies on the dollar in Chapter 13. If the tax is from the last couple of years, or you never filed the return, the debt survives a Chapter 7, but a Chapter 13 plan still lets you pay it over up to five years with no more penalties piling on and with the IRS and FTB barred from levying you while you do.
Three questions tell you which side of the line a tax year is on:
- Is it old enough? The tax year has to be at least three years past the date the return was due. Tax for 2022, due in April 2023, becomes old enough in April 2026. If you took an extension that year, add six months.
- Did you file the return yourself? The return has to have been filed by you, at least two years before the bankruptcy. A late return still counts, but the two-year wait starts the day you filed it. A return the IRS made up for you does not count.
- Has it been on the books long enough? At least eight months (240 days) have to pass after the IRS or FTB officially recorded the amount. For a normal return that happens a few weeks after you file, so it rarely matters. After an audit, it matters a lot.
Yes to all three, and that year’s tax is dischargeable. The catch is that things you may have done to deal with the IRS in the meantime, like submitting an offer in compromise, asking for an appeals hearing, or filing an earlier bankruptcy, stop the clocks while they are pending. That is why the answer for any specific year comes from your IRS and FTB transcripts, not from memory, and why the analysis is the first thing we do at a free consultation.
Listen First
The three clocks, explained in 26 minutes
This episode of the North Star Tax and Legal Briefing walks through the rules on this page the way clients experience them: why filing an extension pushes your discharge date back six months, how an audit years later starts a brand-new 240-day clock, how an offer in compromise or an appeals hearing puts you in the penalty box, what never discharges, and a five-year worked example where a three-week delay in filing turns a surviving tax debt into a discharged one. It is built on Phillip Zagotti’s writing on the subject; the California rules are the same, with the Ninth Circuit’s own case law on late-filed returns discussed further down this page.
The Rules
The same three questions, as the Bankruptcy Code states them
For readers who want the statute behind the short answer: income tax is treated like any other unsecured debt, and discharged, only if all four of the following are true on the day the bankruptcy petition is filed. Fail any one and the tax is a priority claim: it survives a Chapter 7 discharge and must be paid in full through a Chapter 13 or Subchapter V plan. The tests apply identically to federal income tax and to California income tax owed to the FTB.
| Test | Rule | Statute | What pauses the clock |
|---|---|---|---|
| Three-year rule | The return was due, including any extension, more than three years before the petition date | 11 U.S.C. § 507(a)(8)(A)(i) | A prior bankruptcy (the time in the case plus 90 days); a pending offer in compromise or collection due process request (the time pending plus 90 days), under § 507(a)(8) hanging paragraph |
| Two-year rule | The return was actually filed more than two years before the petition | 11 U.S.C. § 523(a)(1)(B)(ii) | Nothing; a return filed late starts its own two-year clock. In the Ninth Circuit, a return filed after the IRS assessed a substitute for return may not count as a return at all |
| 240-day rule | The tax was assessed more than 240 days before the petition | 11 U.S.C. § 507(a)(8)(A)(ii) | A pending offer in compromise (the time pending plus 30 days); a prior bankruptcy (the time in the case plus 90 days) |
| No fraud or evasion | The return was not fraudulent and the taxpayer did not willfully attempt to evade the tax | 11 U.S.C. § 523(a)(1)(C) | Not a timing test; a factual one, litigated case by case |
Every one of those dates lives in your IRS account transcript and your FTB account history: the return due date, the received date, the assessment date, and the codes that show an offer, a CDP request, or a prior bankruptcy. Reading them is a tax skill, not a bankruptcy skill, and it is the reason a bankruptcy attorney who is also a CPA gets a different answer than one who is not.
What never discharges, and what to do about it
Trust fund taxes are never discharged: payroll taxes withheld from employees’ wages and sales tax collected from customers belong to the government the moment they are collected, and the trust fund recovery penalty under I.R.C. § 6672 (and the parallel liability to the EDD and the CDTFA) follows the responsible person through any bankruptcy. Tax for which no return was filed, and tax on a fraudulent return, are likewise excepted under § 523(a)(1)(B) and (C). Tax penalties tied to non-dischargeable tax generally survive as well, although penalties on events more than three years old are often dischargeable even when the underlying tax is not.
Non-dischargeable tax is not the end of the analysis. A Chapter 13 plan pays priority tax over up to five years with penalties frozen and, for unsecured priority claims, no post-petition interest, while the automatic stay stops every levy. A Subchapter V plan does the same for a business’s payroll and sales tax. And outside bankruptcy, an offer in compromise or a partial-pay installment agreement may resolve the balance for less. Because this firm handles all of those tools, the recommendation you get is the cheapest one, not the one the firm happens to sell.
Tax liens survive the discharge. Plan for them.
A discharge eliminates your personal liability for a tax, but a Notice of Federal Tax Lien recorded before the filing remains attached to property you owned on the petition date, including exempt property like your home and retirement accounts, to the extent of their value. The same is true of an FTB lien recorded with the county. If the IRS recorded a lien and you have equity, the lien is a secured claim that has to be dealt with: paid through a Chapter 13 plan at the value of the equity, negotiated for release or subordination after discharge, or simply outlasted, because the lien is only good for the collection statute. We read the lien filings and the equity together before filing, so the discharge order does not come with a surprise attached to your house.
Timing the filing to the day
The three-year rule runs from the return due date, so tax for a year whose return was due April 15 becomes eligible on April 16 three years later, or October 16 if the return was extended, whether or not you actually used the extension. The 240-day rule runs from the assessment date on the transcript, which for a late-filed return or an audit adjustment can be years after the due date. An offer in compromise you filed and withdrew two years ago may have added months to both clocks. When the analysis shows a $60,000 tax year clearing the rules in seven weeks, the right advice is to wait seven weeks, and if a levy or garnishment makes waiting impossible, a Chapter 13 filed now and converted later, or a short installment agreement to bridge the gap, can hold the line. That is planning, and it is free at the consultation.
The Attorney-CPA Difference
The discharge tests are dates on a transcript. We read transcripts for a living.
- IRS and FTB transcripts pulled and analyzed before any filing decision
- Every tolling event identified: prior cases, offers, CDP requests, extensions, substitute returns
- Tax liens, equity, and exemptions modeled together so the discharge actually clears the property
- Bankruptcy compared against an offer in compromise or installment agreement, in writing, before you choose
Questions & Answers
Tax discharge questions, answered
The IRS filed returns for me. Does that count as filing?
Usually not in your favor. A substitute for return under I.R.C. § 6020(b) is not a return filed by you, and in the Ninth Circuit, which includes California, a return you file after the IRS has already assessed on a substitute return may not qualify as a return for discharge purposes at all. The strategy in that situation is specific and depends on the dates; bring the transcripts.
Does the FTB follow the same rules?
Yes. The Bankruptcy Code’s discharge and priority rules apply to state income tax the same way they apply to federal, so California income tax owed to the FTB is analyzed under the same four tests, using the FTB’s own due, filed, and assessment dates.
I owe payroll tax from a business that closed. Can bankruptcy help at all?
The trust fund portion is not discharged, but bankruptcy still helps. Chapter 13 pays it over five years with the stay in place, and the discharge of everything else frees up the income to do so. If the business is still operating, Subchapter V addresses the payroll tax in the company’s plan.
What if bankruptcy is not the right tool for my tax debt?
Then we will tell you, and handle the alternative. An offer in compromise, an installment agreement, penalty abatement, or a collection due process hearing may resolve the balance without a filing. The comparison is the first thing we do.
Find out which of your tax years can go away, and when.
A free tax discharge analysis with an attorney-CPA, built from your actual IRS and FTB transcripts.