Yes, bankruptcy can discharge IRS debt – but only if you pass the 3-2-240 rule that most taxpayers fail.
I’ve sat across from hundreds of desperate clients over my 17 years as a tax attorney who just want a fresh start.
They come in carrying the weight of massive tax debt, bankruptcy papers already printed, ready to sign away their financial future for relief.
And almost every time, I have to tell them the same thing: your tax debt probably won’t qualify for discharge.
Here’s the harsh reality: while Americans owe over $120 billion in back taxes, and 7 million people fail to file their returns each year, bankruptcy only works for a specific subset of tax debts.
The IRS designed it this way intentionally.
They want their money, and they’ve created rules so precise that one day’s difference can mean keeping or losing tens of thousands in debt.
But when bankruptcy does work for tax debt? It can eliminate everything.
I’ve seen clients walk away from $75,000 in IRS debt without paying a penny. I’ve also watched others file bankruptcy on $450,000 in payroll taxes and get nothing discharged – losing assets in the process.
The difference between success and disaster lies in understanding exactly which debts qualify, when to file, and whether bankruptcy is even your best option.
Today, you’ll learn:
- The 3-2-240 rule that determines whether your IRS debt qualifies for bankruptcy discharge
- Which specific tax debts can be completely eliminated through Chapter 7 bankruptcy
- How Chapter 13 creates priority vs non-priority classifications that affect what you’ll pay
- What the automatic stay immediately stops (garnishments, levies) and what continues despite filing
- Why payroll taxes, trust fund penalties, and fraud-related debts never discharge in any bankruptcy
- How unfiled tax returns can completely disqualify you from bankruptcy discharge
- When an Offer in Compromise or Currently Not Collectible status works better than bankruptcy
- The critical difference between tax liens and tax debt in bankruptcy proceedings
- How timing your bankruptcy filing by even one day can save or cost tens of thousands
The 3-2-240 Rule Explained (Your Key to Tax Discharge)
Every tax debt must pass three time-based tests to qualify for bankruptcy discharge. Miss any one of these by even a single day, and that debt survives bankruptcy completely. This isn’t a guideline or a suggestion – it’s federal law, and there are no exceptions.
The 3-Year Rule
Your tax return must have been due at least three years before you file bankruptcy. Not three years from when you actually filed it. Not three years from when you got the bill. Three years from the original due date.
Let’s make this crystal clear with an example. Your 2020 tax return was due April 15, 2021. To discharge this debt through bankruptcy, you cannot file until April 16, 2024. File on April 15, 2024? Too early. That debt survives.
Extensions count toward this time. If you got an automatic extension to October 15, 2021, then October 16, 2024 becomes your earliest bankruptcy date for that year’s taxes. Many taxpayers forget about extensions and file too early, preserving debt they thought would disappear.
The 2-Year Filing Rule
You must have actually filed the tax return at least two years before filing bankruptcy. This catches procrastinators and non-filers hard.
Say you didn’t file your 2018 return until December 2022. Even though that return was originally due in April 2019 (meeting the 3-year rule), you can’t discharge this debt until December 2024 – two years from when you actually filed.
Here’s where it gets worse: if the IRS filed a Substitute for Return (SFR) for you, many courts say you never “filed” at all. That debt becomes permanently non-dischargeable in some jurisdictions. The IRS creates SFRs when you don’t file, estimating your tax owed without any deductions or credits. It’s always higher than what you’d actually owe, and it might lock you out of bankruptcy relief forever.
The 240-Day Assessment Rule
The IRS must have assessed your tax at least 240 days before you file bankruptcy. Assessment happens when the IRS officially records your tax debt in their system – usually shortly after you file your return or they complete an audit.
But certain events reset this clock entirely:
- Filing an amended return
- IRS audit adjustments
- Requesting an Offer in Compromise
- Previous bankruptcy filings
One client came to me ready to file bankruptcy in January. His taxes had been assessed 235 days earlier. Five days. We waited those five days. That patience saved him $42,000.
Quick Test - Will Your Debt Qualify?
Run through this checklist for each tax year you owe. Does your debt meet ALL of these?
- Tax return was due 3+ years ago (including extensions)
- You filed the return 2+ years ago
- IRS assessed the tax 240+ days ago
- It’s income tax (not payroll tax or trust fund)
- No fraud or willful evasion involved
- You actually filed the return (not an SFR)
If you answered “no” to any item, that year’s debt won’t discharge. Period.
What Bankruptcy Immediately Stops (The Automatic Stay)
The moment you file bankruptcy, something powerful happens: the automatic stay kicks in. It’s like hitting a pause button on IRS collections. Within seconds of your filing hitting the court’s electronic system, the IRS must stop all collection activities.
Collections That Stop Day One
When that automatic stay takes effect, the IRS freezes everything:
Wage garnishments halt immediately. If they were taking 25% of your paycheck, your next check comes whole. I’ve had clients file on a Thursday and get their full paycheck on Friday.
Bank levies stop. The IRS can’t touch your accounts. Money they haven’t yet swept becomes protected.
Collection calls cease. No more letters, no more revenue officers at your door. Complete silence.
Property seizures freeze. If the IRS was planning to seize assets, they must stop. Even scheduled auctions get cancelled.
One business owner client was 24 hours from having the IRS seize his equipment – machinery worth $200,000 that would’ve been auctioned for pennies on the dollar. The bankruptcy filing stopped it cold.
What Continues Despite Filing
But the automatic stay isn’t absolute protection. Some things continue:
Tax liens remain attached. If the IRS already filed a Notice of Federal Tax Lien, it stays on your property. Even if the underlying debt gets discharged, the lien survives. You’ll need to deal with it separately.
Criminal tax proceedings continue. Bankruptcy doesn’t stop criminal investigations or prosecutions. If you’re under criminal investigation for tax fraud, bankruptcy won’t help.
New tax obligations accumulate. Taxes for periods after you file aren’t covered. You must stay current or risk dismissal of your bankruptcy case.
Interest keeps running on priority debts. Non-dischargeable tax debts continue accruing interest throughout bankruptcy.
The automatic stay lasts only 30 days in certain situations, especially if you’ve filed bankruptcy before. Multiple filings can eliminate the stay entirely. This isn’t a game you can play repeatedly.
Chapter 7 vs Chapter 13 - Which Discharges IRS Debt?
The type of bankruptcy you file determines whether tax debt gets eliminated completely or just becomes more manageable. Each chapter serves different purposes and offers different outcomes for tax debt.
Chapter 7 - Complete Discharge (If You Qualify)
Chapter 7 bankruptcy can completely eliminate qualifying tax debt. Not reduce it. Not put it on a payment plan. Eliminate it. Forever.
Here’s how it works: you liquidate non-exempt assets to pay creditors. Whatever qualifying tax debt remains after liquidation gets discharged. If you have no significant assets (most people don’t), you pay nothing and still get the discharge.
One client owed $75,000 in taxes from 2017-2019. Every penny qualified under the 3-2-240 rule. He filed Chapter 7, kept his modest home and car (both exempt), and walked away debt-free. The entire process took four months.
But Chapter 7 has strict requirements:
- You must pass the means test (income below state median or no disposable income)
- You can’t have filed Chapter 7 in the past 8 years
- You must complete credit counseling
- All tax returns must be filed and current
If your tax debt doesn’t meet the 3-2-240 rule, Chapter 7 won’t help. That debt survives completely, and you’ve liquidated assets for nothing.
Chapter 13 - Partial Discharge Through Payment
Chapter 13 works differently. Instead of liquidating assets, you propose a 3-5 year payment plan. You keep your property but must pay disposable income toward debts.
For tax debt, Chapter 13 creates two categories:
- Priority tax debts must be paid in full. These are recent taxes, payroll taxes, or anything not meeting the 3-2-240 rule. Your payment plan must pay 100% of priority tax debt, with interest.
- Non-priority tax debts get treated like credit cards. Old taxes meeting the 3-2-240 rule become non-priority. You might pay 10%, 50%, or nothing toward these, depending on your disposable income. Whatever remains after completing your plan gets discharged.
A couple came to me owing $125,000 in mixed tax debt. About $40,000 qualified as non-priority (old enough), while $85,000 was priority (too recent). Their Chapter 13 plan paid the $85,000 in full over 5 years, but only $4,000 toward the old debt. The remaining $36,000 was discharged upon completion.
Quick Decision Chart
Choose Chapter 7 if:
- Most tax debt meets 3-2-240 rule
- Income below state median
- Few non-exempt assets
- Need immediate relief
Choose Chapter 13 if:
- Mix of old and recent tax debt
- Income above Chapter 7 limits
- Want to keep all assets
- Can afford monthly payments
Choose neither if:
- All tax debt is recent
- Dealing with payroll taxes
- Have mostly trust fund penalties
- Better alternatives exist (often the case)
Debts That NEVER Get Discharged
Some tax debts survive any bankruptcy, no matter which chapter you file or how long you wait. Understanding these exceptions prevents costly mistakes.
Payroll taxes and trust fund taxes never discharge. When you withhold taxes from employees’ paychecks, that money belongs to the government. You’re just holding it temporarily. This “trust fund” portion – the actual withholdings – cannot be discharged. Ever.
I watched a restaurant owner file bankruptcy on $450,000 in payroll taxes. He lost assets through Chapter 7 liquidation and still owed every penny afterward. The bankruptcy accomplished nothing except adding attorney fees to his problems.
Tax fraud penalties survive forever. If the IRS assessed fraud penalties, those amounts don’t discharge. The underlying tax might qualify if it meets the 3-2-240 rule, but fraud penalties remain.
Taxes from unfiled returns don’t discharge. You must have actually filed the return. If you never filed and the IRS created an SFR, most courts say that debt can’t be discharged. Some circuits disagree, but don’t gamble on being in the right jurisdiction.
Recent tax years stay with you. Any tax year not meeting the 3-2-240 rule survives bankruptcy completely. This includes the current year and usually the previous 2-3 years.
Willful evasion locks you out. If you intentionally evaded taxes – using fake Social Security numbers, hiding income, destroying records – none of that debt discharges. The IRS will investigate and object to discharge if they find evidence of evasion.
Can You File Bankruptcy with Unfiled Tax Returns?
This question comes up constantly, and the answer frustrates everyone: you cannot receive a bankruptcy discharge if you have unfiled returns for the four years before filing.
The Bankruptcy Code is absolute on this point. All required federal tax returns for the four years preceding your bankruptcy must be filed. Miss even one, and the court can deny your discharge entirely – not just for tax debt, but for everything.
How to Cure Unfiled Returns
If you’re behind on filing, here’s your roadmap:
First, determine what’s missing. Request tax transcripts from the IRS. They’ll show which years have returns on file and which don’t.
File missing returns immediately. Don’t wait for perfect records. File with your best information, even if you have to estimate. You can amend later if needed.
Wait for processing. The IRS typically takes 6-8 weeks to process paper returns. Electronic filing processes faster, but not all prior years can be e-filed.
Then wait longer. Remember the 2-year rule. Filing a late return starts a new clock. You must wait two years from filing before that year’s debt becomes dischargeable.
The SFR Trap Explained
When you don’t file a return, the IRS eventually creates a Substitute for Return. This SFR calculates your tax using only reported income – no deductions, no credits, worst-case scenario.
Here’s the trap: many courts rule that an SFR isn’t a “return” for bankruptcy purposes. Even if you later file a real return, if an SFR was created first, that debt might be permanently non-dischargeable.
Different federal circuits treat this differently. The 1st, 5th, and 10th Circuits generally say post-SFR returns don’t count. Others are more lenient. Don’t gamble on geography – file before the IRS creates an SFR.
Bankruptcy vs IRS Settlement - Which Is Better?
Before you rush to bankruptcy court, consider this: the IRS offers several programs that might work better than bankruptcy, without the credit destruction and asset loss.
Offer in Compromise Statistics
An Offer in Compromise (OIC) lets you settle tax debt for less than you owe. The IRS accepted about 17,000 offers in 2021, with settlements averaging 19% of the original debt.
Compare this to bankruptcy:
- No asset liquidation (keep everything)
- No trustee oversight
- Shorter credit impact (settles immediately vs 7-10 years on credit)
- Can include all tax types (even payroll taxes)
- No waiting periods (can file anytime)
One client owed $200,000 across multiple years, including $50,000 in payroll taxes. Bankruptcy would’ve discharged maybe $75,000 while liquidating his assets. Instead, we secured an OIC for $25,000. He kept everything and saved $175,000.
The catch? OICs have about a 33% acceptance rate. You need to prove you can’t pay the full amount through your remaining collection statute period. Documentation requirements are extensive.
Currently Not Collectible Status
Sometimes the best move is no move. Currently Not Collectible (CNC) status stops all IRS collection while the 10-year collection statute runs.
If you have five years left on your collection statute and qualify for CNC, you might never pay anything. The debt expires when the statute runs out. No bankruptcy, no payments, no credit damage beyond existing tax liens.
CNC works when:
- Income barely covers necessary expenses
- No significant assets to levy
- Health issues prevent working
- Collection would create economic hardship
We placed a client with $167,000 in tax debt into CNC status. She had three years left on her oldest debt’s collection statute. By maintaining CNC status, $89,000 expired before she had to address the remaining balance.
Before You File - Critical Mistakes to Avoid
The difference between successful tax discharge and bankruptcy disaster often comes down to timing and preparation. These mistakes happen constantly and cost taxpayers millions.
1. Tax Refund Trap
File bankruptcy before receiving your tax refund, and the trustee takes it. That refund becomes property of the bankruptcy estate, used to pay creditors.
One client filed Chapter 7 in February, expecting a $9,000 refund. The trustee claimed it immediately. He lost the refund and still had non-qualifying tax debt survive. Had he waited until April, after receiving and spending the refund on legitimate expenses, he would’ve kept that money.
Strategy: If expecting a significant refund, either wait to file bankruptcy or adjust withholdings to eliminate the refund.
2. The Aging Strategy
Sometimes waiting makes debt dischargeable. If your 2021 taxes are two months from meeting the 3-year rule, filing bankruptcy now preserves that debt unnecessarily.
I call this “aging your debt into dischargeability.” Track every tax year’s timeline. Know exactly when each year qualifies. File bankruptcy one day too early, and you’ve locked in debt that would’ve disappeared with patience.
We had a client with $150,000 in tax debt. About $90,000 was 30 days from meeting the 3-year rule. We waited. That month of patience meant $90,000 discharged instead of survived.
3. Documentation Must-Haves
Before filing bankruptcy, gather these documents:
IRS Tax Transcripts – Not your copies, the IRS’s official records. They show:
- Filing dates (proves 2-year rule)
- Assessment dates (proves 240-day rule)
- Any SFRs filed
Audit adjustments
Certified Mail Receipts – If you mailed returns, keep proof. The IRS sometimes loses returns, and your bankruptcy discharge depends on proving you filed.
Assessment Documentation – Print IRS notices showing when tax was assessed. Note any events that might’ve reset the 240-day clock.
Income Documentation – Six months of pay stubs for the means test. Without these, you can’t prove Chapter 7 eligibility.
Missing any of these can delay filing by months or result in the wrong bankruptcy chapter.
Take Action - But Choose Wisely
Bankruptcy can discharge IRS debt, but it’s rarely the best first option. The 3-2-240 rule disqualifies most recent debt, the type causing immediate financial pressure. By the time debt qualifies, you might have better alternatives.
Here’s what 17 years of fighting the IRS has taught me: the agency wants resolution as much as you do. They’d rather collect something through structured agreements than spend resources on enforcement. But they won’t volunteer your best options – you must know what to request.
Before filing bankruptcy, calculate exactly which tax years qualify for discharge. One day’s miscalculation preserves debt unnecessarily.
Consider whether an Offer in Compromise might settle everything for less than bankruptcy would leave you paying. Evaluate if Currently Not Collectible status could run out the collection clock entirely.
Most importantly, don’t navigate this alone. Tax bankruptcy involves three complex systems – tax law, bankruptcy law, and IRS procedures. Missing one detail in any system can cost tens of thousands.
FAQs About IRS Debt and Bankruptcy
Does filing bankruptcy stop IRS collections?
Yes. Filing bankruptcy triggers an automatic stay, which temporarily halts IRS collection activities, including wage garnishments, bank levies, and collection calls. However, the stay may not apply to certain types of tax debt, and it does not eliminate your obligation to pay nondischargeable taxes.
What types of IRS debt cannot be discharged in bankruptcy?
Generally, the following types of IRS debt are not dischargeable in bankruptcy:
- Payroll taxes (trust fund taxes)
- Fraud penalties or debts resulting from tax fraud or evasion
- Recent income tax debts that do not meet the required time criteria
- Certain tax liens that remain attached to your property even after a bankruptcy discharge
Will I lose my tax refund if I file bankruptcy?
You may be required to turn over all or part of a pending tax refund to the bankruptcy estate, depending on your state’s exemption laws and the timing of your filing. If you anticipate receiving a refund, it’s important to discuss this with a qualified bankruptcy attorney before filing.
How far back can IRS debt be discharged in bankruptcy?
For IRS income tax debt to be eligible for discharge, the tax return must have been due at least three years ago, filed at least two years ago, and assessed by the IRS at least 240 days ago. These time-based rules mean that only certain older tax debts qualify for discharge.
Does Chapter 7 remove IRS tax liens?
While Chapter 7 bankruptcy can discharge personal liability for qualifying IRS tax debt, it does not automatically eliminate tax liens that were recorded before the bankruptcy filing. The lien may continue to attach to property even after the debt itself is discharged, unless addressed separately.
Is it better to file Chapter 7 or Chapter 13 for IRS debt?
The best choice depends on your situation:
- Chapter 7 may discharge qualifying older income tax debt completely if you meet all criteria.
- Chapter 13 provides a structured plan to repay priority tax debts and may discharge nonpriority tax debt after the plan is completed.
A bankruptcy attorney can help you determine which option is most beneficial based on the type of IRS debt you owe and your overall financial circumstances.
Can bankruptcy stop an IRS wage garnishment?
Yes – an automatic stay triggered by filing either Chapter 7 or Chapter 13 bankruptcy will generally stop an IRS wage garnishment. However, if your tax debt is not ultimately discharged or fully repaid through the bankruptcy, the IRS may resume garnishment after the case concludes.
Does the IRS forgive debt after 10 years?
The IRS has a 10-year statute of limitations for collecting tax debt, known as the Collection Statute Expiration Date (CSED). In some cases, the IRS may stop collection efforts after this period. However, certain actions – including filing bankruptcy – can pause or extend this 10-year period, so it’s not a guaranteed path to forgiveness.
Can bankruptcy help with state tax debt?
Yes, bankruptcy can sometimes help with state tax debt, such as income tax owed to your state. The dischargeability of state taxes generally follows similar rules to IRS debt, but the exact treatment varies depending on your state’s laws and the nature of the debt.
