Can Bankruptcy Wipe Out Tax Debt?

Understanding How Bankruptcy Impacts IRS Obligations for California Residents

Dealing with overwhelming debt can be stressful enough—but when the IRS is involved, it often feels like there’s no escape. Many California residents struggling with financial hardship often ask: “Can bankruptcy wipe out tax debt?” The answer isn’t a simple yes or no. While bankruptcy can discharge certain types of tax debt, there are strict rules and timelines involved. Understanding these rules is key to determining whether bankruptcy might offer you the relief you’re seeking.

At the Law Offices of Brent D. George, we’ve guided countless individuals in California through the bankruptcy process, helping them make informed decisions about tax obligations and financial recovery. Below, we break down what you need to know about bankruptcy and tax debt.

Types of Bankruptcy That Address Tax Debt

The most common forms of consumer bankruptcy are Chapter 7 and Chapter 13, and both can potentially address tax debt—but in different ways.

• Chapter 7 Bankruptcy is often referred to as “liquidation bankruptcy.” It allows for the discharge of qualifying debts after non-exempt assets are sold to pay creditors.
  
• Chapter 13 Bankruptcy is a “reorganization” plan that allows you to repay debts over a 3- to 5-year period based on a court-approved plan.
  

Each chapter has different implications for tax debt, and eligibility depends on a combination of timing, type of tax, and taxpayer behavior.

When Tax Debt May Be Dischargeable

Certain income tax debts can be discharged in bankruptcy, but only if they meet a strict set of criteria. These are often referred to as the “Five Rules” or the 3-2-240 rule. Let’s take a look:

1. The Taxes Must Be Income Taxes

Only federal or state income tax is potentially dischargeable. Payroll taxes, fraud penalties, or trust fund taxes (like those withheld from employee wages) are not eligible.

2. The Tax Return Must Have Been Due at Least Three Years Ago

This includes any extensions filed. If your return was due on April 15, 2021, but you filed for an extension to October 15, the three-year clock starts from the latter date.

3. The Return Must Have Been Filed at Least Two Years Before Filing Bankruptcy

Even if the tax was due over three years ago, you must have filed the return at least two years prior to filing bankruptcy. In some jurisdictions, late-filed returns may not qualify at all—so this requirement can be complex and jurisdiction-specific.

4. The Tax Assessment Must Be at Least 240 Days Old

The IRS must have assessed the tax liability at least 240 days before you file for bankruptcy. If the IRS suspended collection activity due to an offer in compromise or other appeal, this period may be extended.

5. No Fraud or Willful Evasion

If the IRS finds that you filed a fraudulent return or intentionally evaded paying taxes, that debt will not be dischargeable.

Meeting all five of these conditions is essential. Even if just one is not satisfied, the tax debt will survive the bankruptcy process.

What Bankruptcy Can and Can’t Do for Tax Debts

Here’s a simplified breakdown:

Can Be Discharged	Cannot Be Discharged
Qualifying federal/state income taxes	Payroll taxes
Interest and penalties on dischargeable taxes	Recent income taxes (less than 3 years old)
Taxes assessed over 240 days ago	Fraudulent or evaded taxes

If your tax debt doesn’t qualify for discharge, you still have options. For example, filing under Chapter 13 allows you to restructure and repay non-dischargeable tax debt over a period of time—often with no additional penalties or interest accruing during your plan. This can offer much-needed breathing room, especially for Californians facing both IRS and state (FTB) obligations.

State Tax Debt in California

Just like federal taxes, California Franchise Tax Board (FTB) debts may be dischargeable under the same rules—if they meet the same timing and filing criteria. However, California courts may interpret some of these criteria differently, particularly regarding late-filed tax returns.

Working with an experienced California bankruptcy attorney can make a significant difference when navigating these subtle but important differences in federal versus state tax dischargeability.

Does Filing Bankruptcy Stop the IRS From Collecting?

Yes—immediately. When you file for bankruptcy, an automatic stay goes into effect. This legal provision halts most collection actions, including:

• IRS wage garnishments
  
• Bank levies
  
• Collection letters
  
• Property seizures
  

The automatic stay remains in place during the bankruptcy process, giving you relief from aggressive collection activity. However, this protection may be limited if you’ve had a previous bankruptcy dismissed in the past year.

Should You File Bankruptcy Just to Handle Tax Debt?

Not necessarily. Bankruptcy is a powerful tool, but it’s not the right solution for everyone. If tax debt is your only financial problem, you may have better options, such as:

• Installment agreements with the IRS or FTB
  
• Offer in Compromise (settling tax debt for less)
  
• Currently Not Collectible status (if you can’t afford to pay anything)
  

On the other hand, if your tax debt is part of a larger financial crisis—including credit card debt, medical bills, or foreclosure—then bankruptcy might offer a comprehensive solution.

Getting Legal Guidance

Bankruptcy and tax law are both highly technical, and their intersection can be particularly complex. Mistakes in timing or filing could mean the difference between wiping out thousands in tax debt—or being stuck with it after bankruptcy.

At the Law Offices of Brent D. George, we understand the stress and uncertainty that comes with tax debt. Our team takes a confidential and personalized, strategic approach to each case, helping clients throughout Ventura County explore available options for financial relief.

If you’re unsure whether your tax debt qualifies for discharge—or if bankruptcy is even the right path—we’re here to help guide you with clarity and compassion.

Final Thoughts

While bankruptcy can eliminate certain types of tax debt, it depends on the nature and age of the debt, your filing history, and whether you’ve followed the IRS’s rules. For California residents, working with a local attorney who understands both state and federal nuances can help you protect your assets and find real financial relief.

Contact us today for a free, confidential consultation, and let us assist you on your journey toward a fresh financial start.