Do You Have to Pay Taxes on Discharged Bankruptcy Debt?

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on January 11, 2021

You do not have to pay taxes on discharged bankruptcy debt if you send Form 982, “Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment)”to the IRS along with your tax return. 

Your creditors will send the IRS Form 1099-C, which tells the IRS that your debt has been canceled or discharged.

Can Federal Income Taxes Be Discharged in Bankruptcy?

You may discharge federal income tax through bankruptcy if:

  • The taxes are income taxes only
  • You have not committed fraud or evasion
  • The debt is at least 3 years old
  • You filed a tax return
  • The debt has been assessed by the IRS at least 240 days before filing, or has not been assessed yet

 

Can Back Taxes Be Discharged in Bankruptcy?

Yes, back taxes, as well as many other federal taxes, can be discharged or reduced through bankruptcy. 

Chapter 13 bankruptcy also allows you to include your overdue taxes in your debt repayment plan. 

The discharge also includes penalties and interest generated on the debt.

 

Can Federal Taxes Be Discharged in Bankruptcy?

Yes, many federal taxes, as well as most state taxes, can be reduced or discharged through bankruptcy, including income tax. 

However, if you have a federal lien on any of your property because of back taxes that you owe, bankruptcy will not remove the lien.

Do You Have to Pay Taxes on Discharged Bankruptcy Debt FAQs

Bankruptcy is a legal proceeding in which a debtor declares their inability to pay back their creditors. 
There are three common types of bankruptcy known as “chapters” in the U.S. bankruptcy code, Ch. 7, Ch. 11, and Ch. 13, each with varying criteria and consequences.
Chapter 7 is known as a liquidation bankruptcy. Most of your property will be sold to pay off your debts, then whatever debt in excess of the value of your liquidated property will be cleared.
Chapter 13 bankruptcy is a reorganization bankruptcy. With Chapter 13, you are able to keep your personal property and reorganize your debts to a payment schedule that enables you to pay back your creditors over time (often 3 to 5 years).

What is Bankruptcy?

What Does It Mean to File for Bankruptcy?

Bankruptcy is a legal proceeding in which a debtor declares their inability to pay back their creditors. 

The general idea behind declaring bankruptcy is that it allows debtors a “fresh start”while offering creditors a way to receive some or all of their owed payment. 

Although some debts are forgiven, filing for bankruptcy affects the debtor’s creditworthiness. 

When filing for bankruptcy, secured debts are usually paid for by the asset “securing”the debt, while many types of unsecured debts can be renegotiated. 

What Is Bankruptcy? The Three Chapters of Bankruptcy

There are three common types of bankruptcy known as “chapters”in the U.S. bankruptcy code, Ch. 7, Ch. 11, and Ch. 13, each with varying criteria and consequences.

Ch. 7 Bankruptcy

 The most common type of bankruptcy is Chapter 7. 

Chapter 7 bankruptcy is known as “straight”or “liquidation”bankruptcy.

It is designed to give a “fresh start”by discharging debts that cannot be repaid through the liquidation of the debtor’s assets. 

Upon filing Chapter 7, a trustee is appointed to sell the debtor’s non-exempt assets and distribute the proceeds to creditors. 

For individuals, the law exempts certain assets such as retirement funds, primary residence, tools for their trade, and personal vehicles from being liquidated to pay back creditors. 

This pays back creditors some of what they are owed and protects individuals from having all of their livelihood taken from them. 

Ch. 11 Bankruptcy

Chapter 11 bankruptcy is primarily for companies, allowing them a break on paying their debts in order to restructure, come up with new terms for paying their creditors, and become profitable again. 

This allows companies to stay afloat while coming up with a new way to pay back creditors. 

Chapter 11 is the most complex and expensive form of a bankruptcy proceeding and should therefore be considered after other options have been explored. 

Ch. 13 Bankruptcy

Chapter 13 bankruptcy, known as a “Debtor in Possession”Bankruptcy, stands in contrast with Chapter 7 because it allows the individuals to keep from liquidating their property. 

Chapter 13 creates a new, more affordable payment plan for the debtor to repay creditors, usually lasting 3 to 5 years. 

Once the payment plan is finished, the remaining unsecured debts are discharged. 

Bankruptcy FAQs: