Generally speaking, the bankruptcy discharge will eliminate old income tax debt provided your tax returns from prior years have been filed and the taxes you are seeking to discharge are now more than 3.5 years old. However, while income tax debt can be eliminated by filing for bankruptcy, bankruptcy does not remove tax liens.
What is a Tax Lien?
What exactly is a tax lien? A tax lien is a notice to the world that the owner of property owes taxes. For example, if you owe the IRS $50,000 of back taxes, they might place a lien on your home and record notice in the Montgomery County Register of Deeds. This way, anyone researching title to your home will see that the IRS must be paid before your property can be transferred. In cases where a lien has been filed, the debtor will have to pay it before the property can be sold. This is the case even if the debtor’s personal obligation to pay the taxes has been discharged in bankruptcy. Due to the fact that the Bankruptcy Code places a three-year waiting period on the dischargeability of tax debt, many who file seeking to eliminate obligations to the IRS, or state taxing authorities, have already had liens placed on their property.
Need an example? Let’s say that you filed your 2007 tax returns and realized that your tax bill was a little more than you could handle. As the economy worsened, the tax debt festered and you were forced to live on credit cards. Your tax bill remained delinquent and you received a series of collection letters from the IRS. Eventually the IRS filed a Notice of Federal Tax Lien in the Montgomery County public records. Flash forward to 2012 and your bankruptcy consultation with Rick West, who informs you that your 2007 taxes, because they were originally due and owing on April 15 of 2008, are now dischargeable in chapter 7 bankruptcy (remember the 3 year rule we covered earlier). This means that the IRS will be prohibited from sending collection letters, calling or attempting to force payment of your 2007 taxes through levy. It does not mean however, that the lien against your real estate will go away. Unfortunately, it will remain in place, although it cannot attach to property you receive after the bankruptcy discharge. In order to sell your home, the lien will need to be paid in order to deliver clear title to the purchaser.
If You Don’t Own Real Estate…
When tax lien is filed it attaches to all of your property, most importantly your real estate. As we’ve seen, the filing of a lien operates as a cloud on title which can prevent a home from being sold. What happens if you owe back taxes and the IRS has filed a lien but you don’t own any real estate? In this scenario, the lien becomes a lot less scary. In the case of a debtor who owns valuable real estate, a tax lien can be a dealbreaker for a purchaser. By contrast, if you own very little in the way of assets at the time you file bankruptcy, the lien will only affect those items, and as a practical matter, will do very little to hinder your fresh start once you have emerged from bankruptcy. Ok, so there is a lien against your sofa or your 1995 Ford Taurus, oh well!
The Bottom Line
In most cases, bankruptcy will not remove a tax lien. Tax liens are most dangerous when they attach to real estate. It is always a good idea to meet with an attorney to make sure that the cost of bankruptcy is justified by the financial problems you are facing. Good luck.