What is Bankruptcy?

Bankruptcy gives debtors the opportunity to start afresh financially, permitting them to discharge their liabilities. Bankruptcy effectively releases the debtor from creditor debt collection (or its threat), and it creates in the debtor a legal right not to pay his debt. There are exceptions to the rule. Some debts, such as student loans and certain tax debts are not dischargeable.

What are the different types of Bankruptcy?

The Bankruptcy Code provides for six different types of bankruptcy. There are three common types that are commonly referred to by the chapter of the bankruptcy code that governs each.

The three common types are as follows:

  1. Chapter 7 Bankruptcy – This is the most common type and in the case of an individual often leads to a discharge of most debts within six months of filing a petition. In the case of an individual with primarily consumer debts, their income for the six months prior to filing must generally be no higher than the median income for a household of their size in their state (the “Means Test”). Individuals with higher incomes may also qualify after taking into account certain deductions. Business debtors and individuals with primarily business debts do not have to satisfy the Means Test. Business debtors such as corporations do not get a fresh start but instead liquidate the business through Chapter 7.
  2. Chapter 13 Bankruptcy – This Chapter is only available to individuals with regular income. Under this Chapter, the debtor pays all disposable income monthly to a Trustee for either three or five years. All secured debts are paid. Payment of unsecured debts through the plan can range from zero to 100% depending on the debtor’s disposable income. Debtors whose secured and/or unsecured debts are greater than a certain amount; currently the maximum allowable debts must be no greater than $360,475 for unsecured debts and $1,081,400 for secured debts.
  3. Chapter 11 Bankruptcy – This Chapter is available to individuals and businesses. In the case of an individual, the procedure is very similar to Chapter 13 and is used when the individual’s debts exceed the maximum allowable for Chapter 13.

What Sorts of Claims May Be Discharged and What Types May Not Be Discharged?

Most debts may be discharged in any of the three types of bankruptcy. Examples include credit cards and medical bills.

One major exception is student loans which must be generally paid in full. In a Chapter 13 bankruptcy student loans are paid through the plan, however any remaining balance must still be paid after the plan payments have been made and the debtor has been discharged.

Another exception to discharge is certain income taxes. Generally in Chapter 7, the tax assessment must have become due and payable more than three years before the bankruptcy petition was filed. In Chapters 11 and 13 tax debts that are not dischargeable under Chapter 7 may generally be satisfied for less than the full amount through the plan.

Exceptions to discharge in all bankruptcy cases include:

  1. Taxes that were withheld from employee paychecks but not turned over to the IRS or state tax department are not dischargeable. a number of tax claims may not be discharged (under Chapter 13);
  2. Taxes for which no return was filed (or for which a return was late but within two years before the petition date); and
  3. Taxes for which a debtor filed a fraudulent return or attempted to willfully evade his tax obligation.

If a debtor fails to list the IRS on its schedule of liabilities (or otherwise fails to notify the IRS of his bankruptcy case), his tax debt is not dischargeable, unless the IRS learns of the bankruptcy proceeding, allowing it to file a timely claim.

Recently, the Office of Chief Counsel indicated that certain interest is dischargeable. Specifically, pre- and post-petition interest may be discharged if and only if one’s tax debt under Chapter 13 is discharged.

Liens against the debtor’s property-tax liens included-that are not set aside or satisfied in bankruptcy may not generally be discharged. Yet, the IRS must release liens that are legally unenforceable. Regarding this provision, the Ninth Circuit Court of Appeals held that a bankruptcy proceeding does not require the release of pre-petition tax liens on one’s property, even if the debtor is released from personal liability for the tax, because the government still possesses a right to satisfy the liability with the taxpayer’s property.

May I sue the IRS?

Debtors are permitted to petition a bankruptcy court for damages if an IRS agent willfully violates the rules governing a proper discharge. The damages amount is the lesser of $1 million or the total actual damages that directly resulted (and was proximately caused by) the agent’s willful conduct. However, before a taxpayer may receive damages, he must first exhaust all administrative remedies available. The court may award attorney’s fees that the debtor incurred in his defense against the IRS).


If you have questions about bankruptcy law, contact the Tax Law Offices of David W. Klasing or call 800-681-1295.