Tax Season Just Made Everything Worse
It's April. You just filed your taxes — or maybe you couldn't even bring yourself to file — and the number on the screen made your stomach drop. Between what you owe the IRS and back taxes from previous years, you're looking at a debt that feels absolutely impossible.
Maybe you owe $30,000. Maybe it's $80,000. Maybe it's been growing for years because you were too scared to deal with it, and the penalties and interest have snowballed into something monstrous.
The IRS letters keep coming. The State of New Jersey sent a notice of levy. You're terrified they'll garnish your wages or freeze your bank account.
Here's something most people don't know: certain tax debts can be completely eliminated through bankruptcy.
Not all of them. Not automatically. But the myth that "you can never get rid of tax debt in bankruptcy" is exactly that — a myth.
Which Tax Debts Can Be Discharged?
To discharge federal income tax debt in a Chapter 7 bankruptcy, all five of these conditions must be met:
The 5 Rules for Discharging Tax Debt
1. The Three-Year Rule The tax return must have been due at least three years before you file bankruptcy. For 2021 taxes (due April 2022), you'd need to wait until at least April 2025 to file bankruptcy and have those taxes potentially discharged.
2. The Two-Year Rule The tax return must have been actually filed at least two years before your bankruptcy filing. If you filed your 2020 return late — say, in March 2024 — you'd need to wait until at least March 2026.
3. The 240-Day Rule The IRS must have assessed the tax at least 240 days before you file bankruptcy. Assessment usually happens when you file your return or when the IRS completes an audit.
4. No Fraud The tax return must not have been fraudulent. If you intentionally understated your income or claimed fake deductions, those taxes can never be discharged.
5. No Willful Evasion You must not have willfully attempted to evade the tax. There's a difference between not being able to pay and actively hiding money to avoid paying.
If all five conditions are met, your income tax debt can be wiped out completely in Chapter 7 bankruptcy — just like credit card debt or medical bills.
What About New Jersey State Taxes?
New Jersey income taxes follow the same general rules as federal taxes for bankruptcy discharge purposes. If the NJ tax debt meets the same five conditions, it can potentially be discharged.
However, New Jersey also imposes other types of taxes that have different rules:
- NJ Sales Tax: If you're a business owner who collected but didn't remit sales tax, this is considered a "trust fund" tax and generally cannot be discharged.
- NJ Property Tax: Property tax liens survive bankruptcy, though the personal obligation might be dischargeable in certain circumstances.
- NJ Payroll Taxes: Similar to sales tax, payroll taxes held in trust for employees are not dischargeable.
Chapter 7 vs. Chapter 13 for Tax Debt
Chapter 7: Complete Elimination
If your tax debt qualifies, Chapter 7 wipes it out entirely. Done. The IRS can't collect. New Jersey can't collect. You move on with your life.
The entire process takes 3-6 months.
Chapter 13: Structured Repayment
If your tax debt doesn't qualify for discharge — maybe the returns were filed less than two years ago — Chapter 13 offers a different path.
In Chapter 13, you enter a 3-5 year repayment plan. Here's why this can still be a lifesaver:
- Interest stops accruing on the tax debt during the plan
- Penalties stop accumulating
- The IRS and NJ cannot levy your wages or bank accounts
- You pay the tax debt in manageable monthly installments
- Any remaining qualifying debt at the end of the plan may be discharged
For many people with large tax debts, the Chapter 13 plan payment is dramatically lower than what the IRS was demanding.
The Tax Lien Problem
Here's an important wrinkle: if the IRS or New Jersey has already placed a tax lien on your property, bankruptcy gets more complicated.
A tax lien attaches to your property and survives bankruptcy. Even if the underlying tax debt is discharged, the lien remains on the property. This means:
- You won't owe the money personally anymore
- But the lien stays on your house or other property
- The lien must be satisfied when you sell the property
This is why timing matters. If you act before a lien is filed, bankruptcy can eliminate the tax debt completely. After a lien, the picture gets more complicated but there are still options.
Real Situations We've Seen
The Self-Employed Contractor: A Paterson contractor owed $65,000 to the IRS from 2018-2020. He'd been making estimated payments but fell behind during COVID. The returns were filed on time. All five conditions were met. We filed Chapter 7 and the entire $65,000 was discharged.
The Restaurant Owner: A Bergen County restaurant owner owed $40,000 in NJ sales tax she'd collected but couldn't remit when the business failed. Because sales tax is a trust fund tax, it couldn't be discharged. We used Chapter 13 to stop the penalties and create a 5-year payment plan she could actually afford.
The Divorced Professional: A Fort Lee professional owed $35,000 to the IRS after an audit adjusted his 2019 and 2020 returns. The 2019 debt qualified for discharge (met all five rules). The 2020 debt didn't yet meet the three-year rule. We strategically timed the bankruptcy filing to maximize the discharge.
What About Offers in Compromise?
You've probably seen ads promising to settle your tax debt for "pennies on the dollar." The IRS Offer in Compromise (OIC) program is real, but it's not the miracle the ads suggest.
The IRS accepts only about one-third of OIC applications. They calculate what they think you can pay based on your assets, income, and expenses, and they rarely settle for pennies on the dollar.
For many people, bankruptcy is actually a faster, more certain path to tax debt relief than an OIC. A qualified attorney can analyze both options and recommend the better strategy for your situation.
Stop Running from This
We understand the fear. The IRS is intimidating by design. The letters, the threats, the power to garnish your wages and seize your bank account — it's designed to make you feel helpless.
But you're not helpless. The law provides real solutions. Whether it's a Chapter 7 discharge, a Chapter 13 plan, or a strategic combination of approaches, there's a path forward.
At Perez & Bonomo, we've helped hundreds of New Jersey residents deal with tax debt. We'll review your tax transcripts, analyze which debts qualify for discharge, and create a plan that actually works.
Stop dreading every trip to the mailbox. Call us for a free consultation.