Chapter 7 bankruptcy is designed to provide a fresh start for people who have made some honest financial mistakes and don’t have money left at the end of the month to pay creditors. People use Chapter 7 Bankruptcy to deal with medical bills, business related bills, and credit card bills. They also use chapter 7 bankruptcy to deal with IRS debt i.e. certain types of unpaid taxes. If you qualify, the obligation to pay these debts ends (discharged) and these creditors can’t try and collect the debt any longer.

In exchange for the discharge of debt, the person assigned to oversee the case by the Government (Bankruptcy Trustee) will try to sell any “non-exempt” assets and use the funds to pay creditors. Most Chapter 7 Bankruptcy cases are “no-asset” cases meaning that there isn’t enough equity in property to warrant taking it and distributing it to creditors.

Most bankruptcy filers don’t lose any property as well because there are laws that protect certain assets. The law attempts to ensure that you keep enough of your property so that you have the basic items to survive each day. Some common property items that are safe from collection by the Bankruptcy Trustee in a chapter 7 bankruptcy using Arizona exemptions are:

  • Home Equity to $150,000.00
  • 1 car to $6000.00
  • Personal Property to $6000.00
  • Food, Fuel and provisions to last for 6 months
  • Engagement/Wedding Rings to $2000
  • Erisa Qualified retirement

A Chapter 7 Bankruptcy case usually lasts about 6 months and the documents you file with the Court will list your assets at a garage sale value, your creditor information and your income and budget. There is typically one hearing meant to verify that you have disclosed all assets, income and budget information and this hearing usually takes 5-10 minutes.

The IRS debt obligation will be eliminated at the end of an Arizona case if the following is true:

  • You filed a tax return (1040);
  • You filed it more than 2 years before the bankruptcy petition was filed;
  • That return was due to be filed more than 3 years before the bankruptcy filing;
  • The IRS accounted for or assessed the debt more than 240 days before the bankruptcy filing;
  • There was no fraud associated with the debt

If the tax debt is other than income tax debt it won’t be discharged unless:

  • It is debt from certain penalties and the underlying cause of the penalty is more than 3 years old;
  • It is debt from certain penalties and the underlying tax debt is discharged;
  • The debt is a Transaction Privilege Tax (non-trust fund) and meets the criteria for income tax above;
  • The debt is the employer’s portion of the payroll tax and meets the criteria for income tax above;

I like bankruptcy because it allows my Clients to use specific laws to obtain a fresh start from IRS debt and not rely on what often amounts to the generosity of the IRS to get a fresh start in an Offer in Compromise.

A downside however, is that it does not result in the removal of the IRS’ tax lien. Where there are few assets, the IRS will usually remove the lien on request. Where it isn’t removed, the lien will remain valid and it will stay attached to any assets that existed on the date of the bankruptcy filing for 10 years from the date the debt was assessed (plus time in bankruptcy, offer in compromise and certain appeals). In many cases the lien will stay put for the remainder of the 10 year period, but in some cases the IRS will try to collect on the assets.