Filing for bankruptcy in New York won’t stop an IRS audit. The automatic stay that comes with bankruptcy protects you from collection actions like levies and wage garnishments. But it doesn’t prevent the IRS from continuing to examine your tax returns or assess additional taxes. If you’re facing both an audit and tax debt, understanding what bankruptcy can and can’t do is essential before making any decisions.
Attorney John D’Amato has helped New York residents work through complex situations involving both bankruptcy and IRS issues. Our firm understands how these two areas of law intersect and what options may be available in your specific circumstances.
How the Automatic Stay Works
When you file a bankruptcy petition, an automatic stay goes into effect immediately. This is a court order that stops most of your creditors from taking actions to collect debts you owed before filing. The automatic stay generally stops the IRS’s normal collection procedures, including:
- Sending collection notices on taxes owed before filing
- Issuing levies against your bank accounts or property
- Garnishing your wages for pre-bankruptcy tax debt
- Seizing assets to satisfy tax obligations
- Filing collection lawsuits against you.
These protections remain in place while your bankruptcy case is open.
Why Audits Continue During Bankruptcy
Here’s what many people don’t realize: the automatic stay focuses on collection, not examination. The IRS can still audit your tax returns while you’re in bankruptcy. It can review your records, request documents, and determine if you owe additional taxes.
The IRS Internal Revenue Manual specifically notes that audit activity can continue and assessments can be made during bankruptcy. The agency maintains procedures for coordinating examinations with its insolvency unit when a taxpayer files for bankruptcy during an active audit.
What does this mean in practice? If you were under audit before filing for bankruptcy, that audit will likely proceed. If the IRS selects your return for examination after you file, that audit can move forward as well. The bankruptcy court’s protection against collection doesn’t extend to stopping the IRS from determining how much you actually owe.
What Happens to Audit Results
When the IRS completes an audit and finds you owe additional taxes, it will generally assess those taxes. The automatic stay doesn’t prevent this assessment. However, the IRS cannot take collection action on that new debt while the stay is in effect.
If you disagree with audit findings, bankruptcy creates some complications. The automatic stay typically prevents you from challenging a tax deficiency in Tax Court while your bankruptcy case is pending.
The Taxpayer Advocate Service has noted that taxpayers who filed bankruptcy before an audit assessment spend an average of three years in IRS bankruptcy suspense. During this time, the IRS holds the case while awaiting resolution of the bankruptcy.
Attorney John D’Amato works with clients to navigate these timing issues and develop strategies that address both the bankruptcy process and any ongoing tax disputes.
Can Bankruptcy Eliminate Tax Debt?
While bankruptcy won’t stop an audit, it may be able to eliminate some tax debts. Several factors determine whether or not your tax obligations can be discharged.
According to IRS Publication 908, income taxes may be dischargeable if they meet all of the following requirements:
- The tax return was due at least three years before you filed bankruptcy, including any extensions.
- You filed the return at least two years before your bankruptcy petition.
- The IRS assessed the tax at least 240 days before you filed for bankruptcy.
- You didn’t file a fraudulent return.
- You didn’t willfully try to evade the tax.
These rules are sometimes called the three-year rule, two-year rule, and 240-day rule. Meeting all the requirements is necessary for a tax debt to potentially be discharged.
Some taxes can never be discharged in bankruptcy. Trust fund taxes, which employers withhold from employee wages, fall into this category. Taxes connected to fraudulent returns are also excluded from discharge.
Chapter 7 Versus Chapter 13 Considerations
The type of bankruptcy you file affects how tax issues are handled.
In Chapter 7 bankruptcy, your non-exempt assets are liquidated (sold) to pay creditors. Eligible tax debts may be discharged at the end of the case. According to the U.S. Courts, debts for certain taxes are among those not discharged in Chapter 7.
In Chapter 13 bankruptcy, you create a repayment plan lasting three to five years. Priority tax debts must generally be paid in full through the plan. According to Chapter 13 guidelines, certain taxes that couldn’t be discharged in Chapter 7 may still need to be paid through your Chapter 13 plan.
IRS Collection Statute Considerations
One often-overlooked aspect of bankruptcy involves the IRS collection statute. The IRS generally has 10 years from the date of assessment to collect a tax debt. Filing bankruptcy suspends (pauses) this clock.
The IRS explains that from the date you file bankruptcy until the court discharges, dismisses, or closes the case, the collection statute is suspended. When your bankruptcy concludes, the statute is extended an additional six months.
This means bankruptcy can actually give the IRS more time to collect taxes that survive your case. It’s an important factor to weigh when deciding whether bankruptcy makes sense for your situation.
Frequently Asked Questions on Bankruptcy With IRS Audit
Will the IRS stop sending notices during bankruptcy?
The IRS will stop sending most collection notices for taxes you owed before filing. However, you may still receive informational notices about your account status or notices related to ongoing audits. The automatic stay prevents collection activity, not all communication from the IRS.
Can I file bankruptcy while under IRS audit?
Yes, you can file bankruptcy while the IRS is auditing your returns. The audit will typically continue, but the IRS cannot collect any taxes you currently owe while the automatic stay is in effect. Any new taxes resulting from the audit will also be subject to the stay’s collection protections.
If the audit concerns pre‑petition years, resulting additional assessments are generally treated as pre‑petition claims and subject to the stay for collection, but timing and classification can be complex.
What happens to my tax refund in bankruptcy?
Your tax refund may become part of your bankruptcy estate. In Chapter 7, the trustee may request your refund to pay creditors. The IRS can also offset a refund from before your filing against taxes you owed before bankruptcy. Your specific situation will determine how refunds are handled.
Do I still need to file tax returns during bankruptcy?
Yes. You must continue filing all required tax returns during your bankruptcy case. Failure to file returns or pay current taxes as they come due may result in your case being dismissed.
Key Points to Remember
- Filing for bankruptcy won’t stop an IRS audit from proceeding.
- The automatic stay protects against IRS collection, not examination.
- Some tax debts may be dischargeable if they meet specific timing requirements.
- The IRS collection timeline is suspended during bankruptcy and extended afterward.
- You must continue filing tax returns while in bankruptcy.
- Trust fund taxes and fraud-related taxes cannot be discharged.
Contact John D’Amato for Help With Your Bankruptcy and Tax Case
Dealing with both bankruptcy and IRS issues requires careful planning. The interaction between these two areas of law affects your options and outcomes.
John D’Amato is a respected bankruptcy and IRS solutions attorney serving clients throughout New York. Visit his attorney profile to learn more about the firm’s experience helping clients resolve complex tax and debt situations.
Call (716) 703-9099 to schedule a free consultation.