You open your mailbox and there it is again. Another letter from the IRS. Another notice from the Comptroller of Maryland. Your stomach drops because the tax debt you’ve been carrying has grown from a manageable problem into a mountain. You’re not alone in this, and bankruptcy might offer more relief than you think.
Many people throughout Maryland believe tax debt can never be wiped out. That’s simply not true. While the rules are more complicated than credit cards or medical bills, certain tax obligations can be discharged through bankruptcy. The question is which taxes qualify and what steps you need to take.
What Types of Tax Debt Can Be Discharged?
Not all tax debts are created equal when it comes to bankruptcy. The Bankruptcy Code, specifically 11 U.S.C. § 523(a), draws clear lines about what can and cannot be eliminated.
Income taxes are the only type of tax debt generally eligible for discharge. This includes federal income taxes owed to the IRS and Maryland state income taxes owed to the Comptroller of Maryland. If you’re struggling with old income tax obligations, bankruptcy may provide a path forward.
However, certain tax debts cannot be discharged under any circumstances. Property taxes, payroll taxes (the taxes you were supposed to withhold from employees’ paychecks), sales taxes you collected but never paid, and penalties for fraud are permanently non-dischargeable. These obligations will survive your bankruptcy and must be addressed through other means.
The Rules for Discharging Income Tax in Maryland Bankruptcy
Income tax discharge in Maryland bankruptcy follows what bankruptcy attorneys often call the “3-2-240 rule.” Each number represents a different timing requirement that must be satisfied before your tax debt becomes eligible for discharge.
The Three-Year Rule
Your tax return must have been due at least three years before you file for bankruptcy, with the three-year clock starting from the original due date, including any extensions you properly filed.
Say you owed taxes for 2021. Your return was due April 15, 2022. To discharge that 2021 tax debt, you’d need to wait until at least April 16, 2025 to file bankruptcy. If you received an extension until October 15, 2022, the three-year period wouldn’t begin until that extension date.
The three-year rule applies to each tax year separately. You might discharge taxes from 2020 and 2021 while still owing non-dischargeable taxes from 2023.
The Two-Year Filing Rule
You must have filed a tax return for the debt at least two years before filing bankruptcy. If you never filed a return, or if the IRS filed a substitute return on your behalf, that tax debt cannot be discharged regardless of age.
The date that matters is when the IRS or Comptroller of Maryland received your return, not when you mailed it. If you have unfiled returns, file them immediately and wait two full years before bankruptcy.
The 240-Day Assessment Rule
The tax authority must have assessed your tax debt at least 240 days before you file bankruptcy, with assessment typically happening when you file your return, but can occur later if the IRS audits you.
For most taxpayers, the assessment date is when you filed your return. If the IRS later audited your return and assessed additional taxes, you’d need to wait 240 days from that assessment date.
No Fraud or Willful Evasion
Even if your tax debt meets all timing requirements, it cannot be discharged if you committed fraud on your tax return or willfully tried to evade paying taxes.
Fraud means you intentionally provided false information to reduce your tax liability. Willful evasion includes hiding assets or maintaining double sets of books. Simple mistakes don’t count as fraud, but deliberately lying to the IRS or Comptroller will prevent discharge.
Chapter 7 vs Chapter 13 for Tax Debt
The type of bankruptcy you file affects how your tax debt is handled.
Chapter 7 Bankruptcy and Tax Debt
In Chapter 7 bankruptcy, qualifying tax debts are discharged like credit card debt. If your income tax meets all the requirements, it’s wiped out. Most Chapter 7 cases complete within three to four months, offering the fastest path to relief.
However, if you have substantial non-exempt assets, the trustee may sell them to pay creditors. And if your tax debts don’t meet the discharge requirements, Chapter 7 won’t help manage those obligations.
Chapter 13 Bankruptcy and Tax Debt
Chapter 13 works differently. You propose a three-to-five-year repayment plan. Tax debts are divided into priority and non-priority claims.
Priority tax debts are recent taxes that don’t meet discharge requirements and must be paid in full through your plan. Non-priority tax debts are older taxes that would be dischargeable in Chapter 7 and may be paid pennies on the dollar.
The advantage of Chapter 13 for Maryland state tax bankruptcy is flexibility. Even if your tax debts don’t qualify for discharge, you get up to five years to pay them off without interest or penalties continuing to accrue. The Comptroller of Maryland and IRS must accept the payment terms in your plan.
Chapter 13 also protects your assets. If you have a home with substantial equity or valuable property, Chapter 13 lets you keep everything as long as you make your plan payments.
The Tax Lien Problem
Even if bankruptcy discharges your personal liability for a tax debt, any tax lien filed before your bankruptcy will survive the discharge.
Bankruptcy eliminates your obligation to pay the debt personally, but it doesn’t remove liens from your property. If the IRS or Maryland Comptroller placed a lien on your house before you filed bankruptcy, that lien stays attached to the property even after your discharge.
This matters when you want to sell or refinance. The lienholder must be paid from the proceeds before you see any money. Check for tax liens before filing bankruptcy. If a lien exists, you may negotiate with the IRS or Comptroller to release it after discharge, or use Chapter 13 to pay it off through your repayment plan.
What About Penalties and Interest?
If your underlying tax debt qualifies for discharge, the penalties and interest on that debt are also discharged. That can represent significant savings.
However, if the underlying tax is non-dischargeable, the penalties and interest are also non-dischargeable.
When Tax Debt Doesn’t Qualify
Many people find that some or all of their taxes don’t meet the discharge requirements. Maybe the taxes are too recent, returns weren’t filed, or the debt involves payroll withholding.
If your taxes don’t qualify for discharge, bankruptcy still helps. Chapter 13 gives you three to five years to pay off tax debt through a structured plan. The automatic stay immediately stops IRS levies, wage garnishments, and Comptroller of Maryland collection calls. During your plan, interest stops accruing on most tax debts and penalties stop piling up.
Maryland-Specific Considerations
Maryland residents deal with both federal and state tax debt. The Comptroller of Maryland tax bankruptcy follows the same general rules as federal tax discharge.
Maryland charges 9% interest on unpaid taxes. The Comptroller’s office intercepts state tax refunds, lottery winnings, vendor payments, and even federal tax refunds. They can garnish wages and pursue aggressive collection.
Maryland offers its own offer-in-compromise program, but you must wait two years from assessment before applying. For many people, bankruptcy offers faster relief. When you file bankruptcy in Maryland, both federal and state tax debts are handled in the same case through the U.S. Bankruptcy Court for the District of Maryland.
Steps to Take Before Filing
Filing bankruptcy with tax debt requires preparation. Here are the steps to take before filing:
- Gather your documents. You will need tax returns, IRS account transcripts, notices from the IRS and Maryland Comptroller, and any payment agreements or lien documentation.
- Determine which taxes may qualify for discharge. Calculate the three-year, two-year, and 240-day deadlines for each tax year, as waiting a few months before filing could mean additional relief.
- Check for tax liens. Search IRS records and Maryland court records for any existing liens.
- Consider whether Chapter 7 or Chapter 13 fits your situation. Base this on which taxes qualify for discharge and your overall financial picture.
Key Takeaways
- Tax debt can be discharged through bankruptcy if it meets specific requirements under the 3-2-240 rule: your return must have been due three years ago, filed two years ago, and assessed 240 days ago.
- Both federal IRS debt and Maryland Comptroller of Maryland taxes can be discharged using the same eligibility criteria.
- Chapter 7 quickly eliminates qualifying taxes, while Chapter 13 provides structured repayment for recent taxes that don’t qualify.
- Tax liens survive bankruptcy even when underlying debt is discharged, so check for liens before filing.
- Penalties and interest are discharged along with qualifying tax debt.
- Payroll taxes, recent income taxes, and debts involving fraud cannot be eliminated.
- Chapter 13 can manage non-dischargeable taxes through its repayment structure, stopping interest and penalties while you pay over three to five years.
Frequently Asked Questions
Can I discharge Maryland state income taxes in bankruptcy?
Yes. Maryland state income taxes follow the same discharge rules as federal taxes. If your state tax debt meets the 3-2-240 requirements and doesn’t involve fraud or payroll withholding, it can be discharged.
What happens if I never filed a tax return?
Tax debt from unfiled returns cannot be discharged in bankruptcy. If the IRS or Comptroller filed a substitute return on your behalf, that doesn’t count. You must file your own returns and wait two years before that debt becomes dischargeable.
Will bankruptcy stop an IRS wage garnishment?
Yes. The automatic stay goes into effect when you file and all collection activities must stop, including wage garnishments, bank levies, and collection calls from both the IRS and Maryland Comptroller.
Can Chapter 13 help if my taxes don’t qualify for discharge?
Absolutely. Chapter 13 allows you to pay non-dischargeable tax debts over three to five years. Interest typically stops accruing during your plan, and you’re protected from garnishments and levies.
Do I have to include all tax debt in my bankruptcy?
Yes. Bankruptcy requires you to list all debts. However, only those that meet the discharge requirements will be eliminated. Recent taxes must still be addressed, typically through Chapter 13 repayment.
What if I have both old and new tax debt?
Old taxes that meet the discharge requirements can be eliminated. New taxes that don’t qualify must be paid, either outside bankruptcy in Chapter 7 or through a Chapter 13 plan.
Contact The Grafton Firm
Tax debt doesn’t have to control your life. Whether you’re facing IRS collection, Maryland Comptroller demands, or both, bankruptcy may offer more relief than you realize. At The Grafton Firm, we’ve helped countless Maryland residents eliminate tax debt through bankruptcy.
We know which taxes qualify for discharge, how to time your filing for maximum benefit, and whether Chapter 7 or Chapter 13 better serves your situation. We’ll review your tax situation, calculate discharge eligibility for each tax year, and explain your options in plain English. There’s no judgment here, just practical solutions to real problems.
Don’t wait while penalties and interest keep piling up. Reach out to The Grafton Firm today and take the first step toward financial freedom. We offer a free consultation so you can understand your options before making any decisions. Let us help you regain control.