It’s easy to assume that debts owed to the federal government can’t be discharged in bankruptcy.
Easy, but wrong.
Just because the creditor is Uncle Sam doesn’t mean the debt can’t be wiped out in bankruptcy.
In fact, debts to the government range from freely dischargeable to not-in-this-lifetime nondischargeable.
Honesty required for discharge
All of the discussion that follows assumes that your debt to the government is honestly incurred, and is unsecured.
Secured debts, those for which there is a lien, generally survive a bankruptcy discharge.
So tax liens and SBA liens live beyond a Chapter 7 discharge.
More on limits on tax liens after bankruptcy.
Debts to government dischargeable in bankruptcy
Income taxes for years more than three years before the bankruptcy filing are dischargeable. You count the three years from the due date of the return. If there is a tax lien, the lien survives on existing assets, but doesn’t attach to new property. More on taxes in bankruptcy
Social Security overpayments can be wiped out in bankruptcy. After a bankruptcy filing, your current benefits are not subject to reduction on account of a prior overpayment. More from SSA.
SBA loans are just loans, subject to discharge in bankruptcy. The complication with SBA loans is that they are often secured. It’s important to determine what assets, if any, are pledged to support the loan. A bankruptcy discharge will prevent the SBA from suing you to collect its loan from your wages, savings or other assets; the collateral you gave the lender when the loan was negotiated survives.
PPP loans, like traditional SBA loans, are dischargeable. Most are forgiveable, no bankruptcy required. And most loans to business entities carry no liability for the stock holder or officer. But if you’re liable, bankruptcy will discharge the liability.
More on SBA loan guarantees
Student loans may be dischargeable
Government guaranteed student loans occupy the middle ground in our range of possibilities. A student loan guaranteed by a governmental entity can be discharged if the borrower can show a bankruptcy judge that repayment would create an “undue hardship” on the debtor or the debtor’s dependents. The standard is pretty tough.
Some bankruptcy courts will discharge part of a student loan. Those courts find that repayment in full is a hardship, but partial repayment is possible without undue hardship. The 9th circuit which includes California, is one of those circuits allowing partial discharge of student loans.
Government debts that survive bankruptcy
Fines and penalties owed to a government that are imposed to punish, rather than compensate, can’t be discharged in Chapter 7. There is an exception for tax penalties: if the tax is dischargeable or the event that triggered the penalty occurred more than three years ago, the penalty can be wiped out. 11 USC 523(a)(7). In Chapter 13, all tax penalties are dischargeable.
Trust fund payroll taxes are never dischargeable in bankruptcy. The trust fund portion of payroll taxes is the taxes withheld from the employee’s paycheck for payment to the government. Officers of corporations who short the government for trust fund taxes can be personally liable for shortfall.
Military scholarships and incentive pay remain collectible despite bankruptcy. Most of these exceptions make the debt non dischargeable for a period of years, shorter than the usual statute of limitations. Here’s a more extensive list of governmental exceptions to bankruptcy discharge.
Non dischargeable debts in bankruptcy
Even if a debt is non dischargeable at the end of a bankruptcy case, some of the bankruptcy rules still apply.
Collection of non dischargeable debts is still stayed by the automatic stay. The stay remains in place til the debtor is otherwise discharged, or until a bankruptcy judge lifts the stay as to that debt.
The statute of limitations still controls how long a debt is legally enforceable. The running of time on statute of limitation is suspended while the stay is in place, and sometimes for a specified additional period. But just because a debt is not dischargeable in bankruptcy, applicable law may still allow it to die of old age.