Will Filing For Bankruptcy Cause an IRS Audit?

There may come a time when paying your outstanding bills is no longer a possibility. If you are filing for Chapter 7 bankruptcy or a Chapter 13 bankruptcy case and have outstanding tax issues, you might be worried that bankruptcy could trigger an Internal Revenue Service (IRS) audit.

This article addresses whether filing for bankruptcy sends a red flag to the IRS and why the IRS would audit someone during bankruptcy. It also examines how your bankruptcy can affect the results of a tax audit.

Official IRS Policy on Bankruptcy Filing

No official policy states that the IRS targets people filing for bankruptcy. This doesn’t mean the Internal Revenue Service doesn’t single out people who file a Chapter 7 bankruptcy case. Instead, it notes that there’s no formal IRS policy requiring that IRS workers target taxpayers who file bankruptcy petitions. In other words, a bankruptcy filing isn’t guaranteed to trigger an IRS audit.

According to the U.S. Bankruptcy Courts, the number of bankruptcy petitions in 2023 increased by 13% compared to 2022. By the end of September 2023, 383,810 people had filed for bankruptcy in this country.

Given this number, it would be nearly impossible and extremely impractical for the IRS to audit everyone who filed a bankruptcy petition. Declaring bankruptcy doesn’t mean a person is cheating on their income tax returns. Furthermore, the IRS doesn’t have the financial resources or the staff to automatically audit everyone who files for bankruptcy.

The IRS May Scrutinize Your Finances if You File Bankruptcy

The IRS can get an accurate picture of your financial situation during bankruptcy proceedings. The U.S. Bankruptcy Court staff and the trustee will examine your debts and assets to determine if you qualify for bankruptcy.

The IRS may become privy to the results of this examination. If the trustee reveals assets or income the IRS was unaware of, it could trigger an audit.

The IRS Can Audit You During Bankruptcy

The IRS has the right to audit you when you file for bankruptcy protection. The automatic stay that protects you from most creditors during bankruptcy proceedings does not extend to the IRS.

According to the U.S. Bankruptcy Code, the IRS can take the following actions during bankruptcy:

• Conducting an audit
• Serving notices of tax deficiencies and federal tax liens
• Serving notices of additional tax owed
• Demands for tax returns

If the IRS does audit you, they can go back three tax years. They can review your individual income tax returns and those of any company you own. If the revenue officer uncovers any tax problems, they have the right to take action against the taxpayer.

Filing for bankruptcy will not stop these types of tax problems from being audited. If you fear the IRS will discover tax matters that can interfere with your bankruptcy, let your bankruptcy attorney know immediately. You should also notify your tax preparer that you are filing for bankruptcy.

For more information, review the automatic stay section of the Bankruptcy Code.

Your Chances of an Audit During Bankruptcy

Filing for bankruptcy may not impact your chances of an audit. The IRS may select you for an audit simply because you filed your tax return. There is no hard-and-fast rule prohibiting the IRS from auditing someone in bankruptcy. At the same time, no rule says they are more likely to do so unless significant red flags come to their attention.

Certain groups of taxpayers are at a higher risk of an audit than others. For example, people paid in cash or who receive a large share of their pay through tips may be at a higher risk of an audit.

This happens because these groups sometimes fail to declare all of their income. The IRS is more likely to audit business owners because of errors they may make in bookkeeping or payroll taxes.

Bankruptcy Can Help Protect You From Audit Results

While bankruptcy will not necessarily stop you from being audited, it can at least partially protect you from audit results. Bankruptcy protects you from creditors, including the IRS and other government agencies and institutions.

While many tax debts are nondischargeable, there are some items that you can include in your bankruptcy petition. For the court to discharge these tax debts, you must meet all the following conditions:

• The discharge is for federal income tax, not payroll taxes or a penalty
• You filed valid and accurate tax returns for the tax years in question
• The tax liabilities are at least three years old
• You did not engage in tax fraud or tax evasion
• You are eligible for the “240-day rule”

The 240-day rule protects filers from tax debts the IRS assessed at least 240 days before they filed their bankruptcy petition.

Tax law specifically prohibits the bankruptcy courts from discharging the following tax debts:

• Tax penalties from tax debt otherwise deemed ineligible for discharge
• Tax debts for unfiled tax returns
• Trust fund taxes
• Taxes your employer failed to withhold from your paycheck

You should talk to a bankruptcy or tax lawyer before filing your petition if you have significant tax debt. This is true for both Chapter 7 and Chapter 13 filers.

Related Resources

It’s important to understand all aspects of a bankruptcy filing before committing. The following links offer detailed examinations of important topics:​

• Can Filing for Bankruptcy Clear Credit Card Debt?
• Bankruptcy Fraud
• Bankruptcy and Taxes: Eliminating Tax Debts in Bankruptcy
• Bankruptcy
• What Is Bankruptcy?

Concerned About an IRS Audit?

Everyone’s financial situation is different. If you’re struggling with debt and are afraid of an IRS audit, seek legal advice from a professional. Contact an experienced bankruptcy law attorney near you today.