How the IRS Handles Tax Debts in Chapter 11 Bankruptcy

When a business files Chapter 11, the IRS keeps more leverage than almost any other creditor, and the way the IRS handles tax debts in Chapter 11 bankruptcy is governed by rules that dictate exactly how each category of tax must be classified, paid, and, in some cases, discharged. The automatic stay halts most collection activity the moment the petition is filed, but the plan cannot be confirmed unless it satisfies strict payment terms for every priority and secured tax claim the IRS asserts.

What the Automatic Stay Stops and What It Doesn’t

Filing the petition triggers the automatic stay under 11 U.S.C. § 362(a), which stops the IRS from levying bank accounts, garnishing receivables, or otherwise collecting on pre-petition tax debts while the case is pending.

Core tax administration keeps running, though. Congress carved out exceptions that let the IRS audit the debtor, issue a notice of deficiency, demand unfiled returns, and assess taxes with a notice demanding payment. The one limit on that last power: any lien that would normally arise from a post-petition assessment does not attach to estate property unless the underlying tax will survive discharge and the property leaves the estate.¹

The practical effect is that debtors who assume the stay freezes everything tax-related get blindsided. The IRS often finds additional pre-petition liability through an audit that starts after the petition date, then files an amended claim mid-case.

How the IRS Files Its Claim

The IRS asserts its right to payment by filing a Proof of Claim on Form 410, itemizing the type and amount of tax owed as of the petition date.² Governmental units get 180 days from the date of the order for relief to file, substantially longer than the deadline for private creditors.³

That extended window is not incidental. It gives the IRS time to finish auditing pre-petition returns and lock in a final number. A placeholder claim early in the case, followed by an amended claim once the audit closes, is common practice.

Once timely filed, the claim is presumptively valid. If the classification looks wrong or the amount looks inflated, the debtor has to object, and confirmation feasibility often turns on that review. A successful objection shifts the burden back to the IRS and the bankruptcy court resolves the dispute.

The Three Categories of IRS Tax Debt

Federal tax liabilities fall into one of three buckets depending on their age, whether a lien has been recorded, and the type of tax involved. The bucket determines how much the plan must pay, on what timeline, and whether the debt can eventually be discharged. A plan that misclassifies the IRS claim or underpays it will not be confirmed.

Priority Tax Claims

Priority tax claims must be paid in full through the plan. Under 11 U.S.C. § 507, the priority category covers income taxes for which the return was last due (with extensions) within three years before the filing date, and income taxes assessed within 240 days before the petition. Taxes not yet assessed before filing but still assessable also qualify.⁴

The 240-day window is not a clean count. Time during which an offer in compromise was pending or in effect is excluded, plus another 30 days. Time during which a collection stay was in effect in a prior bankruptcy is also excluded, plus 90 more days. These tolling rules routinely catch debtors who assumed the clock ran uninterrupted.⁴

Beyond income taxes, priority also covers property taxes payable without penalty less than one year before filing, employment taxes with returns due within three years, certain excise taxes, customs duties, and any penalty that compensates the government for actual financial loss related to a priority tax.

Secured Tax Claims

A tax debt becomes secured when the IRS records a Notice of Federal Tax Lien. Under 26 U.S.C. § 6321, when a taxpayer neglects or refuses to pay a tax after demand, the amount owed becomes a lien on all of that person’s property and rights to property.⁵ The lien exists automatically, but it is not enforceable against certain third parties until the IRS files public notice in the state or local office where the property sits.⁶

The secured claim extends only to the value of the collateral. If the debtor owes $500,000 in tax but the liened property is worth $300,000, the claim splits. The $300,000 secured portion must be paid in full with interest, and the federal tax lien stays attached until it is. The remaining $200,000 drops into the general unsecured pool.

General Unsecured Tax Claims

Tax debts that fall outside the priority windows and are not backed by a recorded lien land in the general unsecured pool. The typical example is an income tax liability for a return due more than three years before the petition, timely filed, and assessed more than 240 days before filing. The unsecured tail of a bifurcated secured claim ends up here too.

These claims get pro rata treatment along with trade creditors and other non-priority unsecured debts. They are also the federal tax debts most likely to be discharged.

Trust Fund Taxes and Personal Liability

Trust fund taxes are the amounts an employer withholds from employee paychecks for federal income tax and the employee’s share of Social Security and Medicare. The money belongs to the employees and the Treasury from the moment it is withheld.⁷

The Bankruptcy Code treats trust fund taxes as priority claims regardless of age. Ordinary income taxes lose priority once the three-year and 240-day windows expire; trust fund taxes never age out. The statute grants priority to any “tax required to be collected or withheld and for which the debtor is liable in whatever capacity.”⁴ Every dollar of unpaid trust fund tax must be paid through the plan.

The bigger exposure lands on the people who ran the company. Under 26 U.S.C. § 6672, any person who was responsible for collecting and paying over these taxes and willfully failed to do so is liable for a penalty equal to 100% of the unpaid trust fund amount.⁸ The IRS typically targets corporate officers, directors, or anyone with check-signing authority.⁹

The corporate bankruptcy does not discharge that personal liability. Even if the corporation’s plan pays off the underlying payroll tax debt in full, the IRS can still pursue a responsible person separately. Many plans respond by directing payments to the trust fund portion of the liability first, reducing the exposure of individual officers and directors.

Post-Petition Taxes Are Administrative Expenses

A debtor-in-possession keeps generating tax obligations after the petition is filed. The business is still operating, still paying employees, still owing new taxes. Post-petition tax liabilities are treated as administrative expenses of the estate, not as pre-petition claims.¹⁰

Administrative expense status ranks higher than pre-petition priority tax claims. Under the confirmation rules, administrative expenses generally must be paid in full, in cash, on the effective date of the plan, unless the holder agrees to different terms.¹¹ The IRS does not even need to file a formal request for its administrative expense to be allowed.

The debtor-in-possession must keep filing all required returns and paying post-petition taxes as they come due. Falling behind is one of the recognized grounds for conversion to Chapter 7 or dismissal.¹² Cases that could otherwise succeed die here. A court will not let a business reorganize if it cannot stay current on its ongoing tax obligations.

What the Plan Must Pay, and When

Priority tax claims must be paid in full through regular installment payments in cash over a period ending no later than five years from the date of the order for relief.¹¹ The five-year clock starts on the petition date in a voluntary case, not on the effective date of the plan. Because most Chapter 11 cases take months or years to reach confirmation, the actual runway after the plan goes into effect is often shorter than five years.

“Regular installments” rules out a back-loaded balloon at the end. The treatment of priority tax claims must also be at least as favorable as what any non-priority unsecured class receives.

Because priority claims are paid over time, the plan must include interest so the IRS receives present value. The rate is the one set by non-bankruptcy tax law under 26 U.S.C. § 6621, not the “Till” rate courts use for many other secured claims in bankruptcy.¹³ The underpayment rate equals the federal short-term rate plus three percentage points and adjusts quarterly. It was 7% for the first quarter of 2026¹⁴ and dropped to 6% for the second quarter beginning April 1, 2026. Large corporate underpayments carry a higher rate (short-term rate plus five points), which was 8% for Q2 2026.¹⁵

The same non-bankruptcy interest rate applies to deferred payments on secured tax claims. Secured claims must also be paid in full, though they are not limited to the five-year window. The federal tax lien stays attached to the collateral until the secured amount is fully satisfied, so a default on plan payments exposes the property to IRS collection.

Which Tax Debts Get Discharged

Confirmation of a Chapter 11 plan discharges a corporate debtor from most pre-petition debts.¹⁶ For a corporation the discharge is broad, but the plan still had to provide for full payment of every priority tax claim as a condition of confirmation. The obligation to make the plan payments replaces the pre-petition liabilities. Defaulting on those payments reopens the IRS’s enforcement options.

Individual Chapter 11 debtors face a tighter rule. An individual’s discharge does not eliminate any debt that would be non-dischargeable under Section 523, which explicitly lists priority-type taxes, taxes where the debtor never filed a return or filed late (more than two years before the petition), and taxes connected to a fraudulent return or willful evasion. For an individual, the discharge does not arrive until all plan payments are completed.

General unsecured tax claims sitting outside the priority windows, with timely filed non-fraudulent returns, are the debts most likely to be discharged. Pre-petition penalties tied to dischargeable tax claims are also generally dischargeable, which can provide meaningful relief on older liabilities. Penalties tied to priority tax claims survive to the extent they compensate the government for actual financial loss.

Trust fund tax liability does not discharge at either the corporate or individual level, and the personal Trust Fund Recovery Penalty liability of a responsible person is entirely independent of what happens in the corporation’s case.⁸

If the Plan Fails

Not every Chapter 11 case reaches a confirmed plan, and not every confirmed plan gets completed. When things go wrong, the court can convert the case to Chapter 7 liquidation or dismiss it, whichever serves creditors better.¹⁷

Several of the statutory grounds for conversion or dismissal are directly tax-driven: continuing losses with no reasonable chance of recovery, gross mismanagement of the estate, failure to comply with court orders, and failure to meet filing or reporting requirements. A debtor that falls behind on post-petition returns or payments is handing the IRS grounds to blow up the case.¹²

Conversion to Chapter 7 stops operations. A trustee liquidates the assets and creditors get paid down the priority ladder. The IRS’s priority and secured claims keep their status, but the pool available to pay them is usually smaller because the business is dead. Dismissal can be worse. The automatic stay evaporates, every creditor regains its individual collection rights, and the IRS can immediately resume levies and seizures with whatever it had before the case was filed. Either outcome erases the restructuring opportunity and often leaves the debtor’s principals more exposed than they were before filing, especially on trust fund liability that piled up during a case that went nowhere.

1
Office of the Law Revision Counsel. 11 U.S.C. 362 – Automatic Stay
2
United States Courts. Proof of Claim
3
Legal Information Institute. Federal Rules of Bankruptcy Procedure Rule 3002 – Filing Proof of Claim or Interest
4
Office of the Law Revision Counsel. 11 U.S.C. 507 – Priorities
5
Office of the Law Revision Counsel. 26 U.S.C. 6321 – Lien for Taxes
6
Office of the Law Revision Counsel. 26 U.S.C. 6323 – Validity and Priority Against Certain Persons
7
Internal Revenue Service. Trust Fund Taxes
8
Office of the Law Revision Counsel. 26 U.S.C. 6672 – Failure to Collect and Pay Over Tax
9
Internal Revenue Service. Employment Taxes and the Trust Fund Recovery Penalty (TFRP)
10
Office of the Law Revision Counsel. 11 U.S.C. 503 – Allowance of Administrative Expenses
11
Office of the Law Revision Counsel. 11 U.S.C. 1129 – Confirmation of Plan
12
Internal Revenue Service. Publication 908 (2025), Bankruptcy Tax Guide
13
Office of the Law Revision Counsel. 26 U.S.C. 6621 – Determination of Rate of Interest
14
Internal Revenue Service. Interest Rates Remain the Same for the First Quarter of 2026
15
Internal Revenue Service. Internal Revenue Bulletin: 2026-08
16
Office of the Law Revision Counsel. 11 U.S.C. 1141 – Effect of Confirmation
17
Office of the Law Revision Counsel. 11 U.S.C. 1112 – Conversion or Dismissal