Bankruptcy is a federal reset, not a moral verdict — a constitutional mechanism for discharging debt you cannot pay. The asset-protection side of the question (which accounts a creditor can never reach) lives in section “Asset Protection”; the income chapter’s concern is the tax side: which debts and taxes actually clear, who pays tax on the debt that is forgiven, and what income survives the process.
Two consumer paths. Chapter 7 is liquidation. You must pass a means test — income below your state median, or little disposable income after allowed expenses — after which a trustee sells your non-exempt assets, unsecured debt is discharged in a matter of months, and you walk out owning your future earnings free and clear. Chapter 13 is reorganization, for filers who fail the means test or want to keep non-exempt property or cure a mortgage arrears: you commit your disposable income to a three-to-five year repayment plan and receive a discharge of the remaining balance at the end. (Chapter 11 is the business reorganization, used by individuals only at very high debt levels.)
The discharge is not a clean sweep. Several obligations survive every chapter. Student loans — federal and private — are nearly impossible to discharge absent a proven undue-hardship showing (section “Student Loans”). Domestic support obligations (child support and alimony), debts arising from fraud or willful injury, and most recent taxes ride straight through the discharge untouched.
Filing creates a separate taxpayer. An individual Chapter 7 or 11 filing creates a bankruptcy estate under IRC §1398, “Rules relating to individuals’ title 11 cases” — a distinct taxable entity that files its own Form 1041, takes your pre-petition assets, and is taxed on the income those assets generate. You continue to file your own Form 1040 on wages earned after filing; the fresh-start earnings are yours, not the estate’s. A Chapter 13 filing creates no separate estate under IRC §1399 — you keep filing a single 1040. The distinction decides who pays the tax when the trustee sells a pre-petition asset, and it is the kind of detail that surprises filers who assumed bankruptcy paused their tax life.
Discharged debt: the tax that usually isn’t. Forgiven debt is normally taxable income (the cancellation-of-debt rule under IRC §108). Debt wiped out inside a Title 11 case is the exception: it is fully excluded, with no insolvency dollar cap — the cleanest exclusion in the code. The price is paid in tax attributes, not cash: you must reduce your net operating loss and capital-loss carryovers, credits, and ultimately your asset basis under IRC §1017. Out of court, a forgiven balance qualifies only for the narrower insolvency exclusion, and only to the extent you were underwater. A large debt forgiveness is therefore often far cheaper handled inside bankruptcy than through an informal settlement that lands a Form 1099-C in your mailbox.
Tax debts clear only on a timetable. Income tax is dischargeable only once it has aged: broadly, the return must have been due at least three years before filing, actually filed at least two years before, and assessed at least 240 days before, with no fraud or evasion. Recent income taxes, withheld payroll and trust-fund taxes, and fraud penalties survive every chapter. Bankruptcy is rarely an escape hatch from a fresh IRS assessment — it works on old tax debt, not this year’s.
Do not burn protected money to avoid filing. The most expensive mistake in personal finance is draining a 401(k) or IRA to pay unsecured creditors you could have discharged. Employer plans sit entirely outside the bankruptcy estate and IRAs are shielded to the BAPCPA cap (section “Asset Protection”) — that money is already beyond a creditor’s reach. Cashing it out converts protected, tax-advantaged savings into a taxable, penalized distribution and hands it to creditors who were about to be wiped out. Pre-filing maneuvers backfire just as badly: running up debt you do not intend to repay is fraud, and gifts to relatives or “preferred” repayments in the months before filing are clawback-able preferences the trustee will unwind. The financial bottom is the day you file; the rebuild starts the day after.