What you need to know About the Tax Consequences of Bankruptcy

It’s probably impossible to know all the consequences to your tax bill when you have filed Chapter 7, 11, 12 or 13 bankruptcies. The most important thing to know is yes, there will be consequences. All debtors are required to file all applicable federal, state and local tax returns that become due after a bankruptcy case commences. Failure to file tax returns in a timely manner or obtain an extension can case a bankruptcy petition to be converted to another chapter or dismissed. In chapter 13 cases, the debtor must file all required tax returns for tax periods ending within four years of the filing of a bankruptcy petition. The bankruptcy filing creates a “Bankruptcy Estate”. In chapter 11 cases of individuals, wages and income from self-employment earned during the bankruptcy case are property of the estate and must be reported on the bankruptcy estate’s tax return. The bankruptcy estate generally consists of all the assets of the person or entity filing the bankruptcy petition. It is a separate tax entity under chapter 7 & 11.

If you receive a 1099-C from any of your debtors from a bankruptcy discharge a taxpayer needs to file Form 982 to tell the IRS that this debt was included in your bankruptcy and should be exempted from taxation. Most tax debts will not be discharged in a bankruptcy, meaning after your case is over, and you will still owe any back taxes that may be due. The IRS will continue to accrue penalties and interest on your tax debt through your bankruptcy proceedings, so likely at the end when you are ready to settle with the IRS, your tax debt will be higher. Tax debts that are less than three years old cannot be included in bankruptcy. You must have filed tax returns properly for the previous four years before filing bankruptcy.

Tax refunds are considered income in the bankruptcy and in Chapter 7 cases they will be relinquished to the court. After chapter 7 cases are finalized, all you future tax returns are yours to keep and use as you see fit. Chapter 13 filers must usually pledge part or all of their tax refunds toward creditor repayment. After chapter 13 is completed, usually after three to five years, all future tax refunds belong to the debtor unless he owes newer taxes or defaulted on student loans. The bankruptcy estate is considered a separate entity and the trustee or debtor-in-possession is responsible for preparing and filing the estate’s tax returns and paying its taxes. The debtor remains responsible for filing their own returns and paying taxes on income that does not belong to the estate. The estate must obtain an employer identification number (EIN) for use in this regard. Anyone considering filing bankruptcy should obtain a copy of the IRS Publication 908 Bankruptcy Tax Guide to help you in your decision making and understanding your tax implications.

 

You should always consult with your tax professional to determine if this could pertain to your individual situation and your tax professional would be able to advise you and file your returns correctly.

*Research Material: IRS Publication 908 (Rev.Mar.09) “Bankruptcy Tax Guide”

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