Bankruptcy and Tax Consequences Text Size:

The type of bankruptcy chapter you file affects your taxes. Generally, all of your debts discharged or cleared have no tax consequenses because they're excluded from taxable income. However, you may not be entitled to certain tax benefits that you would otherwise be entitled to use.

Separate Taxable Estates

Filing for Chapter 7 bankruptcy creates a separate bankruptcy estate, which is a separate taxable entity. Chapter 13 doesn't create a separate taxable entity and you would file a tax return just like normal.

In a Chapter 7 bankruptcy, the separate bankruptcy estate creates two taxable estates: Your individual estate as the filer in the case and the bankruptcy estate. If you and your spouse file a joint bankruptcy petition, their new estates are administered jointly by a trustee. Each estate is treated separately for tax purposes. While you're responsible for filing an individual tax return (joint, separate, married filing separate, etc.), the trustee files the bankruptcy estate's tax return.

Responsibilities of the Individual Chapter 7 Debtor

You must still send in a tax return if you declared Chapter 7 bankruptcy. However, you wouldn't include income, deductions or credits that belong to the separate estate.

You have the option of electing to end your tax year on the day before you filed for bankruptcy. If there is any tax due for that time period, it's treated as a claim against the bankruptcy estate, but it can also be collected from you after filing for bankruptcy. Another return must be filed for income earned during the rest of the year.

The Bankruptcy Estate

Trustees managing bankruptcy estates are responsible for preparing and filing the income tax return for the newly created estate. When the bankruptcy estate ends, any remaining assets are returned to the debtor and aren't treated as a taxable transaction.

Automatic Stay and Tax Assessments

An automatic stay (suspension of legal proceedings) results when you file for bankruptcy and includes any proceeding against you from the IRS. However, it doesn't apply to the following situations:

• An audit to determine your tax liability
• A demand for tax returns
• The issuance of a notice of tax deficiency
• The making of tax assessments (setting the value of taxable property) and the issuing of a notice and demand for payment of the tax assessed

Payment of Tax Claims

While your assets or the assets of the bankruptcy estate are under the jurisdiction of the bankruptcy court, they are not subject to levy of a tax lien for those taxes owed within three years of filing your petition. However, the IRS can file a proof of claim, even when the taxes have not been assessed.

The claim can be paid out of the assets of the bankruptcy estate under Chapter 7. Chapter 13 allows you to pay taxes owed over three to five year based on your debt repayment schedule.

Reduction of Tax Attributes

Whether you filed for a Chapter 7 or Chapter 13 bankruptcy, if you excluded the amount of discharged debt from income, you must use the excluded amount to reduce the following tax attributes, including carryovers, generally in following order:

• Net operating losses
• General business credit carryovers
• Minimum tax credits
• Capital losses
• Basis of your property
• Passive activity loss and credit carryovers
• Foreign tax credit

If you filed under Chapter 7, the reduction of tax attributes must be made to the bankruptcy estate.

Questions for Your Attorney

• What happens if I don't elect to file a shortened year after filing Chapter 7 bankruptcy?
• In a Chapter 7 bankruptcy, who is responsible for filing a tax return for the bankruptcy estate?
• Do I need a trustee for my bankruptcy estate?
• Can the IRS still send me notices of tax deficiency after I file for bankruptcy?

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