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Many people connect a Chapter 11 bankruptcy case with a business trying to reorganize its debts and finances. Most Chapter 11 cases do involve corporations, but individuals can use Chapter 11 too. Individuals opting for Chapter 11 may have a business that isn’t a corporation, or may have high-value assets and more complex finances.
Individuals need to be aware of several tax issues that could impact bankruptcy and tax planning decisions. You’ll need your bankruptcy or tax lawyer’s help to steer through these complex issues and how they can affect you and your taxes.
Two Taxpayers: You and Your Bankruptcy Estate
Once you file a Chapter 11 case, all of your assets become part of the bankruptcy estate. The bankruptcy estate is a taxpayer, and one duty of the trustee for your case is to report estate income and file tax returns. The trustee obtains an employer identification number (EIN) for the estate.
The trustee files an income tax return for the estate if its gross income meets or exceeds a certain amount. Generally, tax returns need to be filed for periods after the bankruptcy petition is filed. There are exceptions, though, and the trustee may need to file returns for periods before the petition date when:
- A tax liability is a claim scheduled by the debtor or
- A creditor files a proof of claim
Your finances and tax issues may look different before and after your bankruptcy case. What happens during your case could impact the tax returns you file after your case is complete.
Tax Housekeeping Before and During Your Case
You may start the bankruptcy process by filing a Chapter 7 or 13 petition, and later convert your case to Chapter 11. You will need to have filed your federal tax return and have a copy before filing a Chapter 11 petition. You must give a copy to the trustee or a creditor if asked. If you don’t furnish your tax return, your case can be dismissed.
Once you file your bankruptcy petition, file tax returns on time. Results for not filing include:
- Amounts may be estimated on proof of claim forms
- You may have to respond to motions to compel
- There may be objections to cash collateral
Timing Matters: Filing Tax Returns and Bankruptcy Petitions
Be aware of timing issues when it comes to filing taxes and filing your bankruptcy petition. Your attorney can best help you work through tax planning and filing date issues.
Priority Tax Liabilities
Priority tax liabilities include unsecured claims by a government entity. Unsecured property taxes are a good example. Pay this type of tax liability before you file for Chapter 11. Why? If you don’t, you face personal liability for interest that adds up during the case, regardless of whether the bankruptcy estate pays the taxes.
Discuss with your attorney whether it’s best to use available funds to pay taxes you owe for past years, and current taxes.
Taxable Gains and Timing
Triggering taxable capital gains and your planned bankruptcy filing date need to be addressed. The situation to avoid is the trustee abandoning a tax-burdened asset back to you. Watch for these situations:
You have net operating loss carryovers or can pay the tax on gains. If you have assets with large built-in gains, and little or no equity, it may be best to trigger the gains before filing for Chapter 11. Your attorney may advise you to make a short-year election, and end your tax year the day before you start the Chapter 11 case. If you’re using liquid assets to pay the tax, make estimated tax payments before you file.
You don’t have net operating loss carryovers or assets to pay taxes. Here, don’t trigger gains before you file a bankruptcy petition. You should hope that the trustee doesn’t try to abandon the assets, and resist the trustee’s attempts to do so. Time the filing of your petition so gains are triggered after that date. Another option is to file and let foreclosures occur during a Chapter 11 case.
Work with your attorney and make smart strategy moves when planning and filing your Chapter 11 bankruptcy as an individual. You then stand the best chance to get the financial fresh start you’re looking for.
Questions for Your Attorney
- Can my decisions on triggering capital gains and choosing when to file for Chapter 11 be challenged by anyone, say creditors or the Internal Revenue Service?
- What are the advantages to filing a Chapter 11 case based on my facts?
- Can my choice to use cash to pay off all taxes before I file for bankruptcy be challenged by any of my creditors?