Have you filed for Chapter 7 bankruptcy? This type of bankruptcy involves the selling of your non-exempt property to pay your creditors. The idea is to be able to walk away from your debts and give yourself a fresh start.

There are certain tax issues you should be aware of if you file for Chapter 7 bankruptcy. These issues come from the rules set up by federal, state and local laws. If you run into any difficulty, Lawyers.com can help you find a Bankruptcy or Taxation lawyer.

Bankruptcy Estate – New Taxable Entity

The law treats the bankruptcy estate as a completely new taxable entity. The person managing the estate is called the trustee. The trustee is responsible for liquidating non-exempt estate property to pay back creditors.

Filing a Tax Return

You're responsible for filing your own tax returns during the bankruptcy proceeding. You must pay taxes on income that doesn't belong to the bankruptcy estate. The usual form is IRS Form 1040. The bankruptcy court has the authority to determine the tax amount that should be imposed on you or the estate.

A tax return must also be filed for the bankruptcy estate. The trustee is responsible for filing the tax return and paying the taxes. He must first obtain an employer identification number (EIN) for the estate. He uses the EIN on the estate's tax returns. The trustee uses IRS Form 1041. He may request information on any unpaid taxes that arise after your petition is filed.

Bankruptcy Estate Income

The income of the bankruptcy estate comes from a variety of sources. Your income must be included in the estate if it's entitled to it under the Federal Bankruptcy Code. However, any income you earn after you file the bankruptcy petition isn't included. Income generated by the property in the estate after the petition is filed is included in the estate.

State and Local Taxes

There are a variety of state and local tax issues that can have an effect on bankruptcy cases. Priority and discharge issues are generally resolved based on whether the taxes arose before or after the petition was filed. Other issues include determining taxable income, the carryover of tax losses and the taxability of the discharge of indebtedness. Sometimes discharged debts are treated as income, which can be taxable.

Three sets of tax rules govern the state and local taxation of debtors in bankruptcy. First, there are the state and local tax laws. These laws vary by state and county. Second, the Internal Revenue Code applies to a certain extent. Third, the Federal Bankruptcy Code contains special tax provisions that apply to state and local taxation.

The bankruptcy laws provide for uniformity among federal, state and local tax rules. For example, certain rules prevent state or local tax from being imposed on discharge of indebtedness income unless that income is also subject to tax under the Internal Revenue Code. The tax rules are kept consistent by applying the rule that changes in federal tax law automatically apply to state and local law.

Questions for Your Attorney

  • If I am anticipating a tax liability for the current year, and I file for bankruptcy, can I include that future liability in the bankruptcy case?
  • Can the discharge of debts be treated as income? If so, can I be taxed on this?
  • To what extent can state and local taxes be discharged in bankruptcy?