How Personal Bankruptcy Affects your Taxes (Part II)

In Part I, we looked at the two types of personal bankruptcy, Chapter 7 & 13, and the primary differences between each. Now we will discuss how a bankruptcy filing may impact your taxes. Here are some three common questions that often come up:

Can Tax Debts be discharged through Bankruptcy?

Under the current bankruptcy laws, tax debts are treated the same in both Chapter 7 and 13. You may be eligible to have your past tax debts discharged, but only if you meet certain criteria:

  1. The tax filing due date for the debt in question must be at least three years prior to the bankruptcy filing.
  2. The actual tax return filing must be at least two years prior to the bankruptcy filing.
  3. If this is a case where there was a tax assessment done, it must have occurred at least 240 days prior to the bankruptcy filing.
  4. The debtor must not have filed a fraudulent tax return.
  5. The debtor must not have been found guilty of tax evasion.
  6. If the tax debt in question was incurred during a tax year in which the debtor did not file a return, then the debt is not dischargeable through bankruptcy.

In short, if you have been filing your returns each year and your tax debt is at least three years old at the time you file bankruptcy, it will most likely be discharged provided you meet all of the other filing qualifications.

Am I responsible to pay income taxes on debt discharged through bankruptcy? No. This is one of the advantages of seeking bankruptcy protection; debt discharged is not subject to taxes. Under normal circumstances, this may not always be the case. For example, if you owed a total of $50,000 in credit card debt and negotiated a settlement (directly with the creditor) of $25,000 as paid in full, you may be responsible for income taxes on the $25,000, which was forgiven.

Do I need to file any additional forms during the tax year that I filed bankruptcy? For a consumer bankruptcy, the answer is no. You should be aware, however, that while you are filing your annual 1040 as usual, the bankruptcy trustee would also be filing a 1041 for the bankruptcy estate. In the case of a Chapter 11 bankruptcy (usually filed by a corporation), however, the debtor typically also acts as the bankruptcy trustee and is responsible to file both the 1040 and 1041.

There are other factors that may impact how you should file your income taxes either before or after filing a personal bankruptcy. For additional guidance, speak with a qualified tax professional that can help make sure you start your post-bankruptcy life on the right foot.

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