People who are over their heads in debt and considering bankruptcy have a number of decisions to make regarding bankruptcy and taxes. As bankruptcy attorneys, we often hear questions from clients about how bankruptcy will affect taxes and tax returns. An individual who files for bankruptcy under Chapter 7 or Chapter 13 of the federal Bankruptcy Code is still required to file an individual tax return or to request a filing extension.
If an individual going through chapter 13 bankruptcy fails to file a tax return properly or request a filing extension, it can result in a bankruptcy case being dismissed or converted to chapter 7. Bankruptcy is a complicated process and it can involve changes in the filing of tax returns. A misstep can be costly. It is important to understand the tax implications of a bankruptcy to make forward-looking decisions. You should seek the guidance of a knowledgeable bankruptcy attorney to review your specific situation.
How to File Taxes During Bankruptcy
For a small number of chapter 7 and chapter 11 debtors it may be appropriate and helpful to file two tax returns —an individual Form 1040 return and a Form 1041 return for the bankruptcy estate.
The bankruptcy estate consists of all of the assets an individual owned on the date the bankruptcy petition was filed. It is treated as a separate taxable entity for individuals filing petitions under chapter 7 or 11 of the Bankruptcy Code.
Chapter 7 Tax Filing Requirements
Chapter 7 bankruptcy is available to individuals who cannot make regular payment of their debts, and to businesses that need protection from creditors and are going out of business. A bankruptcy trustee is appointed by the court to dispose of a debtor’s non-exempt assets to raise cash to pay creditors. Many unsecured debts may be discharged.
As the individual going through Chapter 7 bankruptcy, you would file a regular Form 1040 tax return.
Meanwhile, the bankruptcy trustee is responsible for filing a Form 1041 tax return for the bankruptcy estate, if applicable. The requirement to file a return for a bankruptcy estate applies if the estate generated gross income of at least $10,400 in tax year 2017.
You may receive a tax refund while in bankruptcy. In chapter 7, a trustee may request the tax refund if the refund is not exempt. The tax refund would be applied toward satisfaction of the claims filed in the debtor’s case.
If you have difficulty paying your taxes after filing for bankruptcy, you should seek the guidance of a qualified bankruptcy attorney.
Chapter 13 Tax Filing Requirements
Chapter 13 is the most common type of bankruptcy filed in the Eastern District of North Carolina. Only individuals may seek Chapter 13 bankruptcy protection. A chapter 13 bankruptcy allows individuals with regular income to develop a repayment plan to pay all or part of their debts over a period of three to five years. If you successfully complete your repayment plan, you will receive a discharge of debt.
To qualify for a Chapter 13 reorganization of debt, you must have regular income and have filed all required tax returns for the tax periods ending within four years of the bankruptcy filing.
When you file a Chapter 13 petition to reorganize your debt, the bankruptcy estate is not treated as a separate entity for tax purposes. You continue to file the same Form 1040 individual income tax returns that were used before the bankruptcy.
When filing your tax return, you report all income received during the year and deduct any permitted expenses. You do not list as income the amount of forgiven debt due to the Chapter 13 bankruptcy.
Some taxes may be dischargeable under Chapter 13. Whether federal tax debt may be discharged must be determined on a case by case basis. You will need to consult with a bankruptcy attorney to evaluate which tax debts may be discharged in your particular case. If federal tax debt is the reason you are seeking Chapter 13 protection, you may need to increase your withholding or quarterly estimated tax payments.
If you are considering a Chapter 13 bankruptcy, here are some things to keep in mind:
- You must file or get an extension on all applicable federal, state and local tax returns that come due after the case is opened.
- A Chapter 13 filing does not prevent the IRS from intercepting your refund and applying it to the prior liability.
- You should pay all post-petition income taxes in a timely fashion if possible.
- The failure to file tax returns or pay current taxes when they are due can cause the bankruptcy court to dismiss your case or convert it to chapter 7.
A clear understanding of the tax consequences of a bankruptcy filing is an essential step for anyone considering bankruptcy and seeking a brighter future after bankruptcy.
At Sasser Law Firm, our board-certified bankruptcy attorneys have assisted thousands of North Carolina residents in charting a course through financial hardship and addressing tax liability issues. We work with you to identify the best options based on your individual situation. Our goal is to help you take the steps necessary to relieve your financial stress and get back on sound footing. If you are considering bankruptcy and have questions about the tax implications, contact a board certified attorney at Sasser Law Firm for a free consultation.
Source: IRS Publication 908