Filing for bankruptcy is perhaps one of the most complex legal processes that a person has to undergo. Aside from filing the necessary documents and financial statements, debtors should also be concerned with their taxes. Technically, filing an income tax return after a bankruptcy case is filed shouldn’t have to be a problem. But this statement can only be true when a debtor knows what to watch out for, when to file their taxes, and how to file it properly.
Life after bankruptcy
Receiving a discharged from a bankruptcy case is not the end. This is just the beginning of what most debtors would call life after bankruptcy. This also involves filing of taxes.
The Bankruptcy Tax Guide, which is found on the IRS Publication 908 contains all pertinent information relating to tax compliance requirements by the Bankruptcy Code, tax return filing requirements on bankruptcy estates, and any other similar information.
Filing taxes differently
In the case of bankruptcy, the debtor surrenders their right to handle their financial affairs and instead relies on the expertise of the appointed trustee to oversee and handle all their affairs. The major responsibility of the bankruptcy trustee at this point is to ensure that the creditors will be paid with the proceeds that came from the liquidated assets. But then again, debtors are still liable to pay their taxes but instead of just using one form – which is Form 1040, the bankruptcy trustee will have to file Form 1041 for the sake of the bankruptcy estate.
Dismissal of bankruptcy case
As explained in the official Bankruptcy Tax Guide of the IRS, the bankruptcy estate will no longer be treated as a separate entity with taxes once the bankruptcy court dismisses an individual filing for a Chapter 7 or a Chapter 11 case. When this happens, the debtor must file the Form 1040x which is an amended tax return to replace the original Form 1040 which states the full or short year individual returns. Debtors should also take note that all credits, deductions, and incomes reported previously by the bankruptcy estate should be reported on the amended returns that will be filed by the debtor. A statement should also be attached to the said documents to explain why the returns are being amended.
Unpaid tax discharges
Since the bankruptcy court can issue a discharge order for debts which sometimes include taxes, it is important to know which tax debts are available for discharge and which ones are exempted.
Chapter 7 bankruptcy
For Chapter 7 bankruptcy, tax debts that are not possible for discharge include taxes that are entitled to the eight priority, taxes with no filed returns, taxes with a late return of two years after the bankruptcy cases was filed, taxes filed for fraudulent returns, and taxes willfully attempted by the debtor to defeat or evade. Tax penalties are dischargeable except if the event that made the penalty arise occurred within three years of the filed bankruptcy case and the penalty is related to a nondischargeable tax. Also, debtors should note that corporations and other similar entities will not be able to receive a tax discharge under Chapter 7 unless otherwise an individual.
Chapter 11 bankruptcy
Just like in Chapter 7, most of the tax exceptions in the previous chapter can also be applied in Chapter 11 cases given that the case is filed by an individual. In the case of a corporation, a broad discharged can be obtained when the debtor corporation confirms a reorganization plan. However, claims that are considered as priority and secure must be met under the plan. Discharge exceptions are placed when the debtor files a fraudulent report or willfully attempts to defeat or evade taxes.
Chapter 13 bankruptcy
Debtor who completes the agreed reorganization plan under the Chapter 13 bankruptcy shall obtain a broad discharge of all debts provided for by the plan. However, there is the condition that priority tax claims should be given payment in full and that certain taxes be exempted; the same taxes that is exempted in the previous Chapter 7 and Chapter 13 bankruptcy case. Also, a discharge may not be given when the creditor which includes the IRS didn’t receive any notification of the Chapter 13 bankruptcy case to file their claim on time.
There is also the matter of the “hardship discharge” under Chapter 13 wherein a debtor fails to complete all payments agreed due to certain circumstances that the debtor has no control of. When this happens, the debtor shall not be held accountable for his/her failure to commit to the reorganization scheme and the bankruptcy court may grant the debtor a “hardship discharge” in the process. Then again, each unsecured claims must be paid an amount that is not less than the amount that the debtor might have received under Chapter 7 liquidation.
Federal tax liens
Tax that are discharged from bankruptcy may still be considered as a collectable from the debtor’s pre-bankruptcy property especially if the IRS submitted an NFTL even before the filing of a bankruptcy petitions. Generally, perfected liens pass through bankruptcy proceedings without any problem even if the personal liability for the debt of the debtor is discharge. If no NFTL was filed by the IRS before the filing of the bankruptcy petition, then the tax lien will be removed as a result of the filed bankruptcy case even though the debtor tries to exempt the property out of the property of the estate. On the other hand, tax liens due to an assessed tax cannot be removed upon discharge even if no NFTL was filed.
“Forgiven” tax debts
A tax debt is considered “forgiven” once it is cancelled. When this happens, the debtor must include the forgiven debt amount in their gross income for tax purposes. When a forgiven amount exceeds more than $600, the lender should provide the debtor Form 1099-C, or the Cancellation of Debt.
Another way for debtors to handle forgiven debts in bankruptcy is to ensure that tax attributes are properly allocated by filing the IRS Form 982 for the given tax year when the bankruptcy discharged was received by the debtor. Also, having the assistance of a bankruptcy attorney is one of the best ways to ensure that filing taxes right after a discharged bankruptcy is done properly.