This write-up is the ninth in a series of articles dedicated to outlining common events in life that may have significant tax implications when considered on your annual federal tax return filed with the Internal Revenue Service (IRS). This entry specifically covers bankruptcy. For further reading on the impact bankruptcy can have on your federal income tax, see the IRS’s publication on bankruptcy.
Returns for Individual and Bankruptcy Estate
When a debtor files bankruptcy, the filing creates what is known as a bankruptcy estate. The bankruptcy estate consists of all the property that the debtor owned at the time of the bankruptcy, which the bankruptcy trustee—that is, the individual who is responsible for handling the bankruptcy payouts—then uses to pay the debtor’s creditors.
If you have filed a Chapter 12 or 13 bankruptcy, the debtor should continue to file the same federal income tax return forms that you needed to file before filing the bankruptcy. If you have filed a Chapter 7 or 11 bankruptcy, the debtor needs to file a Form 1040 for his personal income tax. In addition, a Form 1041 must be filed for the bankruptcy estate.
With the creation of a bankruptcy estate, a tax return must be filed for the bankruptcy estate. The bankruptcy trustee or the debtor may file the tax return for the bankruptcy estate, depending on who is in control of the assets in the bankruptcy.
End of Tax Year Election
When a debtor files a Chapter 7 or 11 bankruptcy, the debtor may also choose to end his tax year. If the debtor chooses to end his tax year, there are effectively two tax years during the year of the bankruptcy, with the first ending the day before the bankruptcy is filed and the second covering the remainder of the year. The debtor may choose to split the tax year into two parts in this manner if there is a federal income tax liability owed to the IRS up to the point of the bankruptcy. If this is the case, the tax liability in the first tax year can be a claim against the assets in the bankruptcy estate.
Whether the debtor chooses to split the tax year or not, in general, the income of the debtor must be kept separate from the income of the bankruptcy estate for tax purposes, with the income reflect on the returns of each entity, the debtor and the bankruptcy estate.
Freedom from Tax Levy and Tax Priority
Once a debtor has filed a bankruptcy, any of the debtor’s assets that are in the bankruptcy are not subject to an IRS tax levy. This means that the IRS cannot take assets from the bankruptcy estate to satisfy an unpaid tax liability of the debtor.
If a debt is forgiven as a part of the bankruptcy, the debtor must usually include the amount forgiven as income for tax purposes. Usually, the debtor will receive a Form 1099-C from the creditor reflecting the amount of debt that is taxable as income.
If you have filed bankruptcy and you have questions about how it impacts your federal income tax return, you should seek the help of a tax attorney.
- Federal income tax significant events, Part 8 – Moving (taxlawhome.com)
- Federal income tax significant events, Part 7 – Purchasing a Home (taxlawhome.com)
- Federal income tax significant events, Part 2 – Marriage, divorce (taxlawhome.com)
- Federal income tax significant events, Part 1 – Birth (taxlawhome.com)
- Bankruptcy and the Mortgage Forgiveness Debt Relief Act of 2007 (betterbankruptcy.com)
Mark has been a contributor to legal web sites related to bankruptcy, tax, and criminal law since 2011. He has an Accounting degree from Texas A&M University.