The Tax Consequences of Filing for Bankruptcy

Unfortunately, when filing for bankruptcy there are tax consequences that need to be considered. The particular chapter of bankruptcy you file for will determine how your taxes are affected. Typically, when filing bankruptcy, all of your debts that are cleared have no tax consequences because they're not considered taxable income. On the other hand, you may not be entitled to certain tax benefits that you would otherwise benefit from. When looking into bankruptcy as an option, the tax consequences are present when filing chapter 7, there are possible tax responsibilities after filing and the possibility of an IRS proceeding.

Filing Chapter 7

When filing for Chapter 7 bankruptcy, a separate estate is created, which means the consequence is that it is also a separate taxable entity. If you decide to file Chapter 13, then a separate taxable estate is not created and therefore you would file your tax returns as usual. In a Chapter 7 bankruptcy, there are two estates created. The first estate is the bankruptcy estate and the second is your individual estate as the filer. But if you and your spouse decide to file a joint bankruptcy petition, the new estates are administered jointly by a trustee and each estate is treated separately with regards to taxes. In bankruptcy situations, you are still responsible to file your own return, while a trustee is responsible for filing a return for the bankruptcy estate.

Possible Tax Responsibilities

In filing Chapter 7 bankruptcy, you must still send in a tax return. But in the tax return you wouldn't include income, deductions or credits that belong to the bankruptcy estate. A separate return would be filed for the income earned during the rest of the year. You will have the option to end your tax year on the day before you filed for bankruptcy. If there are taxes due for that time period, it is seen as a claim against the bankruptcy estate. The consequence here is that it can also be collected from you after you filed for bankruptcy.

Possible IRS Proceeding

An automatic stay, which is a suspension of legal proceedings, can result when you file for bankruptcy and there is a proceeding against you from the IRS. However, it doesn't apply to an audit determining your tax liability, a demand for tax returns, setting the value of taxable property, the issuing of a notice and demand for payment of the tax assessed and the issuance of a notice of tax deficiency. While any assets under the jurisdiction of the bankruptcy court are not subject to levy of a tax lien for the taxes owed within three years of filing, the IRS can still file a proof of claim, even when the taxes have not been assessed. There are different ways of paying the taxes owed, so it is recommended you speak with the IRS to set up a payment plan.

It is always important when making a major decision, such as filing for bankruptcy, for you to talk with an attorney to discuss all of the implications this may have on your future. As noted above, there are consequences in filing Chapter 7, possible tax responsibilities to you after filing, and the possibility of an IRS proceeding.

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