The interplay of tax obligations and a bankruptcy filing

May 16, 2013

A bankruptcy filing affects all aspects of your financial life, taxes included. Not only can bankruptcy possibly get rid of past tax obligations in certain circumstances, it might also have an effect on the way that future taxes are calculated. Having a cursory understanding of the interplay between tax obligations and a bankruptcy filing can put you in a better position to consider whether or not bankruptcy is right for you. Even if you have already filed for bankruptcy, you could still benefit from learning how a Chapter 7, Chapter 11 or Chapter 13 bankruptcy will affect current and future tax returns.

To file or not to file...

Before considering a bankruptcy filing, many debtors will try other debt management tactics like attempting to negotiate with creditors, seeking a mortgage modification to free up income, applying for loans to pay expenses or selling property to pay bills. For these debtors, bankruptcy is the proverbial "hail, Mary" pass, the last chance they have at a fresh financial start.

Bankruptcy doesn't need to be the last-ditch effort, but it should also only be utilized when it is the best option. Bankruptcy has many short- and long-term effects, including difficulty obtaining credit, the sale of non-exempt assets and, for some, rigid adherence to a repayment plan lasting several years, so a filing should not be made on a whim. That being said, a bankruptcy filing is the only way for some people to escape insurmountable debt.

Treatment of taxes

One definite positive about bankruptcy is that, in some cases, it will get rid of credit card, medical debt or business debt, and might even be able to discharge some tax debts. Discharge of tax debt is not guaranteed, and it is only available to filers that meet exacting criteria set forth in the tax code, including:
- The debt must be at least three years old
- The filer must have submitted tax returns for the two years prior to a bankruptcy filing
- Taxes must have been assessed at least 240 days (approximately eight months) prior to the filing
- There must be no attempt on the part of the filer to evade taxes or submit fraudulent information to tax authorities

Even if these conditions are met, it is still possible that either the tax authority or the bankruptcy court will disallow a tax debt's discharge. In that instance, all or part of the debt might still be due.

Tax returns during/following bankruptcy

During a bankruptcy filing - and for the tax year afterward - the bankruptcy debtor and the bankruptcy trustee must both file tax returns. The debtor must file his or her own individual tax form (form 1040), and the trustee must file on behalf of the bankruptcy estate (form 1041). Failure to properly file tax returns could possibly result in the bankruptcy being dismissed or some debts not being dischargeable.

Only you can make the difficult decision about whether bankruptcy is the best move for you financially. An experienced bankruptcy attorney in your area can give you more information about your legal rights and your options to get the fresh financial start you need.

Article provided by The Law Offices of James C. Shields
Visit us at www.shieldslaw.net