Ever wondered how bankruptcy affects your taxes? Whether you’re planning to file for bankruptcy, recently filed, or are simply curious, here are all your questions about bankruptcy and taxes, answered by TaxGlobal.
Why would someone file for bankruptcy?
People file for bankruptcy when they have debts they can’t repay, including from credit cards. Bankruptcy gives you a chance to “start over” financially. Of course, your credit score will suffer, so it’s not exactly like starting over, but it does give you more time to pay your debts and/or eliminate your debts altogether.
What happens when someone files for bankruptcy?
When you file for bankruptcy, creditors cannot collect payment from you, and you may have the option to either pay part of your debts over time, or simply not pay them at all. Depending on which type of bankruptcy you file for, you may forego the right to manage your own finances, in which case the court will appoint a trustee to manage them for you. Your financial assets will then be handled as an estate.
How do taxes work if you file for bankruptcy?
When you file for bankruptcy, you must report it to the IRS. Then, depending on which type of bankruptcy you file for, there are three different tax requirements.
Chapter 7 bankruptcy
If you file for Chapter 7 bankruptcy, you must sell your personal assets to pay off your debts. In this case, you’re still required to file and pay taxes.
How to file taxes for Chapter 7 bankruptcy:
File Form 1040 yourself, the same as you would for any individual tax return, and have your trustee file Form 1041 for your estate.
Chapter 11 bankruptcy
Chapter 11 bankruptcy is a more complicated type of bankruptcy, most commonly used for businesses. In this type, you keep possession of your assets and property, which means you function as the trustee yourself and can borrow more money.
How to file taxes for Chapter 11 bankruptcy:
File Form 1040 as usual, but also file Form 1041, which is the estate tax return, for your bankruptcy estate.
Chapter 13 bankruptcy
Chapter 13 bankruptcy is also known as the wage earner’s plan. The most common type of bankruptcy for individuals, this is likely the type you’ll file if you have a regular source of income. It allows you to come up with a plan to repay either all or part of your debt over three to five years. Once you’ve filed, creditors can’t collect any money from you.
How to file taxes for Chapter 13 bankruptcy:
File Form 1040 and pay your taxes as usual.
Does filing for bankruptcy change my tax refund?
This depends on which type of bankruptcy you file.
Chapter 7 and 11 bankruptcy: If your tax refund is for the tax year during or after which you filed for bankruptcy, it won’t be included as part of your estate. If it’s for a previous year and you’ve since filed for bankruptcy, it will be included as part of your estate.
Chapter 13 bankruptcy: If your tax refunds comes in after your bankruptcy becomes active, it’s considered part of your estate. To avoid receiving a refund, you could adjust your tax withholdings so you won’t overpay.
What if the IRS takes my refund?
Your bankruptcy estate may take your refund in order to pay your debts. But if the IRS mistakenly takes your refund, file a claim for relief and damages. You can do this by sending a written claim to the IRS, specifically, to the Chief of the Local Insolvency Unit for the judicial district in which you filed for bankruptcy.
Can I file bankruptcy for tax debts?
Taxes, unlike credit card debts, are classified as nondischargeable priority debt. This means you can’t get rid of your tax debt by filing bankruptcy. It’s still something you need to pay, and as a priority, you’ll be expected to pay back your tax debt before other debts.
However, there are situations in which your tax debt may be forgiven if you file for bankruptcy. For this to be the case, you must meet all the following conditions:
Have debt from your own, personal income that is at least three years old
Have filed a valid tax return for the debt at least two years before you file for bankruptcy
Have your debt documented by the IRS at least 240 days before you file for bankruptcy
Have no history of tax evasion or fraudulent returns
The IRS must not have a lien on your personal assets
Need help filing bankruptcy taxes?
If you’ve recently filed or are planning to file for bankruptcy, and need help filing your taxes, TaxGlobal can help. Use our platform to match with a tax professional who can guide you through the process.