Bankruptcy

Bankruptcy

Bankruptcy is an option if you’re unable to pay your overdue federal taxes. Other alternatives include setting up a payment plan with the IRS or making an offer in compromise.

Chapter 13 bankruptcy is the most common type for individuals. Here are some essential points to bear in mind if you’re contemplating this route:

1. You must file all relevant tax returns for tax periods ending within four years before your bankruptcy filing.
2. Throughout your bankruptcy process, you should either continue to file all necessary returns or obtain an extension of time to do so.
3. You must pay all current taxes due during your bankruptcy case.
4. If you fail to file returns or pay your current taxes while your bankruptcy case is ongoing, it could lead to the dismissal of your case.

Businesses, such as partnerships and corporations, usually file bankruptcy under Chapter 7 or Chapter 11 of the bankruptcy code, although individuals can also opt for these chapters. For more detailed information on tax-related bankruptcy, please refer to Publication 908, Bankruptcy Tax Guide, and Publication 5082, What You Should Know about Chapter 13 Bankruptcy and Delinquent Returns PDF.

Bankruptcy can have significant effects on your tax situation. Here’s a list of key points to consider:

1. Timely Filing and Payment: After declaring bankruptcy, you must file income tax returns and pay any income tax due on time1.
2. Impact on Tax Refunds: In a Chapter 7 bankruptcy, you may lose your tax refund once, but any refund on income earned post-bankruptcy is yours2. For Chapter 13 bankruptcy, tax refunds based on income earned before filing are considered part of your estate3.
3. Filing Taxes Post-Bankruptcy: Filing an income tax return after bankruptcy doesn’t have to be problematic, provided you know the rules and regulations4.
4. Nondischargeable Priority Debt: Taxes are generally considered nondischargeable priority debt according to bankruptcy law, which means that they are not eliminated by bankruptcy, and repayment is typically required56.
5. Clearing Tax Debt: Only federal or state income tax debt can be discharged through bankruptcy. Other taxes, such as fraud penalties or payroll taxes, cannot be eliminated7.
6. Taxable Income from Discharged Debt: Generally, any debt that is canceled, forgiven, or discharged becomes taxable income and needs to be reported on your tax return.

Remember, it’s essential to consult with a financial advisor or tax professional to understand the full implications of bankruptcy on your specific tax situation.

Footnotes:

1. IRS
2. Debt.org
3. Upsolve.org
4. TurboTax
5. H&R Block
6. Forbes
7. Burr Law Office
8. Efile.com