Filing Bankruptcy and Taxes

By | February 1, 2014

What happens with taxes when you file bankruptcy?

There are four types of bankruptcy available to individuals and certain tax rules will apply in the year that an individual taxpayer files for bankruptcy. Most individual bankruptcies have been under Chapter 7 or Chapter 13. There are several big differences in each type of bankruptcy that are beyond the scope of this article.

When a taxpayer files a petition in bankruptcy, all collection efforts against him and his property, including efforts by IRS, are automatically stopped by order of law. Tax debts may be eliminated in bankruptcy in the same way as other debts, but broad special exceptions to discharge apply to tax debts that can make them nondischargeable. Overall, the IRS usually wins and it is hard to discharge tax debts in a personal bankruptcy.


Filing Bankruptcy and Taxes

Tax debts excepted from discharge in individual bankruptcies under Chapters 7, 11, and Chapter 13 include taxes for which a return was not filed or was filed late during the two years before the bankruptcy; taxes for which the debtor made a fraudulent return or attempted to evade or defeat the taxes; and taxes that receive certain “priority” in bankruptcy.


Discharging Tax Debts

Tax debts that are incurred more recently are harder to discharge in bankruptcy and the lawyer guiding you through a bankruptcy should provide more information upon this as each taxpayer could be in a unique situation. Tax debtors need to also remember that tax liens attaching to property before a taxpayer files for bankruptcy generally survive the bankruptcy and are enforceable against the property, even after the tax debt giving rise to the lien has been discharged.

Under special tax rules, taxpayers will generally not be on the hook for income from discharged debt in bankruptcy. Again, this is a very complicated area and it best solved by consulting a tax attorney and bankruptcy attorney who are familiar with the tax effects of filing for bankruptcy.


Tax Refund After Declaring Bankruptcy

If you are considering filing for Chapter 7 bankruptcy and you are expecting to receive or have received a tax refund, you probably want to know what happens to that refund. A bankruptcy trustee will also probably be interested in what is happening with your tax refund. If you recently declared bankruptcy, the government may seize your tax refund. An outside trustee might be interested in any tax refund that the debtor receives based on her individual 1040 filing. Depending on state and federal laws and the size of the refund, it might have to be turned over to the trustee to help pay off debt.

Partnerships and corporations file bankruptcy under Chapter 7 or Chapter 11 of the bankruptcy code. Individuals may also file under Chapter 7 or Chapter 11. For additional tax information on bankruptcy, refer to Publication 908, Bankruptcy Tax Guide and Publication 5082, What You Should Know about Chapter 13 Bankruptcy and Delinquent Returns