Bankruptcy and Taxes - Chapter 12, Chapter 13
2008 was a tough year for many people. It is important to know the tax ramifications
of bankruptcy or insolvency.
Insolvency
A taxpayer reaches insolvency when their liabilities exceed their total assets.
Generally, you must include forgiven debt as income on your tax return. If you are
insolvent and you have debt forgiven by a lender, you can exclude that debt from
income on your tax return through the insolvency exclusion.
Bankruptcy
Chapter 12 or 13
Individuals that file a petition for Chapter 12 or 13 of the Bankruptcy Code should
continue to file the same federal income tax return. Include all income received
during the year on your tax return. However, do not include any debt canceled in
income on your return. You must reduce losses in property by the amount of cancelled
debt.
Chapter 7 or 11
When you file for bankruptcy under chapter 7 or 11 of the Bankruptcy Code a separate
estate is created that is made up of property that belonged to you prior to the
filing date. The bankruptcy estate is a separate entity from you as a taxpayer.
Under chapter 7, the estate is placed in the care of a trustee appointed by the
court to liquidate your nonexempt assets. In a chapter 11 filing, the debtor stays
in control of the estate as a debtor-in-possession. All wages and income following
the bankruptcy filing are yours and not subject to the obligations of the bankruptcy
estate. If your bankruptcy filing is rejected, you will have to amend your taxes
with a 1040X as if you had never filed the claim.
You must file an income tax return during the period of bankruptcy proceedings.
However, you should not include income, deductions, or credits belonging to the
separately created bankruptcy estate. You have the option of ending the tax year
on the day prior to submitting your bankruptcy petition.
More information on individual bankruptcy, or the bankruptcy of corporations