How Bankruptcy Affects Your Taxes
If you filed for bankruptcy, it is important to know the tax consequences of insolvency or bankruptcy. Generally, any debt you owe that is canceled, forgiven, or discharged becomes taxable income and needs to be reported on your tax return. You should receive a Form 1099-C, Cancellation of Debt, from the creditor or lender that forgave the debt. You can then use this form to report your canceled debt within your eFile account and the tax app will add it to your tax return. Add all your income, deductions, and other information to your account and eFileIT to the IRS and state(s).
Reasons that you will receive a 1099-C might be:
- Foreclosure,
- Repossession,
- Abandonment of property or return of property to a lender, or
- Modification of a loan on your principal residence.
If you owe past due federal taxes that you cannot pay, bankruptcy may be an option. Other options include an IRS payment plan or an offer in compromise; see additional options to pay IRS taxes online or through the mail.
Related: What types of debts are subject to offset or garnishment?
An income tax return is required to be filed if you continue to earn income following bankruptcy. During bankruptcy, file any required returns and pay due taxes timely in order to reduce penalties.
Types of Bankruptcy
Bankruptcy is a status claimed by an individual, business, or municipality when they have determined they are unable to pay or repay any outstanding obligations or debts. Claiming bankruptcy allows an individual or business to essentially start over financially, though it is treated as a last resort when too much debt has accrued.
There are various types of bankruptcies to claim, depending on the situation, called chapters. The most common is chapter 7 bankruptcy where the individual can liquidate their property and distribute it to collectors or creditors.
Chapter 7
This form is the most common as it is the simplest. When you claim chapter 7 bankruptcy, you are claiming liquidation bankruptcy, meaning you are liquidating or distributing all your assets to creditors in order to satisfy debts. This then allows you to start over and rebuild your finances from scratch.
Chapter 9
Applicable to municipalities (towns, cities, counties, etc.), this chapter is a form of protection that allows the municipalities to develop a plan before their finances or assets are seized. This form is not used often; in fact, Detroit, Michigan was the first city to file for chapter 9 bankruptcy in 2013 and is known as the biggest chapter 9 case.
Chapter 11
For businesses and individuals, claiming chapter 11 can allow you to reorganize your finances. In this case, debtors - the individual or business - retains control of their business or personal finances and does not have to sell their assets. This form allows the individual or business to rebuild and emerge the same rather than start over like chapter 7. It generally requires more work and is thus less common.
Chapter 12
Specific to farmers or fishermen, claiming chapter 12 bankruptcy allows the individual or debtor to devise and develop a plan to repay creditors over a limited time period - generally, three to five years.
Chapter 13
This form of bankruptcy allows individuals with regular earned income to develop a plan to repay their debts - often referred to as the wage earner program. This can allow individuals to rebuild their finances instead of starting over and helps them avoid foreclosure on their home or other property.
Chapter 15
For multi-country cases, this chapter creates a cooperation between U.S. bankruptcy judges, foreign courts, and a foreign creditor.
Claiming bankruptcy can be a way to get yourself out of immense trouble if you are faced with large debts. Use the table above to understand your situation and consider working with a financial advisor to select and work through the chapter of bankruptcy that works best for you.
- See tips and facts about Chapter 13 bankruptcy and delinquent tax returns.
- 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 taxable income received during the year on your tax return, but do not include any debt canceled as income on your return. You must reduce losses in property by the amount of canceled debt.
- Chapter 7 or 11: When you file for bankruptcy under Chapter 7 or 11 of the Bankruptcy Code, a separate estate is created which 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 via Form 1040-X as if you had never filed the claim.
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.
Liquidating
As an individual or business, liquidating is the process of selling or surrendering your assets in order to satisfy debts. When you liquidate your property or other asset, you are able to pay off debts and begin to rebuild your finances or start over.
You must file an income tax return during the period of bankruptcy proceedings. However, you should not include income, deductions, or tax 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.
When you prepare your tax return on eFile.com, we will select and prepare any forms needed to report your bankruptcy information to the IRS and file them with your return.
Find more information see IRS Publication 908, Bankruptcy Tax Guide on individual bankruptcy or the bankruptcy of corporations.
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