Bankruptcy is a scary word for many individuals, but what most people don’t know is that it can also offer a glimmer of hope for those seeking a fresh start. What do you do when you decide to declare bankruptcy? How does bankruptcy impact your taxes?
Learn more about whether you should consider bankruptcy to relieve yourself of back taxes by reading the rest of the article.
Of course, no one wants to go bankrupt. It does happen though as thousands of people each year in the United States file for federal bankruptcy and the vast majority of these are related to individuals and not businesses.
The purpose of bankruptcy is to eliminate or repay a portion of the debt under the protection of a court. People have the option of filing between Chapter 7 and Chapter 13 bankruptcy.
● Chapter 7: A trustee sells or liquidates your property to pay back some of the money you owe. However, you are still allowed to protect some items from being sold.
● Chapter 11: Businesses or individuals can consider this option. The goal of this type of bankruptcy is to reduce and reorganize debt instead of discharging it. The good news is that your business can continue to operate or you can retain certain assets.
● Chapter 13: You are allowed to keep your property, however, you must make monthly payments to repay a portion of the debt.
Even if a court allows you to declare bankruptcy, you still need to file your income tax return. You also have the option of requesting an extension from the IRS. In the case of estate bankruptcy, you will need to file an estate tax return (Form 1041).
It is very important that you file taxes under bankruptcy. Why? Failure to do so could result in the court dismissing your bankruptcy case.
The good news is that if a creditor forgives your debt as part of the bankruptcy proceedings, the debt is not considered taxable income. It is possible that the creditor might send you a 1099 form instead.
Ultimately, bankruptcy should not impact your tax return. The most important thing is just that you make sure you file federal income tax returns and estate tax returns.
Even though the cancelation of debt is normally considered taxable income, debts that are discharged in a court of law under bankruptcy protection are specifically excluded from income under the current tax rules.
Regardless, personal bankruptcy expenses, like legal fees, are not deductible. Expenses for business bankruptcy, on the other hand, are deductible as a business expense.
Frankly, not all of the tax debt you owe the IRS can be erased. Debt like child support, student loans, court fines, and penalties are still items that you need to pay back.
Are you having trouble figuring out how you’ll pay back the tax debt? The good news is that a bankruptcy filing will prevent the federal government from collecting taxes you might owe until the issue is discharged. So it does buy you time to get a handle on your tax debt.
While rare in terms of bankruptcy, if you are owed a refund from the IRS you need to realize that the refund is considered an asset. Under Chapter 7 bankruptcy, it means you need to use the refund to pay off creditors.
You reached out for professional support when dealing with bankruptcy. Why not do the same for your tax debt?
Not all tax debt goes away in bankruptcy. Additionally, failing to file taxes while going through bankruptcy proceedings could terminate the agreement. So it is important that you remain compliant with the IRS every step of the way.
Levy & Associates has more than two decades working with the IRS and our team includes former IRS agents. We are experts in taxes and can help you resolve your remaining tax debt. Contact us for a free initial consultation at 800-TAX-LEVY, or visit www.www.levytaxhelp.com.
Levy & Associates is available for free initial consultations. We’re happy to answer any questions you have about the audit process or address any concerns about your specific situation.
There’s never a good time to be audited, and the time-consuming process will take away from your business or family if you try to face it alone. Let us handle and coordinate communication, so you can return to your daily life.