Bankruptcy and Taxes: What happens when you file for bankruptcy

November 02, 2022 : H&R Block

Editor’s Note: Do you have more debts than income and don’t see an end in sight? If you’re going through bankruptcy or are considering filing, there are probably a lot of questions going through your mind. We’ll cover all aspects that relate to bankruptcy and taxes in this post.

Here’s what you’ll find on this guide to taxes and bankruptcy:

What happens when you file for bankruptcy?
Filing taxes after bankruptcy
Will filing bankruptcy affect your tax refund
Does bankruptcy clear tax debt?
Get help with bankruptcy taxes

What happens when you file for bankruptcy?

Bankruptcy occurs when you suffer financial hardship – including credit card debt – and can’t repay outstanding debts. People file a bankruptcy case to get a second chance at improving their personal finances – it’s the government’s way of maintaining the social security of its citizens.

woman contemplating bankruptcy and taxes

Depending on the type of bankruptcy discharge, it may let you either pay down over time or it could eliminate your debt all together. Plus, once you file, secured creditors are blocked from trying to collect payment from you. It’s best to work with a bankruptcy lawyer to learn about the process of filing for bankruptcy.

The bankruptcy process can have a big impact on much of your financial life, including your tax responsibilities. So, for taxes, what happens when you file for bankruptcy? Read on as we explain.

Filing taxes after bankruptcy

If you filed or are planning to file bankruptcy, there are specific steps you should take to report this information to the IRS.

With some types of bankruptcy, you give up the right to handle your own financial affairs and a trustee is appointed to manage them. Your assets become part of an estate, like when someone dies.

There are three types of bankruptcy, which determine how your taxes are handled:

Chapter 7 tax return requirements:

Chapter 7 of the bankruptcy code requires you to sell your personal assets, with some exceptions, to pay off debt collectors or secured creditors If you file for Chapter 7 bankruptcy you must still file and pay personal taxes. File Form 1040, just as you would each year for your individual tax return. Please note: Your designated chapter 7 bankruptcy trustee shouldn’t fill out this form – it’s your responsibility.

With Chapter 7, the trustee should file Form 1041 for the bankruptcy estate.

Chapter 11 tax return requirements:

Most common with businesses (and more complicated than other chapters) Chapter 11 is a type of bankruptcy in which you, the debtor, generally remain in possession of your financial assets and exempt property. With this type of bankruptcy filing, you are the appointed trustee, and you can borrow new money. You should file Form 1040 as well as Form 1041, the estate tax return for the bankruptcy estate.

Chapter 13 tax return requirements:

Chapter 13 bankruptcy, or wage earner’s plan, allows those with regular income to develop a debt relief plan to repay all or part of their debts. This is the most common type of bankruptcy filing for individuals. Under Chapter 13, you can suggest a repayment plan to make installments to creditors over the course of three to five years. After your case is active, creditors can’t collect from you.

When in Chapter 13 bankruptcy, you must continue to file and pay taxes via Form 1040.

Will filing bankruptcy affect my tax refund?

If you recently filed for bankruptcy, you’re probably wondering if it will affect your refund. Whether your refund becomes part of the bankruptcy estate depends on the type of bankruptcy your file.

  • With Chapter 7 and 11 bankruptcy filings, if the tax refund you received is for a tax year after you filed for bankruptcy it isn’t part of your estate. If the refund is for a tax year prior to the bankruptcy filing, it will be included in your estate.
  • With Chapter 13, your estate includes the refunds received once your bankruptcy case is active. You can adjust your tax withholding to avoid overpaying which could result in a refund

What if the IRS wrongly took your refund?

If your refund was offset and the IRS was aware of the bankruptcy, you can file a claim with the IRS for relief and damages. Claims should be sent in writing to the IRS, addressed to the Chief of the Local Insolvency Unit, for the judicial district in which the taxpayer filed the underlying bankruptcy case.

Depending on the type of return and bankruptcy you filed, the bankruptcy estate might take your refund to pay your other debt settlements.

Does bankruptcy clear tax debt?

Above we’ve covered the bankruptcy basics and how it affects any refund you may have received, but what about the tax debt you owe? If you find yourself owing taxes while in Chapter 13, Chapter 11 or Chapter 7, you may ask: “Can you file bankruptcy on taxes or tax debt?”

While filing for bankruptcy will generally stop debt collectors from attempting to collect your debts. When the bankruptcy is complete some debts are discharged, meaning they are erased. Taxes are different because they are generally considered nondischargeable priority debt according to bankruptcy law, which simply means that bankruptcy doesn’t eliminate the debt you owe to the IRS and debt repayment is given priority over the creditor’s claims.

There are some times when taxes are considered dischargeable debt that can be forgiven when filing for bankruptcy. The following conditions need to be met to discharge debt:

  • Your debt must be from your personal income
  • The debt must be at least three years old
  • You must have filed a valid tax return for the debt at least two years prior to filing for bankruptcy
  • The IRS must have documented the debt at least 240 days before filing for bankruptcy
  • You must not have had a history of tax evasion or filing fraudulent tax returns
  • The IRS doesn’t have a lien on your personal assets

Get help with bankruptcy taxes

Let H&R Block guide you through the tax repercussions of bankruptcy. Whatever Chapter you filed, we can assist you in making sure you’ve settled your tax obligations.

Please note: For bankruptcy issues outside of taxes, be sure to get legal advice from a bankruptcy lawyer or legal professional. They will guide you through topics like bankruptcy laws, undue hardship, and debt consolidation, and more that may affect your finances.

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