Bankruptcy is a legal process that allows individuals or businesses to eliminate or repay their debts under the protection of the court. When someone files for bankruptcy, it can have significant implications for their financial situation, including their tax obligations. In this article, we will explore what changes and what doesn’t change in terms of taxes when someone goes through bankruptcy.
Impact on Tax Debts
Dischargeable tax debts: In some cases, bankruptcy can help individuals or businesses eliminate certain tax debts. To be eligible for discharge, the tax debt must meet specific criteria, such as being income-based and at least three years old. Additionally, the tax return associated with the debt must have been filed at least two years before filing for bankruptcy. If these conditions are met, the tax debt can be discharged, and the individual or business will no longer be responsible for paying it.
Non-dischargeable tax debts: Not all tax debts can be discharged through bankruptcy. Some types of tax debts, such as those related to fraud or tax evasion, are generally not eligible for discharge. Additionally, if the tax debt is relatively recent or if the individual or business has not filed the required tax returns, it is unlikely to be discharged. Non-dischargeable tax debts will remain the responsibility of the debtor even after bankruptcy.
Effect on Tax Returns
Timing of bankruptcy filing: The timing of a bankruptcy filing can affect how tax returns are handled. If an individual or business files for bankruptcy before the tax return deadline, they may need to include the bankruptcy estate’s income and expenses on their tax return. On the other hand, if the bankruptcy is filed after the tax return deadline, any tax refunds owed to the debtor may become part of the bankruptcy estate.
Priority of tax claims: When someone goes through bankruptcy, the priority of tax claims can determine how they are treated. Generally, tax claims are given a higher priority compared to other unsecured debts, such as credit card debts. This means that tax debts may need to be paid first from any available assets before other creditors can receive payment.
Continued Tax Obligations
Filing tax returns: Bankruptcy does not exempt individuals or businesses from their ongoing obligation to file tax returns. Even if someone has filed for bankruptcy, they must still submit their tax returns on time and accurately report their income and expenses. Failure to do so can result in penalties and potential legal consequences.
Payment of future tax debts: Bankruptcy does not relieve individuals or businesses from paying their future tax obligations. After the bankruptcy process is complete, the debtor will still be responsible for fulfilling their tax obligations, including paying any taxes owed for future years.
In summary, bankruptcy can have both positive and negative implications for tax debts and obligations. While some tax debts may be discharged through bankruptcy, others may remain the responsibility of the debtor. The timing of the bankruptcy filing can also impact how tax returns and refunds are handled. It is important for individuals or businesses considering bankruptcy to consult with a qualified tax professional or bankruptcy attorney to understand the specific implications for their tax situation.
– IRS: Bankruptcy Tax Guide – www.irs.gov/publications/p908
– Nolo: Bankruptcy and Taxes – www.nolo.com/legal-encyclopedia/bankruptcy-and-taxes