Personal bankruptcy can have a major impact on an individual’s financial circumstances. It can help people avoid wage garnishments and attempts to seize their assets. It can also potentially discharge some people’s debts so that they can fulfill their other financial obligations.
With tax season approaching, those going through financial challenges may worry about how the decision to file for bankruptcy might impact their income tax returns. Significant changes in an individual’s income or expenditures can affect their federal income tax obligations.
Those preparing for a bankruptcy filing or working their way toward a discharge may have questions about the potential impact that the bankruptcy might have on their income tax returns. What do people need to know about tax consequences when filing for personal bankruptcy?
Bankruptcy does not typically alter income tax liability
For the most part, a personal bankruptcy filing has minimal impact on income tax obligations. Whatever the filer owes in taxes is likely to remain a valid financial obligation. Current and recent income tax obligations are not dischargeable debts. Typically, people can only discharge income tax debts when they are three years old or older.
The amount due for the current year is not likely to change because of a bankruptcy filing. People do not have to report the amount discharged as income. There is an income tax document required for the bankruptcy estate. However, the trustee appointed by the courts handles the preparation and submission of that document. The one exception to this rule arises in a Chapter 11 case where the filer is their own trustee. In such cases, they may have to file Form 1041 for the bankruptcy estate.
The main responsibility of the filer is to prepare their income tax return as usual. Even those who may not otherwise need to file a tax return because they do not currently have a job typically must file an annual income tax return after a personal bankruptcy. In cases where individuals file for Chapter 13 bankruptcy, any significant income tax refund could be subject to interception. They may have to surrender their income tax refund to contribute toward their repayment plan.
Learning more about how personal bankruptcy filings may affect different financial matters can be beneficial for those seeking debt relief. Those who learn about the nuances of the bankruptcy process may avoid mistakes that could ultimately cost them more in the long run.