- Does Bankruptcy Filing Affect My Requirement to File My Tax Return?
- Does Bankruptcy Affect My Obligation to Pay Back Taxes?
- The tax debt must have become due 3 or more years prior to the date of the filing of the bankruptcy case (“the 3-year rule”);
- The tax return must have been filed 2 or more years prior to the date of filing of the bankruptcy case (“the 2-year rule”);
- The taxes cannot have been assessed within the 240 days prior to the bankruptcy filing;
- Other actions tolling the above timeframes cannot have occurred, such as the filing of an offer in compromise.
- Will Filing for Bankruptcy Cause Me to Owe More Taxes?
- The Bottom Line Regarding Bankruptcy & Tax Returns
Whether or not a Chapter 7 or Chapter 13 bankruptcy filing will affect a tax return negatively is a frequent question received by bankruptcy lawyers.
It is also an imprecise question. What does it mean for a tax return to be affected by bankruptcy? Are we talking about the requirement to file a tax return? Or the obligation to pay back taxes? Are those asking concerned that bankruptcy filing will increase the amount of taxes owed?
This article discusses all of these concerns—and more.
Does Bankruptcy Filing Affect My Requirement to File My Tax Return?
Short answer to this question: no.
Quite the opposite.
The Michigan bankruptcy lawyer that you hire to assist you with your Chapter 7 or Chapter 13 will, in fact, likely require that you file not only any return required to be filed in the current tax year but also any past-due tax return for prior years that you haven’t yet filed.
It is a requirement of the US Bankruptcy Code (Federal law, in other words) that all tax returns required to have been filed prior to the filing of a bankruptcy have been filed.
You will also be required to turn those returns over to either the Chapter 7 or Chapter 13 Trustee assigned to your case—and potentially to the US Trustee that polices the bankruptcy system on behalf of the US Department of Justice and to creditors wishing to contest your right to a discharge or the discharge of a debt.
When you file for bankruptcy in the US, you are asking the Federal government for an enormous benefit: the legal discharge of debt that, in all likelihood (although not always!), you did agree to otherwise repay.
The price pay (in addition to bankruptcy attorney’s fees and filing fees) is the requirement that you disclose an enormous amount of information about yourself, your income, your expenses, your debts, your assets—and your finances.
Tax returns are key to these required disclosures.
Further, a key requirement for your entitlement to discharge of debt in bankruptcy is that you not have incurred any debt through fraud.
A tax return and the supporting documentation behind it and any IRS or Michigan Treasury contesting or rejecting a tax return may evidence tax fraud. (Not to mention any actual prosecution for tax fraud.)
In addition, although tax debts can be discharged in bankruptcy under the right circumstances, they are otherwise classified as “priority debts” within the bankruptcy process.
This means that, when a Chapter 7 or Chapter 13 Trustee disburses money to your creditors from your so-called “Bankruptcy Estate,” tax creditors such as the Internal Revenue Service, the State of Michigan Department of Treasury, and the City of Detroit Tax Assessor’s Office must be paid first.
Tax debts are paid before credit card, medical, back rent, or other forms of non-priority debt.
Finally, you must turn over your filed tax returns because any refunds owed to you from those returns are assets belonging to that Bankruptcy Estate mentioned above.
This “Bankruptcy Estate” is the legal construct containing all of your property and any claim to property—including tax refunds—owned or to which you are entitled as of the date of filing of your Chapter 7 or Chapter 13 case.
In a Chapter 7 bankruptcy, property that is not exempted by your Michigan bankruptcy lawyer in your bankruptcy petition can be seized by the Chapter 7 Trustee, liquidated to cash, and then distributed to your creditors.
In a Chapter 13 bankruptcy, assets are not seized, but any non-exempt value in assets can affect the required amount of your monthly Chapter 13 Plan payment. This payment, made monthly to the Chapter 13 Trustee, is used to repay some of what you owe to your creditors.
Non-exempt assets can and do include tax refunds to which you are entitled or which are owed to you.
There is very little exemption available to protect a tax refund asset.
Does Bankruptcy Affect My Obligation to Pay Back Taxes?
Either yes or no.
As noted above, it is possible to discharge income tax debt in Chapter 7 or Chapter 13 bankruptcy. However, the circumstances in which they are discharged is very limited.
If you are considering filing for bankruptcy to relieve yourself of a tax payment obligation, you should always consult an experienced bankruptcy attorney before proceeding.
That said, in short, in order to discharge a tax debt in bankruptcy, the debt must meet the following criteria:
The tax debt must have become due 3 or more years prior to the date of the filing of the bankruptcy case (“the 3-year rule”);
The tax return must have been filed 2 or more years prior to the date of filing of the bankruptcy case (“the 2-year rule”);
The taxes cannot have been assessed within the 240 days prior to the bankruptcy filing;
Other actions tolling the above timeframes cannot have occurred, such as the filing of an offer in compromise.
There is case-law, further, enforcing additional requirements or points of dispute with a taxing authority that should be discussed with a bankruptcy lawyer prior to filing.
For example, if you did not timely file your return for a given tax year and the IRS then filed a “substitute return,” this is a major issue for the dischargeability of the tax debt.
If none of these apply and you simply owe the taxes as a non-dischargeable priority debt, the bankruptcy will only affect your obligation to repay the taxes under Chapter 13.
A Chapter 13 bankruptcy will stay any enforcement action by the IRS or other taxing authority and will allow you to repay the back due tax debt through the Chapter 13 Plan at 0% interest.
This is a primary reason why some filers opt for a Chapter 13 bankruptcy rather than Chapter 7, which will only stay the IRS or Michigan Treasury’s collection activity for a couple of months at best.
Will Filing for Bankruptcy Cause Me to Owe More Taxes?
If you owe more in taxes when you exit a Chapter 7 or Chapter 13 bankruptcy than you did when you entered the process, it will not be the bankruptcy that caused it.
This would only occur if the tax debt were non-dischargeable in bankruptcy and was not paid down in any way during the bankruptcy process.
The excess debt would arise from the interest and penalties that arise under non-bankruptcy law, such as the US Tax Code, when you don’t pay a tax debt.
If the bankruptcy stays collection enforcement of a tax debt (as it does) but does not pay down the debt, naturally, you will continue to incur fees and penalties on the back end.
You would incur those same fees outside of bankruptcy.
An ancillary issue the question of the receipt of a 1099-A or 1099-C after a debt is discharged in bankruptcy.
If you receive a 1099 from one of your discharged unsecured creditors after your bankruptcy is completed, it will unfairly inflate your income for that tax year for tax purposes.
The issuance of 1099s after bankruptcy is not uncommon, however. It can easily be dealt with by a competent CPA with the filing of a certain form with your tax return.
If your accountant doesn’t know what to do with such a 1099, shop for one that does.
The Bottom Line Regarding Bankruptcy & Tax Returns
The bottom line with regard to bankruptcy and your tax return and your tax debt is that, as noted, it can get very complicated very fast.
If you have not filed one or more years’ worth of Federal or Michigan tax returns and may owe tax debt, or may be owed tax refunds, from those years, it is essential that yon consult a bankruptcy lawyer experienced with tax issues.
Detroit Bankruptcy Lawyer Walter Metzen is a Board Certified Bankruptcy Expert. Attorney Metzen has assisted thousands of Chapter 7 and Chapter 13 debtors successfully for over 30 years.
If you have tax issues and are considering filing for bankruptcy, contact us now to schedule your free initial consultation.