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How Bankruptcy Affects Tax Returns 

EH Law Group  June 4, 2024

With financial uncertainty on the rise, many individuals are considering bankruptcy to manage mounting debts. However, the implications of bankruptcy extend beyond immediate debt relief; it also affects various aspects of your personal finances, including your tax returns.  

At EH Law Group, our experienced bankruptcy attorneys in San Mateo and San Francisco, California, are here to guide you through this involved process and ensure you understand how bankruptcy impacts your tax situation. 

Understanding Bankruptcy

Before diving into the specifics of how bankruptcy affects tax returns, it's essential to have a clear understanding of what bankruptcy entails. Bankruptcy is a legal process designed to help individuals and businesses eliminate or repay their debts under the protection of the bankruptcy court.  

There are several types of bankruptcy. For individuals, the most common are Chapter 7 and Chapter 13

Chapter 7 Bankruptcy 

Chapter 7 bankruptcy, also known as "liquidation bankruptcy," involves the sale of a debtor's non-exempt assets by a trustee to pay off creditors. This type usually takes about four to six months to complete and primarily discharges unsecured debts such as credit card balances and medical bills. 

Chapter 13 Bankruptcy 

Chapter 13 bankruptcy, often referred to as the "wage earner's plan," allows individuals to keep their property and repay their debts over three to five years through a court-approved repayment plan. This type of bankruptcy is suitable for people with a regular income who want to catch up on missed mortgage or car loan payments while discharging unsecured debts. 

Bankruptcy and Tax Returns

One of the most significant concerns for individuals considering bankruptcy is its impact on tax returns. Here, we explore the direct effects of bankruptcy on tax-related matters, including the discharge of tax debts, the timing of filing, and the treatment of tax refunds. 

Discharge of Tax Debts 

Not all tax debts can be discharged in bankruptcy. Specific conditions must be met for tax liabilities to be eligible for discharge: 

  • Type of tax: Only federal income tax debts can be discharged. 

  • Age of the debt: The tax debt must be at least three years old. 

  • Filing requirements: The taxpayer must have filed a tax return for the debt at least two years before filing for bankruptcy. 

  • Assessment date: The IRS must have assessed the tax debt at least 240 days before the bankruptcy filing. 

If these conditions are met, Chapter 7 bankruptcy can discharge qualifying tax debts, whereas Chapter 13 allows for the inclusion of tax debts in the repayment plan, making it easier to manage tax obligations. 

Timing of Filing 

The timing of your bankruptcy filing can significantly impact your tax return: 

  • Pre-petition debt: Any tax debt incurred before filing for bankruptcy is considered pre-petition debt and may be included in the bankruptcy case. 

  • Post-petition debt: Tax debts incurred after filing are not included in the bankruptcy case and must be paid separately. 

It's wise to strategically time your bankruptcy filing to maximize the benefits and minimize complications related to your tax situation. 

Treatment of Tax Refunds 

Tax refunds can be a contentious issue in bankruptcy. Here's how they are generally treated: 

  • Chapter 7 bankruptcy: Tax refunds due for the period before filing are considered part of the bankruptcy estate and may be used to pay creditors. However, refunds for post-filing periods are typically not affected. 

  • Chapter 13 bankruptcy: Tax refunds are usually considered disposable income and must be paid into the repayment plan, unless otherwise specified by the court. 

In both cases, it's essential to disclose all expected tax refunds to your bankruptcy attorney to avoid potential issues. 

Tips for Filing Taxes During Bankruptcy

Approaching tax return filings during bankruptcy can be challenging. Here are some practical tips to help you stay compliant and maximize available benefits: 

  • File all required returns: Ensure all past and current tax returns are filed promptly. Failure to do so can delay your bankruptcy case and complicate matters. 

  • Consult with a tax professional: Working with a tax professional with experience in bankruptcy can help you understand the nuances of tax filings during the bankruptcy process. 

  • Keep detailed records: Maintain thorough records of all income, expenses, and tax filings. Accurate documentation is important for both your bankruptcy case and tax return preparation. 

  • Communicate with your bankruptcy attorney: Regularly update your bankruptcy attorney on any changes in your financial situation, including tax-related matters, to ensure your case proceeds smoothly. 

Post-Bankruptcy Tax Considerations

Emerging from bankruptcy is just the beginning of your financial recovery. Managing tax obligations post-bankruptcy is essential to rebuilding your credit and avoiding future financial challenges: 

  • Rebuilding credit: Pay your taxes on time and in full to demonstrate financial responsibility, which can help rebuild your credit score. 

  • Avoid future tax issues: Create a budget and stick to it to prevent falling behind on tax payments and accumulating new tax debts. 

  • Seek professional advice: Continue working with a tax professional, financial advisor, and bankruptcy attorney to manage your finances effectively and make informed decisions. 

Allow Our Bankruptcy Attorneys to Help

At EH Law Group, we understand bankruptcy and its impact on your tax situation. By strategically managing your tax obligations during and after bankruptcy, you can maximize the benefits of the process and set yourself up for long-term financial stability.  

Our empathetic attorneys are dedicated to helping Bay Area residents make it through the bankruptcy process and achieve financial relief. Offering over 3 decades of combined experience, Eddy Hsu and Grace Ho offer personalized guidance and support to ensure you make informed decisions and move toward a brighter financial future. 

If you're considering bankruptcy and need experienced legal advice on how it will affect your tax returns, reach out to our attorneys at EH Law Group today to schedule a consultation. 

For more information and to get started on your path to financial freedom, visit our offices in San Mateo or San Francisco, California, or contact us online. We proudly serve clients throughout Santa Clara County, Oakland, Daly City, and South San Francisco.