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How Might Declaring Bankruptcy Affect Your Taxes?

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Whether you're in the process of having your debts discharged through a Chapter 7 bankruptcy or are reorganizing your debts in a Chapter 13, your taxes will look a little different this year. But it's important to file; if you don't file a tax return for the year in which your bankruptcy estate was open, your case could be dismissed or converted, costing you money. Read on to learn more about how declaring bankruptcy can affect your federal income taxes.

How Bankruptcy Affects Your Taxes 

Unless you're expecting a huge refund that could affect your eligibility for bankruptcy, it's usually a good idea to delay any bankruptcy filing until after April 15 or your extension date.

In some uncommon cases, you may owe additional taxes on "cancellation of debt" income. Although the bankruptcy trustee will handle the tax filings and obligations for the bankruptcy estate, it can be a good idea to visit a certified professional accountant the year after you've declared bankruptcy for advice on correctly classifying (and paying taxes on) your income during your "bankruptcy year." The last thing you want to do is inadvertently accrue more debt that makes it hard to pay your bills.

Filing Taxes When You're Currently In Bankruptcy 

If you're filing for a Chapter 13 bankruptcy, two forms will be filed for each year in which you're in bankruptcy: your normal 1040 form and a form for the bankruptcy estate. Failing to file a 1040 for any of these years, even if you have no income and/or no tax obligation, could mean the conversion of your bankruptcy filing to a Chapter 7 liquidation. And accruing more debts, including tax debts, while you're actively in bankruptcy could give the trustee discretion to dismiss your case entirely. 

Fortunately, in most cases, your bankruptcy will have a minimal impact on your income tax return for the prior year (that is, the year before you filed). While it's a good idea to see a CPA the next year to ensure your clean financial slate remains clean, using tax software or an in-store associate for income tax help for the prior year's taxes should be sufficient.

For situations in which you're expecting a big refund, don't be surprised if this refund is seized by the trustee to pay your creditors. Depending upon whether the debts you're reorganizing or discharging are secured or unsecured, your creditors may require payment in full from any available funds before your bankruptcy case can conclude. 

For additional information about bankruptcy, contact a lawyer who is familiar with bankruptcy law.