Bad things can happen to good people: Illness, job loss, catastrophic medical expenses and natural disasters can wreck havoc on individual finances. In some cases, the only solution is to file for bankruptcy protection.
Bankruptcy not only affects your finances and credit rating, you’ll also have to take a different approach to filing your taxes. Here’s a brief look at those changes. Remember, if you are facing bankruptcy, it’s best to consult with a bankruptcy attorney for advice regarding your individual circumstances.
Once a consumer (also known as the debtor) files for bankruptcy, they are in effect turning over their affairs to a trustee. The trustee will then act on the debtor’s behalf in managing any non-exempt assets used for repaying creditors. This arrangement forms an estate, much like an estate for an incapacitated or deceased person.
The debtor will file their customary 1040 form, and either the debtor or the trustee will file the 1041 form, which is the estate’s tax return.
Chapter 7: This form of bankruptcy is for individuals and married couples. In this case, there will be no trustee, since there are no assets that can be used to repay creditors. The tax scenario changes in that the debtor will not only file their 1040, they will also file their 1041 form on behalf of the bankruptcy estate.
Chapter 13: This is also for individuals and couples who have non-exempt assets that can be used for repaying creditors. The trustees manages these assets and utilizes them for repayment. Any tax refunds, for example would be used for repayment to creditors via the bankruptcy estate each year until creditors are paid off.
You will file your regular 1040 form, and the bankruptcy trustee will file the 1041 form on behalf of the bankruptcy estate.
Although post-bankruptcy tax filings are best handled by a qualified tax professional, learning about a bankruptcy’s impact on your tax scenario will hopefully demystify the process for you.
The decision to file for bankruptcy is never easy, and it takes careful consideration under the guidance of a qualified bankruptcy attorney.
By filing on behalf of yourself and the estate, there is less chance for errors or omissions when it comes to filing taxes in the wake of a bankruptcy filing. Plan carefully, enlist a bankruptcy attorney and a tax advisor, and you can begin to rebuild your finances over time.