As your mailbox fills up with various W2s and 1099s, now is a good time for our annual reminder of certain tax-related issues in bankruptcy.
If you intend to file for bankruptcy (or think you might), do not use your tax refunds to pay unsecured debt until you have consulted with an attorney. First – you would be wasting money on a debt that could be discharged. Second – such a payment could be considered a preference and recovered by the Trustee for redistribution. Third – using tax refunds to pay bankruptcy-related costs can help expedite your case to prevent things like creditor harassment, lawsuits, wage garnishments, bank levies, utility shut-offs, repossessions, and foreclosures.
Tax refunds are generally considered a contingent asset. Most debtors can exempt their tax refunds and protect them from being seized by the Trustee. Debtors who do not have sufficient exemptions to protect their refunds can plan their filing strategically to minimize the Trustee’s interest. (For example, debtors using Wisconsin state exemptions to protect equity in real estate should file shortly after they have received their refund and deposited it, availing themselves to a depository account exemption. Most other debtors can exempt their tax refunds with federal exemptions.)
All debtors who have filed Chapter 13 bankruptcy are required to submit copies of their tax returns to the Trustee.
Some debtors who have filed Chapter 13 bankruptcy may be required to submit 1/2 of their tax refunds to the Trustee. Consult your bankruptcy attorney if your are uncertain about this obligation.
Debtors who plan to file under Chapter 13 (but haven’t yet) should plan to file their 2013 tax returns as soon as possible. Cases filed after December 31, 2013 cannot be confirmed until after the 2013 tax returns are on file (even though they are not due to the IRS and state until 4/15/2014).
Debts discharged in bankruptcy are not income for federal tax purposes. If you receive a cancellation of debt notice, show it to either your bankruptcy attorney or tax professional.
If you owe tax debt – certain debts more than 3 years old can be discharged in bankruptcy. Tax debts entitled to priority status (generally, but not limited to taxes 3 years old or younger) can be folded into and paid through a Chapter 13 Plan with no interest.
If you owe tax debt and have already filed Chapter 13 Bankruptcy, notify your attorney immediately. The IRS can file claims for post-petition taxes that will need to be funded.