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Declaring Bankruptcy

  • Bankruptcy proceedings begin with the filing of a petition with the bankruptcy court. The filing of the petitions creates a bankruptcy estate, which generally consists of all the assets of the person filing the bankruptcy petition.
  • A separate taxable entity (bankruptcy estate) is created if the bankruptcy petition is filed by an individual under chapter 7 or chapter 11 of the Bankruptcy Code.
  • The tax obligations of the person filing a bankruptcy petition (the debtor) vary depending on the bankruptcy chapter under which the petition was filed.
  • Generally, when a debt owed to another is canceled the amount canceled or forgiven is considered income that is taxed to the person owing the debt.
  • If a debt is canceled under a bankruptcy proceeding, the amount canceled is not income. However, the canceled debt does reduce the amount of other tax benefits the debtor would otherwise be entitled to.
  • Creditors are treated more fairly according to the priorities stated in bankruptcy laws to effect an equitable distribution of debtor’s property

Individuals in Chapter 7 or 11

  • When an individual debtor files for bankruptcy under chapter 7 or Chapter 11 of the Bankruptcy Code, the bankruptcy estate is treated as a new taxable entity, separate from the individual taxpayer.
  • A husband and wife may file a joint bankruptcy petition whose bankruptcy estates are jointly administered; However, the estates will be treated as two separate entities for tax purposes. Two separate bankruptcy estate income tax returns must be filed (if each spouse separately meets the filing requirements).

In Chapter 7:

  • The bankruptcy estate in a chapter 7 case is represented by a trustee.
  • The trustee is appointed to administer the estate and liquidate any nonexempt assets.
  • The debtor continues to file an individual tax return on Form 1040.
  • The bankruptcy trustee files a Form 1041 for the bankruptcy estate.

In Chapter 11:

  • The debtor often remains in control of the assets as a “debtor-in-possession” (“DIP”) and acts as the bankruptcy trustee.
  • The bankruptcy court, for cause, may appoint a trustee if such appointment is in the best interests of the creditors and the estate.
  • The debtor-in-possession, must file both a Form 1040 individual return and a Form 1041 estate return for the bankruptcy estate (if return filing requirements are met).

Individuals in Chapter 13

  • Chapter 13 is basically Debt Adjustment. Most individuals would be eligible if they have a regular income, owe unsecured debts of less than approximately $360,00, and owe secured debts of less than approximately over a $1 million. These numbers change and fluctuate every year.
  • The Chapter 13 is initiated, when a debtor files a voluntary petition in bankruptcy court.
  • Creditors may not file involuntary petition under Chapter 13.
  • Filing of petition, just like Chapter 11 stays all collection and straight bankruptcy proceedings against the debtor.
  • Debtor has exclusive right to propose a plan, upon failure of which, creditors may force debtor into involuntary proceeding under Chapter 7.
  • Court must appoint trustee in Chapter 13 cases.
  • Debtor engaged in a business may continue to operate that business subject to limitations imposed by court.
  • Completion of plan discharges debtor from debts dischargeable by law.
  • Chapter 13 relief is not available to corporations or partnerships.


1041 – Tax Return for Trusts & Estates

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