Filing Your Income Taxes & Bankruptcy: What You Need to Know

Tax Return 1040The April 15th deadline is looming — it’s almost time to file your 2013 tax return. If you are struggling with debt and thinking about filing for bankruptcy, you may have some questions about how your tax return and bankruptcy will affect each other. For example:

  • Should you file your tax return if you are considering bankruptcy?
  • If you owe taxes this year, can you get rid of the debt in bankruptcy?
  • Will you get to keep your tax refund if you file for Chapter 7 bankruptcy?

Here are answers to some common questions about tax filing time and bankruptcy.

Should I File a Tax Return If I am Thinking About Bankruptcy?

Yep. When you file for Chapter 7 or Chapter 13 bankruptcy, you are supposed to provide the bankruptcy trustee with copies of your tax returns for the previous two years. If you don’t have a good reason for not filing those returns, the trustee will likely require that you file them before your bankruptcy gets under way. (To learn more, see Nolo’s article Gathering Your Documents for Bankruptcy.) So you might as well do it now. If you have a good reason why you can’t file your tax return this year, talk to a bankruptcy attorney.

If you file for Chapter 13 bankruptcy, the trustee will probably require that you provide him or her with your tax return for each year that you remain in the bankruptcy case.

If I Owe Taxes This Year and Can’t Pay Them, Can I Wipe Them Out in Chapter 7 Bankruptcy?

Wouldn’t that be great? But no, you cannot discharge (eliminate) recent income tax debts in bankruptcy. So if you owe a bundle this year and don’t pay up, that debt to the IRS will survive your bankruptcy. You can, however, discharge older income tax debts if they meet certain criteria. (For details, see Nolo’s article Eliminating Tax Debts in Bankruptcy.)

Most people know that credit card debt is discharged in Chapter 7 bankruptcy (with a few exceptions). But if you’re thinking about getting rid of tax debt by paying your tax bill with your credit card, think again. Bankruptcy laws specifically state that if you put nondischargeable income tax debt on your credit card, that part of your credit card debt won’t be wiped out in bankruptcy. (See Can I discharge credit card charges used to pay off income tax debt?)

What Happens to My Tax Debts in Chapter 13 Bankruptcy?

If you file for Chapter 13 bankruptcy, you pay tax debts through your plan (which lasts from three to five years). You repay nonpriority tax debts at a discount, and the remainder is discharged at the end of your case. You have to repay priority tax debts in full, but you often pay them at 0% interest and because you pay them over the life of your plan, this gives you more time for repayment. (To learn more, including which tax debts are priority and which are nonpriority, see Nolo’s article Tax Debts in Chapter 13 Bankruptcy.)

If I Get a Tax Refund This Year, Will I Lose It if I File for Chapter 7 Bankruptcy?

If your concern is not tax debt, but your tax refund, then a little planning is in order. Here’s why.

When you file for Chapter 7 bankruptcy, all of your property and assets become part of the bankruptcy estate. Unless your property is protected by law (the laws that allow you to keep certain property in bankruptcy are called exemptions), the bankruptcy trustee can sell it and use the proceeds to repay your creditors. (You can learn how this works in Nolo’s article Exemptions in Chapter 7 Bankruptcy.)

If you get a tax refund this year and then file for bankruptcy, that refund becomes part of the bankruptcy estate. You may be able to protect the money by using an exemption. Most states don’t have a specific exemption that covers tax refunds, but some allow you to exempt a certain amount of cash. And many states have a wildcard exemption that you can use to protect any type of property. (You can find your state’s exemptions in Bankruptcy Exemptions by State – choose the link for your state.)

But if you stand to lose your tax refund in bankruptcy, you could use another strategy to keep the money – delaying your bankruptcy filing. After you get your tax refund, spend it on necessities (like your rent or food). Once it’s gone, then file for bankruptcy. If you plan to do this, however, speak with a local bankruptcy attorney first. Bankruptcy courts vary as to what types of expenses count as “necessities.” And some attorneys may advise you to keep your tax refund in a separate account. (To learn more, see Nolo’s article How to Spend Down Tax Refunds in Chapter 7 Bankruptcy.)