Filing taxes in bankruptcy: What you must know

The tax season is drawing near. Even the thought of filing taxes can lead to a significant amount of stress – especially for households already struggling with considerable debt.

If individuals are right in the middle of their bankruptcy filing to handle that debt, they might have many questions about how they should proceed with this tax season. In these cases, it is often helpful to consult an experienced bankruptcy attorney to determine how to manage taxes during bankruptcy and protect one’s financial future.

However, here are a few of the most common questions individuals have regarding taxes and bankruptcy.

1. Will they still have to file taxes during their bankruptcy?

The automatic stay may prevent the Internal Revenue Service (IRS) from collecting past tax debts, but it does not mean individuals do not have to file their current taxes.

The IRS requires individuals to still file their taxes on time. However, individuals in the middle of a bankruptcy filing do have the option to request an extension. That way, they do not have to rush to meet the April 15 deadline while concentrating on their bankruptcy.

2. Will they file their taxes as usual?

Generally, individuals will file their New Mexico and federal taxes as they usually do with one difference:

  • Individuals still have to file a W-2 and a 1040 to report their gross income to the federal government; and
  • The bankruptcy trustee will often file the 1041 form. This is for the bankruptcy estate and reports the income that will be distributed to creditors. Trustees file this form if the income is $12,200 or more.

Important note: Filing taxes post-bankruptcy may not require an additional form, but individuals often do have to report any canceled – or discharged – debts. In many cases, the IRS considers discharged debts to be taxable income.

3. What happens to their tax refund in bankruptcy?

The answer to this question is not as straightforward as many others. There are a few options, including:

  • The tax refund may go into the bankruptcy estate and be distributed to creditors; or
  • Individuals might use federal bankruptcy exemptions to protect their refund.

If individuals owe money to the IRS, then they must make sure they pay their taxes on time. If they do not and accrue more debt during the bankruptcy filing, they face a risk of getting their case converted or dismissed entirely. That is why it is critical to understand how taxes work during bankruptcy.