Filing Taxes After Bankruptcy: Is Discharged Debt Income to You?

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Filing Taxes After Bankruptcy: Is Discharged Debt Income to You?

Is a 1099 from a Creditor After My Bankruptcy Case was Completed Considered Taxable Income?

A very important question I’m often asked this time of year by my clients is what effect does their bankruptcy have, if any, on their income taxes.    The exact question is whether or not debts discharged (forgiven) in a bankruptcy case must be included as income on federal or state income tax returns.

This often arises when a client receives a Form 1099 statement from a creditor after their discharge in bankruptcy has been granted.    Creditors send 1099 statements when they are required to, but this does not necessarily mean that the amount on the 1099 form must be included in the taxpayer’s gross income for that year.

Debts Discharged in Bankruptcy are NOT Included in the Taxpayer’s Income

In general, outside of bankruptcy, if a creditor forgives a debt that is owed by you, then that may need to be included in income.   However,  there is an exception to this rule pursuant to Internal Revenue Code section 108 which provides that  debts “forgiven” (i.e. discharged) in a bankruptcy case do NOT need to be included as income for forgiveness of debt.

However, even though the discharged debts are not part of a debtor’s gross income, the amount discharged can be required to reduce any tax attributes that the debtor/taxpayer may have, such as net operating losses, capital loss carryforwards, basis reductions and others.  It is important to discuss these issues with your accountant–preferably before filing bankruptcy, but certainly after.

FILE IRS FORM 982 After Bankruptcy Discharge

The correct way to ensure that you do not have to pay taxes on any debt “forgiven” in bankruptcy, and properly allocate any tax attributes, is to file IRS Form 982 for the tax year in which you received your bankruptcy discharge.  See IRS Publication 4681 for detailed information explaining all the above.   Many people and even accountants are unaware of this form and the importance of filing it.   Be proactive and mention it to your accountant before filing your returns (or, file it as an amendment to your return).

 

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By | 2016-10-18T13:35:42+00:00 April 18th, 2011|Categories: Bankruptcy Law, tax issues|5 Comments

About the Author:

Attorney Mark Markus has been practicing exclusively bankruptcy law in Los Angeles, California since 1991. He is a Certified Specialist in Bankruptcy Law by the State Bar of California Board of Legal Specialization, AV-Rated by martindale.com, and A+ rated by the Better Business Bureau. Google Plus

5 Comments

  1. Drew January 14, 2017 at 5:32 am - Reply

    Could you elaborate on what this statement by you means: “the amount discharged can be required to reduce any tax attributes that the debtor/taxpayer may have, such as net operating losses, capital loss carryforwards, basis reductions and others”? This sounds like it is treated as income.

    • Mark Markus February 25, 2017 at 12:28 pm - Reply

      You would really need to discuss this with a tax attorney, but reductions from income are not income. The IRS Code requires you to list all income, including income from “cancellation of debt”. The exception to this is in the event that the cancellation of debt occurs through a bankruptcy discharge. However, the tradeoff for excluding that cancellation of debt from income is that certain tax attributes are reduced, so you cannot–for example–use the full amount of a net operating loss or a cost basis reduction that you would otherwise be entitled to in order to reduce your OTHER income (e.g. wages, investments, etc.)

  2. larry February 5, 2015 at 7:02 am - Reply

    can bankruptcy attorney fees be deducted on income tax?

    as part of our bankruptcy we have had to buy back an automobile and truck. Is any of that deductible?

    • Mark Markus February 5, 2015 at 10:19 am - Reply

      That’s something you’d need to discuss with either a tax attorney or a CPA. It most likely depends on what the deductions are for, (e.g. business deductions under Schedule “C” vs. ordinary itemized deductions), but that’s not something a bankruptcy attorney can opine on.

  3. […] in bankruptcy are excluded from income so, as a prior article of mine explored,  you don’t have to pay taxes on debts you get rid of in a bankruptcy case because the debts were forgiven.   Pretty nice, […]

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