The Impact of Bankruptcy on Tax Obligations in Texas

 Posted on April 03, 2024 in Income Taxes

When faced with overwhelming debt, bankruptcy can allow you to breathe again financially. However, it is crucial to understand the impact bankruptcy can have on your tax obligations. A Texas lawyer can help you determine how different types of bankruptcy affect your taxes and what you need to know to navigate the process effectively.

The Basics of Bankruptcy and Taxes

Bankruptcy is a legal process designed to help individuals and businesses eliminate or restructure their debts. The two most common types of bankruptcy in Texas are Chapter 7 and Chapter 13. While bankruptcy can relieve many debts, it is important to note that it does not automatically eliminate all tax obligations.

Chapter 7 Bankruptcy and Tax Debts

Chapter 7 bankruptcy, or liquidation bankruptcy, can discharge certain types of tax debts. To be eligible for discharge, the tax debt must meet specific criteria:

• The taxes must be income taxes (not payroll taxes or fraud penalties).
• The due date for the tax return should be at least three years prior to filing for bankruptcy.
• A tax return should be filed no less than two years prior to filing for bankruptcy.
• s should be assessed by the IRS a minimum of 240 days before filing for bankruptcy.

If your tax debts meet these requirements, they may be discharged through Chapter 7 bankruptcy. However, it is essential to consult with a lawyer to determine if your specific tax debts qualify for discharge.

Chapter 13 Bankruptcy and Tax Debts

Chapter 13 bankruptcy, known as reorganization bankruptcy, permits the restructuring of debts and the creation of a repayment plan over three to five years. Under this bankruptcy category, tax debts are considered priority debts and must be fully paid through the repayment plan.

Although Chapter 13 bankruptcy does not eliminate tax debts, it offers a structured plan to pay them over time. By filing for Chapter 13, you can halt the accumulation of interest and penalties on your tax debts, simplifying the process of fulfilling your financial responsibilities.

Tax Consequences of Bankruptcy

When you file for bankruptcy, there are several tax consequences to consider:

• Discharged debts: If your tax debts are discharged through Chapter 7 bankruptcy, you may need to report the discharged amount as income on your tax return. This is known as cancellation of debt (COD) income.
• Property sales: If you sell property as part of your bankruptcy proceedings, any gain on the sale may be subject to capital gains tax.
• Tax attributes: Bankruptcy can also impact your tax attributes, such as net operating losses, credit carryovers, and basis in property. These attributes may be reduced or eliminated due to the bankruptcy filing.

Working With a Lawyer Can Help Strengthen 

The laws surrounding bankruptcy and tax law can be complex. To make informed decisions and protect your financial interests, it is important to consult an attorney with expertise in both bankruptcy and tax law.

Your attorney can help you:

• Determine which type of bankruptcy is best for your situation.
• Identify which tax debts may be dischargeable.
• Develop a strategy for managing non-dischargeable tax debts.
• Understand the tax consequences of bankruptcy and plan accordingly.

Contact a San Antonio, TX Bankruptcy Lawyer

Bankruptcy can offer essential relief for individuals overwhelmed by debt; however, understanding its effects on tax responsibilities is vital. By working with a Kerrville, TX bankruptcy attorney, you can navigate the bankruptcy process effectively and develop a plan for managing your tax debts. Call Law Offices of Chance M. McGhee at 210-342-3400 for a free consultation.