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Effect Of Insolvency & Bankruptcy On Your Tax

Effect Of Insolvency & Bankruptcy On Your Tax

One of the most stressful events in life is experiencing financial difficulty. Whether personally or in your business, it can take its toll on one's well being. It might become impossible to manage the debt, which makes bankruptcy the way out. 

Even though bankruptcy is terrible, having to deal with taxes makes the entire process pretty complicated. 


How does bankruptcy affect your taxes?

The decision to be bankrupt might be voluntary, or it might be due to your creditor's actions. After the bankruptcy decision is final, the bankruptcy trustee will be mandated to take over your affairs, which could involve your asset's disposing to settle the creditors. 

Also, if you earn any income, you are mandated to pay regularly to the trustees in a bid to take care of your creditors from your surplus income. 


Tax Returns 

The fact that you are bankrupt does not mean you will not file your tax return; One needs to file it regularly. If you get any tax refund from the IRS regarding income earned before the bankruptcy, this will be classified as an asset, and your estate trustee might claim it. 

Also, all refunds you got from the IRS for income that came during the bankruptcy period will be considered income by the bankruptcy trustee. With this, the trustee might claim the tax refund if you have an outstanding payment.

You can only keep your tax refund when the bankruptcy is discharged.

If you do not send your tax return on time until the bankruptcy date, Uncle Sam might mandate the trustees to be updated on all income tax returns you owe to establish the value of any tax debt you owe. Not doing this might trigger default assessment based on what the IRS estimates to be your tax judging by their intuition and other information available to them. Without a doubt, such an evaluation will hardly be accurate, and most times, any error will hardly favor you. As a result, you have to make sure your tax returns are up to date before the IRS files one for you. 


Capital Gains Tax on Disposing of Assets 

As stated earlier, a bankruptcy trustee will likely try to dispose of some of your assets to take care of your debt. These disposals will trigger a series of Capital Gains tax liabilities. 

Judging by the tax law, when the bankruptcy trustee vests your asset, it will be ignored. With this, if there is a disposal by any of your trustees, you will be assumed to make the disposal based on the tax law. With this, you will be liable for any capital gains or loss, which should reflect, in your tax return.


Business Operator 

One cannot be in charge of a company or the secretary during the bankruptcy period. It is, however, possible to be a sole proprietor. If there is an existing business in which you became bankrupt, the trustee will advise the IRS of your bankruptcy.

People that wish to remain in business after bankruptcy should trade using their own name because trading utilizing a business name or an assumed name will involve you making your bankruptcy status known to every party you deal with.


What if Uncle Sam is your creditor?

If you are entitled to a refund from Uncle Sam during the bankruptcy period, the IRS might withhold it from taking care of any pre-bankruptcy debt, child support debt, family assistance, etc., that you incur. 

The IRS will not recover any outstanding debt that you have with Uncle Sam after the discharge of your debt that is part of the bankruptcy. 



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