4 Tax-Related Questions You Might Have About Bankruptcy

Filing for bankruptcy is a beneficial but complex option for folks who feel as if they are drowning it debt, so it's natural to have questions about the process. You might be concerned about losing your federal tax refund or wonder whether filing for bankruptcy can help you prevent tax-related liens, and the answers to those questions may impact your decision to file. Read on to learn about how bankruptcy may affect you at tax time. 

Can I Keep My Refund if I File Bankruptcy?

You worked hard all year long, and the last thing you probably want to do is part with a well-deserved tax refund. Luckily, you may not have to. Bankruptcy attorneys understand how important your federal and state refunds are to you and your family, and they will fight to ensure that you do not have to part with your funds. 

Depleting your bank account before the trustee has a chance to intercept the tax refund may seem like the best course of action, but talk with a bankruptcy lawyer about your plans first. Be very careful before you spend your refund, as the trustee appointed to your case may dismiss your bankruptcy request if it looks as if you are being wasteful with the funds. It may be a better decision to have your attorney request an exemption so that you can keep your money from the IRS.

Can a Bankruptcy Erase Tax Debts?

Your ability to erase a tax debt depends on the type of bankruptcy that you decide to file. If you file Chapter 7 bankruptcy, the judge may agree to dismiss some -- or all -- of your tax debts. People who file Chapter 13 bankruptcy are generally not eligible to have any of the tax debts erased, but the court will often set up a convenient payment plan for the past-due amount. 

Unfortunately, judges do not always erase tax debts. When you meet with one of the experienced bankruptcy attorneys in your area, make sure that you ask about the money that you owe the IRS or your state's Department of Revenue. Your lawyer will help you figure out a practical solution that benefits both you and the tax agency, whether you only owe a few bucks or you are thousands of dollars in debt.  An attorney can even help if you have a lien against your property for failing to pay tax debts on time. 

Do I Need to Report a Bankruptcy on My Federal Income Tax Return?

It is usually not mandatory to report a bankruptcy on your federal income tax return. However, laws are different in each state, so you may still need to mention the bankruptcy when you file your state taxes. You should also remember that cancelled debts may count as taxable income, so that can impact your taxes. 

Even if you don't report the bankruptcy, there are still things you should remember about your taxes. For example, the IRS requires individuals who file Chapter 13 bankruptcy to submit four prior years of tax information to the trustee. If you didn't file a return every year, don't fret. Your bankruptcy specialist understands that unexpected incidents, such as a serious medical condition or long-term disability, may affect your ability to file. The attorney will explain why you didn't file to the trustee and judge so that your failure to file does not have a negative impact on your case. 

Remember, bankruptcy laws vary by state. The answers above are generally accurate for most situations, but your bankruptcy proceedings may result in a different outcome. To avoid confusion, it's best to meet with a bankruptcy attorney to learn more about how filing for bankruptcy will impact your tax situation.