Struggling with your finances can be stressful enough without worrying about taxes. Here, you'll learn how filing for bankruptcy could impact your federal taxes with the IRS. 

One method of discharging debts is through bankruptcy. Basically what happens in a bankruptcy stays in a bankruptcy and does not impact an individual’s 1040 return. This material only deals with issues that must be reported on a taxpayer’s 1040 and only provides a very basic overview of what occurs in a bankruptcy. COD income that results from a bankruptcy discharge is reportable on the return for the bankruptcy estate not on an individual’s 1040. Any debt which is forgiven under a Title 11 bankruptcy is excludable from income.

When an individual files a Chapter 7 (liquidation) or Chapter 11 (reorganization) petition, a bankruptcy estate is established! A bankruptcy estate is treated as a separate taxable entity from the individual debtor and generally includes all legal and equitable interests in property of the debtor as of the initiation of the case. A bankruptcy estate continues until the bankruptcy proceeding is closed and the bankruptcy trustee is responsible for filing the estate’s tax returns and paying its taxes (IRC Sec 6012(b)(4)).

When a bankruptcy petition is filed, tax attributes of the individual debtor that existed on the first day of the debtor’s taxable year (i.e., January 1st for calendar year filers) are deemed to be transferred to the bankruptcy estate. (IRC Sec 1398(g)) These “tax attributes” include:

Upon termination of the bankruptcy estate, the unused portions of the same tax attributes are deemed to be transferred back to the debtor (IRC Sec 1398(i)). COD income that results from a bankruptcy discharge is reportable on the return for the bankruptcy estate. For Chapter 7 and 11 cases, the tax attributes to be reduced are those of the bankruptcy estate not the individual debtor (IRC Sec 108(d)(8)).