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Taxation of the Bankruptcy Estate

Steven WalkerMarch 4, 2022

The taxation of the bankruptcy state is not always obvious, and below are the key highlights for debtors to keep in mind.  The IRS is well versed with these rules, and running afoul can lead to tax controversy issues, such as an audit.

Property of the Bankruptcy Estate

  • All legal or equitable interests of the debtor in property as of the commencement of the case. 11 U.S.C. Sec. 541.
  • Ask who is the debtor (single individual, married couple, or married individual).
  • Ask what type of property (exempt property, community property, after-acquired property, abandoned property).

Taxation of the Bankruptcy Estate

  • Separate bankruptcy estate – chapter 7 and 11
  • Success to assets, liabilities, and tax attributes
  • Trustee files Form 1041
  • No separate taxable entity for chapter 13

Section 1398 Short-Period Election

  • If an election is made under section 1398, the debtor’s tax year is divided into two short tax years:
  • The first short tax year starts when the debtor’s tax year would have started had the election not been made (Jan. 1 for most individuals) and ends the day before the bankruptcy petition is filed.
  • The second short tax year begins the day the bankruptcy petition is filed and ends when the debtor’s tax year would have ended had the election not been made (Dec. 31 for most individuals).
  • In certain circumstances, it’s advantageous to make the election. See homework problems for details.