Tax Matters for Chapter 13 Debtors (part II)
PREPARING TAX RETURNS & DEBT CANCELLATION WHILE IN CHAPTER 13 Filing Chapter 13 bankruptcy rarely alters how one prepares and files annual tax returns. A Chapter 13 debtor should continue to prepare and file all required federal, state and local income tax returns after filing for bankruptcy relief just as was done prior to filing for bankruptcy relief.(6) This includes all sole-proprietors and all self-employed individuals in Chapter 13, but not corporations, partnerships, or other separate entity.(7) When preparing and filing a post-petition tax return, the Chapter 13 debtor is required to report all income received during the entire year and claim any deductions or allowable expenses. A debtor need not include as income on any tax return debts cancelled because of the debtor's bankruptcy or discharged as part of the bankruptcy process. A debtor sometimes will receive a Form 1099-C from a creditor included in the bankruptcy. Often, the creditor determines under non-bankruptcy tax law that it is required to report any debt forgiveness, reduction or cancellation. --Debt Cancellation-- As a general rule, if a debt is cancelled or forgiven, other than as a gift or bequest, the one for whom it is forgiven, the debtor, must include the amount cancelled or forgiven in gross income for tax reporting purposes. A debt is defined very broadly by the IRS and includes any indebtedness for which the debtor is liable or that attaches to property the debtor owns. If any debt is forgiven or cancelled, whether in whole or in part, in the amount of $600 or more, the lender should issue a Form 1099-C to the debtor. The lender also submits the Form 1099-C to the IRS and is essentially reporting its loss; triggering the necessity of an equal gain to be reported by the debtor to whom it is issued. The IRS automatically cross-checks all Form 1099s submitted for parallel reporting. This being the generally rule, there are notable exceptions - in fact, most individuals filing for relief under the Bankruptcy Code, whether Chapter 7 or Chapter 13, will be able to exclude forgiven or cancelled debt from gross income for tax purposes. The IRS classifies the exceptions to the generally rule as "exceptions" and "exclusions" as follows: --Exceptions-- The exceptions to cancelled/forgiven debt included as gross income: o The cancellation of a student loan for a student required to work for certain employers. o The cancellation of debt that would have been deductible if paid. o The reduction of a debt by the seller of property if debt arose from purchase of property. --Exclusions-- Debt cancelled or otherwise forgiven is not included in gross income if: o The cancellation takes place in a Title 11 case (United States Bankruptcy Code). o The cancellation takes place when the debtor is insolvent. o The cancelled debt is qualified farm debt (debt incurred in operating a farm). o The cancelled debt is qualified real property business indebtednesss. o The cancelled debt is qualified principal residence indebtedness (subject to certain time limitations). Cancelled debt in a Title 11 case, is the exception available to most Chapter 13 debtors. Title 11 is the Bankruptcy Code. The exclusion, however, is applicable only if the debtor is under the jurisdiction of the court and the cancellation of debt occurs as part of a confirmed plan or a discharge under a Title 11 case. This primary exclusion takes precedence over any other stated exclusions. In short, this mean none of the debt discharged or "cancelled" in a bankruptcy case is included in the debtor's gross income in the year it was cancelled.(8) But, as previously noted, the IRS will expect the 1099-C to be reported. This concern is remedied through the use of Form 982, entitled Reduction of Tax Attributes Due to Discharge of Indebtedness. The form is available at IRS.gov and includes instructions. This allows the 1099-C to be reported and accounted for and additionally provides explanation as to why the cancelled debt is not being included as income on the tax return. ___________________ (6) 11 U.S.C. ? 109(e). Here, an individual would also include a joint filing by husband and wife, as provided for by 11 U.S.C. ? 302, and as referenced in 11 U.S.C. ? 109(e). (7) Generally, if the business operations are reported for federal tax purposes under a Schedule C included as part of an individual's Form 1040, the business is NOT a separate entity. (8) Certain losses, credits, and basis of property must be reduced by the amount of excluded income, but not below zero.