Are There Tax Consequences to Filing for Bankruptcy Protection?

During a chapter 7 and chapter 13 bankruptcy case, a debtor (the person who files for bankruptcy protection) proposes to discharge their dischargeable debts. In chapter 7, the debtor is seeking to be relieved of these financial obligations permanently. In chapter 13, the debtor is looking to restructure the debt and make payments on the debt over time.

Outside the bankruptcy court, when a person settles a debt, the Internal Revenue Service (IRS) sees the transaction as income to the person who is benefitting from the transaction. As such, it will require them to pay income tax on the monies that they do not have to pay the creditor.

For example, let’s say you owe a credit card $5,000, and you agree with the credit card company to only pay $2,000 in full satisfaction of the debt. The additional $3,000 that you did not pay would be considered income, and the creditor would be required to send you a 1099-C tax form. The person who does not have to pay the $3,000 will be required to pay income tax on that amount as if it was money earned at their job.

In a bankruptcy situation, though, if the $5,000 debt was included and discharged, there would be no tax consequences. This is one of the major advantages of filing for bankruptcy protection. Of course, all other conditions must be appropriate under all other circumstances for this benefit to work.

If you are considering filing for bankruptcy protection and would like a complimentary strategy session for Estate Planning, Bankruptcy and Personal Injury, please contact Dellutri Law Group. We would be happy to set an appointment for you at a convenient time so that you can discuss whatever financial challenges that you are facing with an expert bankruptcy attorney. At the end of the strategy session, you will have a plan to deal with your situation, and you may be shocked that filing for bankruptcy protection is not your best option.