How does bankruptcy affect taxes?

Everyone struggles with finances; even those making millions in Hollywood are not immune. According to a recent Huffington Post article, Dionne Warwick is one of the most recent in a string of celebrities to file for relief through bankruptcy.

In an interesting twist, the Grammy winning female artist is facing financial difficulties primarily in the form of backed tax payments. According to the article, the star owes over $10 million in taxes to the IRS. She is considering filing for relief through bankruptcy to discharge the tax debts.

Although not everyone can relate to the millions Ms. Warwick owes, many can relate to struggling to make ends meet. As a result, those who find themselves in this situation may consider filing for bankruptcy.

Bankruptcy is designed to offer those who struggle with debt an opportunity for financial relief. Before filing a petition for relief, it is important to know the various impacts that can be tied to filing for relief through bankruptcy, including the impact on taxes.

Bankruptcy and taxes: The basics.

Some of the main issues that can arise regarding taxes during a bankruptcy petition include:

  • Audits. A bankruptcy filing will not stop an audit.
  • Discharge. Not all taxes are dischargeable through bankruptcy. Payroll taxes and penalties issued for the commission of fraudulent acts are not eligible for discharge in bankruptcy.
  • Personal federal and state income taxes can be discharged.

Discharging personal federal and state income taxes can be a complicated process. In order to qualify, the debt must be at least three years old and the returns must have been filed at least two years before petitioning for bankruptcy relief.

Often, forgiven debt is considered taxable income. This is not the case with bankruptcy. As a result, the forgiven debt should not be subject to taxation.

Impact of a Chapter 7 versus a Chapter 13

The type of bankruptcy petition, such as a chapter 7 or chapter 13, also impacts how tax debts are handled. Generally, those who file for relief under a chapter 7 petition are more likely to have tax debts discharged. Those who file under a chapter 13 are more likely to remain liable for tax debt, having these debts enter a repayment plan.

The impact of bankruptcy on taxes is only one of many considerations to look into prior to filing for bankruptcy. Contact an experienced bankruptcy attorney to help better ensure that you choose the right chapter and are fully aware of the impact a bankruptcy petition can have. This professional can help you weigh the pros and cons of a bankruptcy petition before filing, helping you to make an informed decision after considering all the potential issues that may arise.