Taxation Consequences of Individual Bankruptcy Filing
This paper will discuss the tax consequences of a bankruptcy filing by a non-corporate individual. Most of the discussion will focus upon the status of the discharge of indebtedness, which is the object of a bankruptcy filing, and the tax liability of the bankruptcy estate.
Under the Bankruptcy Code, there are two different types of bankruptcy filings: liquidation and reorganization. In a liquidation bankruptcy (Chapter 7) all of the property owned by the debtor at the date of bankruptcy is placed in the bankruptcy estate, which is a separate entity from the debtor, administered by a court-appointed trustee. As will be explained later, the estate is taxed as a separate entity from the debtor. This property, placed in the estate, is then used to satisfy the debts of the debtor and the expenses of the bankruptcy proceedings. In a reorganization bankruptcy (Chapters 11 & 13) the debtors property is again placed in the bankruptcy estate, but the debtor also files a plan, approved of by his creditors and confirmed by the bankruptcy court, under which the debtor proposes to pay, in whole or in part, the debts he owes over a period of time. The creditors are guaranteed payment of no less than the amount which they would have received under a Chapter 7 liquidation. Because the debtor pays the creditors from future earnings, he or she generally remains in possession of the property in the estate; as will be explained later, the estate in a Chapter 13 reorganization is not a separate entity for tax purposes.
The main difference between a Chapter 11 reorganization and a Chapter 13 reorganization is that Chapter 13 is intended for use by individuals who are not corporations who have future earning potential. These persons would be unnecessarily harmed by a Chapter 7 liquidation, which often would result in the loss of the family home; on the other hand, a Chapter 11 reorganization woul...