The filing of a bankruptcy petition for an individual debtor under chapter 7 or chapter 11 of the bankruptcy code creates a separate taxable bankruptcy estate. The trustee (for chapter 7 cases) or the debtor-in-possession (for chapter 11 cases) is generally responsible for preparing and filing the estate’s tax returns and paying its taxes. The debtor remains responsible for filing returns and paying taxes on any income that does not belong to the estate.
If a bankruptcy case begins, but later is dismissed by the bankruptcy court, the estate is not treated as a separate taxable entity. If tax returns have been filed for the estate, amended returns must be filed to move income and deductions from the estate’s returns to the debtor’s returns. If no returns have been filed, report all income and deductions on the debtor’s returns.
The following discussions provide tax information for the bankruptcy estate.
Treatment of income, deductions, and credits. The gross income of the bankruptcy estate includes any of the debtor’s gross income to which the estate is entitled under the bankruptcy law. The estate’s gross income also includes any income the estate is entitled to and receives or accrues after the beginning of the bankruptcy case. Gross income of the bankruptcy estate does not include amounts received or accrued by the debtor before the bankruptcy petition date.
The bankruptcy estate may deduct or take as a credit any expenses it pays or incurs, the same way that the debtor would have deducted or credited them had he or she continued in the same trade, business, or activity and actually paid or accrued the expenses. Allowable expenses include administrative expenses, such as attorney fees and court costs. These are discussed later under Administrative expenses.
The bankruptcy estate figures its taxable income the same way as an individual figures his or her taxable income. The estate can take one personal exemption and either individual (itemized) deductions or the basic standard deduction for a married individual filing a separate return. The estate cannot take the higher standard deduction allowed for married persons filing separately who are 65 or older or blind. The estate uses the rates for a married individual filing separately to figure the tax on its taxable income.
Transfer of assets between debtor and estate. Bankruptcy law determines which of the debtor’s assets become part of the bankruptcy estate. These assets are treated the same in the estate’s hands as they were in the debtor’s hands.
A transfer (other than by sale or exchange) of an asset from the debtor to the bankruptcy estate is not treated as a ‘‘disposition’’ for income tax purposes. This means that the transfer does not result in gain or loss, recapture of deductions or credits, or acceleration of income or deductions. For example, the transfer of an installment obligation to the estate would not accelerate gain under the rules for reporting installment sales. The estate is treated the same way the debtor would be regarding the transferred asset.
When the bankruptcy estate is terminated, that is, dissolved, any resulting transfer (other than by sale or exchange) of the estate’s assets back to the debtor is not treated as a disposition. This transfer does not result in gain or loss, recapture of deductions or credits, or acceleration of income or deductions to the estate.
The abandonment of property by the estate to the debtor is a nontaxable disposition of property.
Attribute carryovers. The bankruptcy estate must treat its tax attributes the same way that the debtor would have treated them. These items must be determined as of the first day of the debtor’s tax year in which the bankruptcy case begins. The bankruptcy estate gets the following tax attributes from the debtor:
- Net operating loss carryovers,
- Carryovers of excess charitable contributions,
- Recovery of tax benefit items,
- Credit carryovers,
- Capital loss carryovers,
- Basis, holding period, and character of assets,
- Method of accounting,
- Passive activity loss and credit carryovers,
- Unused at-risk deductions, and
- Other tax attributes as provided in regulations.
Certain tax attributes of the estate must be reduced by any excluded income from cancellation of debt occurring in a bankruptcy proceeding. See Debt Cancellation, later.
Termination of the estate. If the bankruptcy estate has any tax attributes at the time it is terminated, they are assumed by the debtor.
Passive and at-risk activities. For bankruptcy cases beginning on or after November 9, 1992, treat passive activity carryover losses and credits and unused at-risk deductions as tax attributes that the debtor passes to the bankruptcy estate and the estate passes back to the debtor when the estate terminates. Additionally, transfers to the debtor (other than by sale or exchange) of interests in passive or at-risk activities are treated as exchanges that are not taxable. These transfers include the return of exempt property to the debtor and the abandonment of estate property to the debtor.
Cases beginning before November 9, 1992. If a bankruptcy case begins before November 9, 1992, and ends on or after that date, the debtor and the trustee for an individual chapter 7 case (the debtor-in-possession for an individual chapter 11 case) can elect to have these provisions apply. In a chapter 7 case, the election is made jointly by the debtor and the trustee of the bankruptcy estate. In a chapter 11 case, the election is incorporated in the bankruptcy plan. See IRS regulations 1.1398–1 and 1.1398–2 for more information on how to make this election.
Administrative expenses. The bankruptcy estate is allowed a deduction for administrative expenses and any fees or charges assessed it. These expenses are generally deductible as itemized deductions subject to the 2% floor on miscellaneous itemized deductions. However, administrative expenses attributable to the conduct of a trade or business by the bankruptcy estate or the production of the estate’s rents or royalties are deductible in arriving at adjusted gross income.
The expenses are subject to disallowance under other provisions of the Internal Revenue Code, such as disallowing certain capital expenditures, taxes, or expenses relating to tax-exempt interest. These expenses can only be deducted by the estate, and never by the debtor.
If the administrative expenses of the bankruptcy estate are more than its gross income for the tax year, the excess amount may be carried back 3 years and forward 7 years. The amounts can only be carried back or forward to a tax year of the estate and never to the debtor’s tax year. The excess amount to be carried back or forward is treated like a net operating loss and must first be carried back to the earliest year possible. For a discussion of the net operating loss, see Publication 536, Net Operating Losses.
Change of accounting period. The bankruptcy estate may change its accounting period (tax year) once without getting approval from the Internal Revenue Service. This rule allows the trustee of the estate to close the estate’s tax year early, before the expected termination of the estate. The trustee can then file a return for the first short tax year to get a quick determination of the estate’s tax liability.
Carrybacks from the estate. If the bankruptcy estate itself has a net operating loss, separate from any losses passing to the estate from the debtor under the attribute carryover rules, the bankruptcy estate can carry the loss back not only to its own earlier tax years but also to the debtor’s tax years before the year the bankruptcy case began. The estate may also carry back excess credits, such as the general business credit, to the pre-bankruptcy years.
Return Requirements and Payment of Tax
The trustee (or debtor-in-possession) must file an income tax return on Form 1041, U.S. Income Tax Return for Estates and Trusts if the estate has gross income that meets or exceeds the amount required for filing. This amount is the total of the personal exemption amount and the basic standard deduction for a married individual filing separately. See the Form 1041 instructions for the current year’s amount.
If a return is required, the trustee (or debtor-in-possession) completes the identification area at the top of the Form 1041 and lines 23–29 and signs and dates it. Form 1041 is a transmittal for Form 1040, U.S. Individual Income Tax Return. Complete Form 1040 and figure the tax using the tax rate schedule for a married person filing separately. In the top margin of Form 1040, write ‘‘Attachment to Form 1041. DO NOT DETACH.’’ Attach Form 1040 to the Form 1041.
Note:The filing of a tax return for the bankruptcy estate does not relieve the individual debtor of his or her tax filing requirement.
Estimated tax. The trustee or debtor-in-possession must pay estimated tax (if any is due) for the bankruptcy estate. See the Instructions to Form 1041–ES, Estimated Income Tax for Fiduciaries, for information regarding the dollar limits and exceptions to filing Form 1041–ES and paying estimated tax.
Employer identification number. The trustee (or debtor-in-possession) must obtain an employer identification number (EIN) for a bankruptcy estate if the estate must file any form, statement, or document with the IRS. The trustee uses this EIN on any tax return filed for the bankruptcy estate including estimated tax returns. The trustee can obtain an EIN for a bankruptcy estate by filing Form SS– 4, Application for Employer Identification Number. Form SS–4 is available at IRS or Social Security Offices. Trustees representing ten or more bankruptcy estates (other than estates that will be filing employment or excise tax returns) may file a consolidated application to obtain blocks of ten or more EINs by following the procedures set out in Revenue Procedure 89–37, 1989–1 C.B. 919.
Note:The social security number of the individual debtor cannot be used as the EIN for the bankruptcy estate.
Employment taxes. The trustee (or debtor-in-possession) must withhold income and social security taxes and file employment tax returns for any wages paid by the trustee (or debtor), including wage claims paid as administrative expenses. Until these employment taxes are deposited as required by the Internal Revenue Code, they should be set apart in a separate bank account to ensure that funds are available to satisfy the liability. If the employment taxes are not paid as required, the trustee may be held personally liable for payment of the taxes. See Publication 15,Circular E, Employer’s Tax Guide, for details on employer tax responsibilities.
The trustee has the duty to prepare and file Forms W–2, Wage and Tax Statement, in connection with wage claims paid by the trustee, regardless of whether the claims accrued before or during bankruptcy. If the debtor fails to prepare and file Forms W–2 for wages paid before bankruptcy, the trustee should instruct the employees to file an IRS Form 4852, SUBSTITUTE FOR FORM W–2, WAGE AND TAX STATEMENT OR FORM 1099R, DISTRIBUTIONS FROM PENSIONS, ANNUITIES, RETIREMENT OR PROFIT-SHARING PLANS, IRA’S, INSURANCE CONTRACTS, ETC., with their individual income tax returns.
Disclosure of return information. The debt-or’s income tax returns for the year the bankruptcy case begins and for earlier years are, upon written request, open to inspection by or disclosure to the trustee. If the bankruptcy case was not voluntary, disclosure cannot be made before the bankruptcy court has entered an order for relief, unless the court rules that the disclosure is needed for determining whether relief should be ordered.
For information concerning the disclosure of the bankruptcy estate’s tax return see Disclosure of return information, earlier, under Responsibilities of the Individual Debtor.