You, as the individual debtor, generally must file income tax returns during the period of the bankruptcy proceedings. Do not include on your return, the income, deductions, or credits belonging to the separate bankruptcy estate.
Also do not include as income on your return, the debts canceled because of bankruptcy.
However, the bankruptcy estate must reduce certain losses, credits, and the basis in property (to the extent of these items) by the amount of canceled debt. See Debt Cancellation, later.
You have the option of ending your tax year on the day before you filed your bankruptcy petition. This allows the tax due on that short period return to be a claim against the bankruptcy estate. See Election to End Tax Year, later.
See Tax Procedures, later, for information about determining and paying the amount of tax due.
Tax attributes. Certain deduction and credit carryovers and decisions that you made in earlier years are taken over by the bankruptcy estate when you file for bankruptcy. These include carryovers of deductions, losses, and credits, your method of accounting, and the basis and holding period of assets. These are referred to as tax attributes.
When the estate is terminated, you assume any remaining tax attributes that were taken over by the estate and generally assume any attributes arising during the administration of the estate. See Attribute carryovers, later under The Bankruptcy Estate, for a list of attributes. Also, see Administrative expenses under The Bankruptcy Estate for a limitation.
Disclosure of return information. The bankruptcy estate’s income tax returns are open, upon written request, to inspection by or disclosure to you the individual debtor. The disclosure is necessary so that you can properly figure the amount and nature of the tax attributes, if any, that you must assume when the bankruptcy estate is terminated.
In addition, your income tax returns for the year the bankruptcy case begins and for earlier years are open to inspection by or disclosure to the bankruptcy estate’s trustee. See Disclosure of return information, later, under The Bankruptcy Estate.
Transfer of assets to the estate. Bankruptcy law determines which of your assets become part of the bankruptcy estate. Generally, all of your legal and equitable interests become property of the estate. However, you may ‘‘exempt’’ certain property from the estate.
A transfer (other than by sale or exchange) of an asset from you 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.
If you receive any assets from the bankruptcy estate when it terminates, do not treat the transfer as a taxable disposition. You treat these assets the same as the bankruptcy estate would have treated them. This includes using the same basis, holding period, and character of the assets as the bankruptcy estate did before it was terminated.
Abandonments. If you receive abandoned property from the estate, you receive the same basis in the property that the estate had.
Carrybacks from your activities. As the individual debtor, you cannot carry back any net operating loss or credit carryback from a tax year ending after the bankruptcy case has begun to any tax year ending before the case began. The estate, however, can carry the loss back to offset your pre-bankruptcy income.
Election to End Tax Year
If you are an individual debtor and have assets (other than those you exempt from the bankruptcy estate), you may choose to end your tax year on the day before the filing of your bankruptcy case. Then your tax year is divided into 2 ‘‘short’’ tax years of fewer than 12 months each. The first year ends on the day before the filing date, and the second year begins with the filing date and ends on the date your tax year normally ends. Once you make this choice, you may not change it. Any income tax liability for the first short tax year becomes an allowable claim (as a claim arising before bankruptcy) against the bankruptcy estate. If this tax liability is not paid in the bankruptcy proceeding, the liability is not canceled because of bankruptcy and it can be collected from you as an individual.
If you do not choose to end the tax year, then no part of your tax liability for the year in which bankruptcy proceedings begin can be collected from the estate.
Making the election. If you choose to end your tax year, you do so by filing a return on Form 1040 for the first short tax year on or before the 15th day of the fourth full month after the end of that first tax year.
Example.John Doe files a bankruptcy petition on July 10. To have a timely filed election, he must file Form 1040 (or an extension) for the period January 1 through July 9 by November 15.
To avoid delays in processing the return, write ‘‘Section 1398 Election’’ at the top of the return. You may also make the election by attaching a statement to an application for extension of time to file a tax return (Form 4868 or other). The statement must say that you choose under section 1398(d)(2) to close your tax year on the day before the filing of the bankruptcy case. You must file the application for extension by the due date of the return for the first short tax year. If your spouse decides to also close his or her tax year, see Election by debtor’s spouse, next.
Election by debtor’s spouse. If you are married, your spouse may also join in the choice to end the tax year, but only if you and your spouse file a joint return for the first short tax year. You must make these choices by the due date for filing the return for the first short tax year. Once you make the choice, it cannot be revoked for the first year; however, the choice does not mean that you and your spouse must file a joint return for the second short tax year.
Later bankruptcy of spouse. If your spouse files for bankruptcy later in the same year, he or she may also choose to end his or her tax year, regardless of whether he or she joined in the choice to end your tax year. Because each of you has a separate bankruptcy, one or both of you may have 3 short tax years in the same calendar year. If your spouse had joined in your choice, or if you had not made the choice to end your tax year, you can join in your spouse’s choice. But if you had made an election and your spouse did not join in the election, you cannot join in your spouse’s later election. This is because you and your spouse, having different tax years, could not file a joint return for a year ending on the day before your spouse’s filing of bankruptcy.
Example 1. Paul and Mary Harris are cal
endar-year taxpayers. A voluntary chapter 7 bankruptcy case involving only Paul begins on March 4.
If Paul does not make an election, his tax year does not end on March 3. If he does make an election, Paul’s first tax year is January 1—March 3, and his second short tax year begins on March 4. Mary could join in Paul’s election as long as they file a joint return for the tax year January 1—March 3. They must make the election by July 15, the due date for filing the joint return.
Example 2. Fred and Ethel Barnes are calendar-year taxpayers. A voluntary chapter 7 bankruptcy case involving only Fred begins on May 6, and a bankruptcy case involving only Ethel begins on November 1 of the same year.
Ethel could choose to end her tax year on October 31. If Fred had not elected to end his tax year on May 5, or if he had elected to do so but Ethel had not joined in his election, Ethel would have 2 tax years in the same calendar year if she decided to close her tax year. Her first tax year is January 1—October 31, and her second year is November 1—December 31.
If Fred had not decided to end his tax year as of May 5, he could join in Ethel’s choice to close her tax year on October 31, but only if they file a joint return for the tax year January 1—October 31. If Fred had elected to end his tax year on May 5, but Ethel had not joined in Fred’s choice, Fred could not join in Ethel’s choice to end her tax year on October 31, because they could not file a joint return for that short year. They could not file a joint return because their tax years preceding October 31 were not the same.
Example 3. Jack and Karen Thomas are calendar-year taxpayers. A voluntary chapter 7 bankruptcy case involving only Karen begins on April 10, and a voluntary chapter 7 bankruptcy case involving only Jack begins on October 3 of the same year. Karen chooses to close her tax year on April 9 and Jack joins in Karen’s choice.
Under these facts, Jack would have 3 tax years for the same calendar year if he makes the election relating to his own bankruptcy case. The first tax year would be January 1—April 9; the second April 10—October 2; and the third October 3—December 31.
Karen may (but does not have to) join in Jack’s election if they file a joint return for the second short tax year (April 10—October 2). If Karen does join in, she would have the same 3 short tax years as Jack. Also, if Karen joins in Jack’s election, they may file a joint return for the third tax year (October 3—December 31), but they are not required to do so.
Annualizing taxable income. If you choose to close your tax year, you must annualize your taxable income for each short tax year the same way it is done for a change in an annual accounting period. See Short Tax Year in Publication 538, Accounting Periods and Methods, for information on how to annualize your income and how to figure your tax for the short tax year.
Filing requirement. If you elect to end your tax year on the day before filing the bankruptcy case, you must file the return for the first short tax year as explained earlier under Making the election.
If you make this election, you must also file a separate Form 1040 for the second short tax year by the regular due date. You should note on the return that it is the ‘‘Second Short Year Return After Section 1398 Election.’’
If the bankruptcy case is later dismissed, you (the debtor) must file an amended return to replace any full or short year returns that you filed. Attach a statement to any amended return you file explaining why you are filing an amended return. In this situation, no bankruptcy estate is created for tax purposes. Income that was or would be reported by the bankruptcy estate must be reported on your return.