IRC Section 1398 Election: Banruptcy and the Creation of a Short Tax Year - John R. Dundon II, Enrolled Agent
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IRC Section 1398 Election: Banruptcy and the Creation of a Short Tax Year

The Perturbing New Treatment of Patents Under the Tax Cut & Jobs Act (TCJA)

IRC Section 1398 Election: Banruptcy and the Creation of a Short Tax Year

If you are an individual debtor in a chapter 7 or 11 bankruptcy case you may be able to elect to close your tax year for the year in which the bankruptcy petition is filed as of the day before the date on which the bankruptcy case commences. If you make this election your tax year is divided into 2 short tax years of less than 12 months each. The first year ends on the day before the commencement date and the second year begins on the commencement date.

If for example you filed a bankruptcy petition under chapter 7 or 11 on May 1, 2012 and elected to close your tax year at the commencement of your case, your first short year for 2012 runs from January 1 through April 30, 2012. The second short year runs from May 1, 2012, through December 31, 2012. To have a timely filed election for the first short year, you must file Form 1040 (or an extension) for the period January 1 through April 30th by September 15.

Here are some things that I’ve learned in regards to bankruptcy and federal tax obligations:

1. No part of your income tax liability for the year in which the bankruptcy case commences can be collected from the bankruptcy estate. In other words it the debt will probably not be discharged.

2. You cannot make a short-year election if you have no assets in the bankruptcy estate other than exempt property.

3. To avoid delays in processing the short year return, write “Section 1398 Election” at the top of the return. The statement must say that you chose under IRC section 1398(d)(2) to close the debtor’s tax year on the day before the filing of the bankruptcy case.

4. You may also make the election by attaching a statement to IRS Form 4868 – Application for Automatic Extension of Time to File. File Form 4868 by the due date of the return for the first short tax year.

5. If you are married your spouse may join in the election to end the tax year. If a joint election is made, you must file a joint return for the first short tax year. This is irrevocable. However you do not necessarily have to file a joint return for the second short tax year.

6. 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 the debtor’s tax year. Because each spouse has a separate bankruptcy, one or both of you may have 3 short tax years in the same calendar year.

7. If you do not make an election to end the tax year, the commencement of the bankruptcy case does not affect your tax year.

8. If the short year election is made, your federal income tax liability for the first short tax year becomes an allowable claim against the bankruptcy estate. However the tax liability for the first short tax year is not subject to discharge under the Bankruptcy Code and can be collected from the estate.



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