10 Oct IRS Notice 2006-83: The Bankruptcy Estate
When an individual files a bankruptcy petition under chapter 7 or 11 of the bankruptcy code a bankruptcy estate is established. The bankruptcy estate is treated as a separate taxable entity. If a trustee is appointed, the trustee is responsible for preparing and filing the estate’s tax returns and paying its taxes. If not then the debtor-in-possession (aka the person filing the petition) is responsible for filing the bankruptcy estate return, IRS Form 1041. Additionally if you are the debtor-in-possession you must also take care to file tax returns and pay taxes on income that is NOT part of the bankruptcy estate via IRS Form 1040. Before filing tax returns for the bankruptcy estate, the trustee or debtor-in-possession must obtain an employer identification number (EIN) for the estate. The trustee or debtor-in-possession uses the EIN on any tax returns filed for the estate, including estimated tax returns.
Once a bankruptcy court dismisses a case the estate is no longer treated as a separate taxable entity and the debtor is treated as if the bankruptcy petition was never filed. The most important lesson I learned is that the debtor must file amended returns on IRS Form 1040-X to replace the returns previously filed for the bankruptcy estate. Include on the amended returns the items of income, deductions, and credits that were reported by the bankruptcy estate on its returns and were not reported on returns the debtor previously filed.
Here are Some Other Things I learned about a Bankruptcy Estate and the IRS:
1. The bankruptcy estate must reduce certain losses, credits, and basis in property by the amount of canceled debt.
2. Take care to properly report on your personal return income or assets not part of the bankruptcy estate.
3. The bankruptcy exclusion cannot be used to exclude debt that was canceled while under the bankruptcy court’s protection however other exclusions such as insolvency may apply.
4. The gross income of the bankruptcy estate includes income generated by property in the estate after the commencement of the case.
5. Gross income of the estate does not include amounts received or accrued by the debtor before the commencement of the case and does not include any income that the debtor earns after the bankruptcy petition date.
6. For cases filed after October 16, 2005, earnings from services performed by an individual debtor after the commencement of the chapter 11 case are property of the bankruptcy estate under 11 U.S.C. section 1115.
7. Under IRC 1398(e)(1), gross income of the estate includes income that the debtor earns for services performed after the bankruptcy petition date and should be included on the estate’s return in cases filed after October 17, 2005.
8. If a chapter 11 case is converted to a chapter 13 case, the chapter 13 estate is not a separate taxable entity and earnings from post-conversion services and income from property of the estate realized after the conversion to chapter 13 are taxed to the debtor.
9. A debtor-in-possession may be compensated by the estate for managing or operating a trade or business that the debtor conducted before the commencement of the bankruptcy case. For cases filed after October 16, 2005, such payments should be reported by the debtor as miscellaneous income on his or her individual income tax return. Amounts paid by the estate to the debtor-in-possession for managing or operating the trade or business may qualify as administrative expenses of the estate.
10. When a chapter 11 bankruptcy case is closed, dismissed, or converted to a chapter 12 or 13 case, the bankruptcy estate ends as a separate taxable entity. It is important to send notice of such event to ensure that gross income and proceeds and payments realized after the event are reported under the correct Taxpayer Identification Number
11. If a chapter 11 case is converted to a chapter 7 case, the bankruptcy estate can continue to exist as a separate taxable entity.
12. The significance of allocation, according to IRC 31(a) if for example purposes 20% of the wages reported on Form W-2 for a calendar year were earned after the commencement of the case and are included in the estate’s gross income, 20% of the withheld income tax reported on Form W-2 must also be claimed as a credit on the estate’s income tax return. Likewise, 80% of wages must be reported by the debtor and 80% of the withheld income tax must be claimed as a credit on the debtor’s income tax return.
13. The debtor must attach a statement to his or her income tax return stating that the return is filed subject to a chapter 11 bankruptcy case. The statement must also show the allocations of income and withheld income tax, describe the method used to allocate income and withheld tax, and list the filing date of the bankruptcy case, the bankruptcy court in which the case is pending, the bankruptcy court case number, and the bankruptcy estate’s EIN.
14. The debtor-in-possession or trustee must attach a similar statement to the estate’s income tax return.
16. 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. Consequently, the transfer does not result in gain or loss, recapture of deductions or credits, or acceleration of income or deductions.
17. When the bankruptcy estate is terminated or dissolved, any resulting transfer (other than by sale or exchange) of the estate’s assets back to the debtor is also not treated as a disposition. The transfer does not result in gain or loss, recapture of deductions or credits, or acceleration of income or deductions to the estate.
18. The abandonment of property by the estate to the debtor is a nontaxable disposition of property. If the debtor received abandoned property from the estate, the debtor has the same basis in the property that the estate had.
19. 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: NOL 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, as well as Other tax attributes as provided in regulations.
20. Certain tax attributes of the estate must be reduced by any excluded income from cancellation of debt occurring in a bankruptcy proceeding. When the estate is terminated or when the case ends the debtor assumes any remaining tax attributes that were taken over by the estate and generally assumes any of the listed attributes that arise during the administration of the estate.
21. For bankruptcy cases beginning after November 8, 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 and the abandonment of estate property to the debtor.
22. The bankruptcy estate is allowed a deduction for administrative expenses and fees or charges assessed. These expenses are generally deductible as itemized deductions and are not 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.
23. The bankruptcy estate may change its accounting period (tax year) once without IRS approval. This rule allows the bankruptcy trustee 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.
24. The debtor cannot carry back any NOL or credit carryback from a tax year ending after the bankruptcy case has begun to any tax year ending before the case began.
25. If the bankruptcy estate has an NOL that did not pass to the estate from the debtor under the attribute carryover rules, the 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.
26. The trustee or debtor-in-possession must file an income tax return on IRS Form 1041 if the estate has gross income that meets or exceeds the amount required for filing.
27. 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. 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.
28. The filing of a tax return for the bankruptcy estate does not relieve the individual debtor of his or her tax filing requirement.
29. The trustee or debtor-in-possession must pay estimated tax (if any is due) for the bankruptcy estate. See the Form 1041-ES instructions for information on the dollar limits and exceptions to filing Form 1041-ES and paying estimated tax.
30. 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 IRC, they should be set aside in a separate bank account to ensure that funds are available to satisfy the liability.
31. If the employment taxes are not paid as required, the trustee may be held personally liable for payment of the taxes. Further, the trustee has the duty to prepare and file Forms W-2 for wage claims paid by the trustee, regardless of whether the claims accrued before or during bankruptcy.
32. If the debtor fails to prepare and file Forms W-2 for wages paid before bankruptcy, the trustee should instruct the employees to file IRS Form 4852, or IRS Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., with their individual income tax returns.