Today I am going to talk to you about bankruptcy and taxes. Kind of a depressing subject, but maybe not. Maybe it is an opportunity to help you get out from under a difficult situation. You may find yourself in a spot where your liabilities exceed your assets, and you need to have a way out. This video is not about the mechanics or legalities of bankruptcy-before pursuing bankruptcy, you need the help of a qualified bankruptcy attorney, to walk you through the steps and to talk to you about your options. However, this video is for those who have already begun the bankruptcy process and are looking for some guidance.
Video Transcript - Bankruptcy and Taxes
It is time to get down to the Brass Tacks. My name is Mel Sams and I'm the Managing Associate of Sams CPA, and today I'm going to talk to you about bankruptcy and taxes. Kind of a depressing subject, but maybe not. Maybe it's an opportunity to help get out from under some difficult business considerations or situations, and for individuals, too. You may find yourself in a spot where your liabilities exceed your assets, and you need to have a way out. And this video is not so much to talk about the mechanics or legalities of bankruptcy, because I would tell you before pursuing bankruptcy, you need the help of a qualified bankruptcy attorney, to walk you through the steps and to talk to you about your options.
But what we're going to talk to you about today is, you've already started the bankruptcy whether you're an individual, or you're a business. You've already started, what to expect now from the IRS and tax side of things. First of all, there's a couple different types of bankruptcy that we hear about. Chapter 7 bankruptcy is typically a liquidation. Your assets are sold or liquidated to pay creditors. Typically, a fresh start, a clean start however you want to look at it. Then we get into Reorganizations. Now, there are Chapter 11 and Chapter 13 Reorganizations, depending on whether you're a business or an individual.
But, let's talk about businesses primarily under the Chapter 11 Reorganization. You're going to your creditors and saying, "I don't want to see everything I've got. I want to keep operating, but I've gotta figure out a way to pay you. We all need to agree on a payment plan or a different payment structure." So, your attorney and your creditors and you, you all get together. Everybody talks, you come to an agreement. Now what? We still have to file with the IRS. The IRS can certainly be a creditor and often is a creditor in bankruptcy. They're no different than any other lender or person that you may owe money too.
So, if you're a business and you file bankruptcy, or you're an individual who owns a business and you file bankruptcy, it definitely changes some of your filing requirements, in terms of what forms you use. In terms of how you report things, how you pay taxes. In a nut shell, when you're a business owner and you file for Chapter 13 bankruptcy you want to reorganize, you want to restructure. You essentially transfer ownership of your businesses over to the bankruptcy estate, which is created ... An entity created to facilitate the payment of your creditors. So when you go to file your corporate tax returns, they're going to look a lot different after filing your bankruptcy petition than before. You need a CPA who knows this subject and who has done this before to help you put the proper filings together. The last thing you want to do is come out of a bankruptcy and then find yourself in trouble with the IRS because the correct filings weren't done. That's no good.
Finally, taxation. Who ... Do you pay taxes in bankruptcy? Do you ... You know, what happens there? If you sell everything off do you owe tax? All great questions and those are all very specific questions that should be answered on a case-by-case basis. But one thing I can tell you is forgiveness of debt, in general. Typically, when you do not pay a creditor the full amount that you owe, it's likely that you might have income in the form of cancellation of debt or forgiveness of debt whereby, a bank or a lender or a creditor, takes less money then what you actually owe them. A lot of times, people would negotiate credit card debt, think they're okay. And then at the end of the year they get a 1099 for the difference that the credit card company forgave. And it's an unpleasant surprise to get in January when you think you have already addressed this problem.
Typically, cancellation of debt income can be tax free, if you were insolvent at the time of the debt forgiveness. So it's very important to know two things. One, you know how to determine if you're insolvent. For the IRS definition it's very basic. If the value of your assets are exceeded by the value of your liabilities, you're insolvent. You do not have enough assets to satisfy your debt. If you're insolvent at the time of the debt forgiveness, generally you can exclude that cancellation of debt income from tax. Same way with your primary residence. If you have a reduction in the mortgage, as many people did years ago in the financial crisis. And you have that reduction in your principle, your mortgage company may have sent you a 1099. Well, certain laws protect those homeowners who got that forgiveness of debt from having to pay tax on the amount of debt that was forgiven. Now, there have been a lot of law changes in this area in recent years, so I definitely recommend you take your specific case, talk to your attorney, talk to your CPA and find out exactly what to expect from the government and from your creditors, upon the completion or filing of your bankruptcy.
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