Bankruptcy and Individuals Cont'd
Filing requirement. If the debtor elects to end the tax year on the day before filing the bankruptcy case, the debtor must file the return for the first short tax year as explained earlier under Making the election.
If the debtor makes this election, the debtor must also file a separate Form 1040 for the second short tax year by the regular due date. To avoid delays in processing the return, write "Second Short Year Return After Section 1398 Election" at the top of the return.
If the bankruptcy case is later dismissed, the debtor must file amended returns to replace all full or short year returns filed as a result of the bankruptcy case. Attach a statement to the amended returns explaining why the debtor is filing an amended return. In this situation, no bankruptcy estate is created for tax purposes. Income that was or would have been reported by the bankruptcy estate must be reported on the debtor's amended returns.
Taxes and the Bankruptcy Estate
The commencement of a bankruptcy case creates an estate, which generally
includes all legal or equitable interests in property of the debtor
as of the commencement of the case. There are certain exceptions. Exempt
property and abandoned property are initially part of the bankruptcy
estate, but are subsequently removed from the estate. Excluded property
is never included in the estate.
When an individual files a bankruptcy petition under chapter 7 or 11,
the bankruptcy estate is treated as a separate taxable entity from the
debtor. The trustee or debtor-in-possession is responsible for preparing
and filing the estate's tax returns and paying its taxes. The debtor
remains responsible for filing his or her own returns and paying taxes
on income that does not belong to the estate.
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.
See Employer identification number, later.
If the debtor is an individual in a chapter 7 or 11 bankruptcy, do not
include on the debtor's individual income tax return the income, deductions,
or credits that belong to the bankruptcy estate. Also, do not include
as income on the debtor's return any 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.
If the debtor is an individual in a chapter 7 or 11 case and the bankruptcy
court dismissed the case, the estate is no longer treated as a separate
taxable entity. The debtor is treated as if the bankruptcy petition
was never filed. The debtor must file amended returns on Form 1040X
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.
Note.
The debtor may not be able to claim certain deductions such as administrative
expenses of the estate and the bankruptcy exclusion that the estate
could have claimed. Also, the bankruptcy exclusion cannot be used to
exclude debt that was canceled while the debtor was under the bankruptcy
court's protection. But the other exclusions (such as insolvency) may
apply.
Income of the estate in chapter 7 cases of individuals. The gross
income of the bankruptcy estate includes any of the debtor's gross income
to which the estate is entitled under the Bankruptcy Code. It also includes
income generated by the bankruptcy estate, from property in the estate,
after the commencement of the case.
Gross income of the estate does not include amounts received or accrued
by the debtor before the commencement of the case. Additionally, gross
income of the estate in a chapter 7 case does not include any income
that the debtor earns after the bankruptcy petition date.
The estate income in individuals' chapter 11 cases. For chapter
11 individual cases filed before October 17, 2005, gross income of the
estate is determined in the same manner as in chapter 7 cases involving
individuals. Notably, gross income of the estate generally does not
include any income that the debtor earns after the commencement of the
bankruptcy case.
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. Under IRC section 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.
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. If the chapter 11 case is converted
to a chapter 7 case, 11 U.S.C. section 1115 does not apply after conversion
and:
" Earnings from post-conversion services will be taxed to the debtor,
rather than the estate, and
" The property of the chapter 11 estate will become property of
the chapter 7 estate.
Any income on this property will be taxed to the estate even if the
income is realized after the conversion to chapter 7. If a chapter 11
case is dismissed, the debtor is treated as if the bankruptcy case had
never been filed and as if no bankruptcy estate had been created.
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. See Administrative expenses, later.
Notice to persons required to file information returns (other than Form W-2, Wage and Tax Statement) in chapter 11 cases of individuals filed after October 16, 2005. For chapter 11 cases of individuals filed after October 16, 2005, within a reasonable time after the commencement of a chapter 11 bankruptcy case, the trustee or the debtor-in-possession should provide notification of the bankruptcy estate's EIN to persons that are required to file information returns for the bankruptcy estate's gross income, gross proceeds, or other types of reportable payments. See IRC section 6109(a)(2). Because these payments are the property of the estate under 11 U.S.C. section 1115 for chapter 11 cases filed after October 16, 2005, the payors should report the gross income, gross proceeds, or other reportable payments on the appropriate information return using the estate's name and EIN as required under the IRC and regulations (see IRC sections 6041 through 6049).
The trustee or debtor-in-possession should not, however, provide the EIN to a person filing Form W-2 reporting the debtor's wages or other compensation, as 11 U.S.C. section 1115 does not affect the determination of what are wages for purposes of federal income tax withholding or the Federal Insurance Contributions Act (FICA). See IRC sections 3121(a) and 3401(a). An employer should continue to report all wage income and tax withholding, both pre-petition and post-petition, on a Form W-2 to the debtor under the debtor's social security number.
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. The debtor should, within a reasonable time, send notice of such event to the persons previously notified of the bankruptcy case to ensure that gross income and proceeds and other reportable payments realized after the event are reported to the debtor under the correct TIN rather than the estate.
If a chapter 11 case is converted to a chapter 7 case, the bankruptcy estate will continue to exist as a separate taxable entity. Gross income (other than post-conversion income from the debtor's services), gross proceeds, or other reportable payments should continue to be reported to the estate if they are property of the chapter 7 estate. Income from services performed by the debtor after conversion of the case to chapter 7 is not property of the chapter 7 estate. After the conversion, the debtor should notify payors required to report the debtor's nonemployee compensation that compensation earned after the conversion should be reported using the debtor's name and TIN, and not the estate's name and EIN.
The debtor in a post-BAPCPA chapter 11 case is not required to file a new Form W-4 with an employer solely because the debtor filed a chapter 11 case and the post-petition wages are includible in the estate's income and not the debtor's income. However, a new Form W-4 may be necessary if the debtor is no longer entitled to claim the same number of allowances previously claimed because certain deductions or credits now belong to the estate. See Employment Tax Regulations section 31.3402(f)(2)-1. The debtor may wish to file a new Form W-4 to increase the income tax withheld from post-petition wages allocated to the estate to avoid having to make estimated tax payments for the estate. See IRC section 6654(a).
Self-employment taxes in chapter 11 cases of individuals filed after October 16, 2005. IRC section 1401 imposes a tax upon the self-employment income of every individual. Self-employment income is the net earnings from self-employment derived by an individual. Net earnings from self-employment are gross income from self-employment less deductions attributable to the business. Neither 11 U.S.C. section 1115 nor IRC section 1398 addresses the application of the self-employment tax to the earnings from the individual debtor's continuing services. Because the debtor continues to derive gross income from the performance of services as a self-employed individual after the commencement of the bankruptcy case, the debtor must continue to report the debtor's individual income on Schedule SE (Form 1040) of the debtor's income tax return. The schedule includes the self-employment income earned post-petition and the attributable deductions. The debtor must pay any self-employment tax imposed by IRC section 1401.
Employment taxes and the obligation to file Form W-2 in chapter 11 cases of individuals filed after October 16, 2005. Chapter 11 cases of individuals filed after October 16, 2005, post-petition wages earned by a debtor are generally treated as gross income of the estate. The reporting and withholding obligations of a debtor's employer have not changed. 11 U.S.C. section 1115 does not affect the determination of wages under the FICA. See IRC section 3121(a). Similarly, the determination of wages for Federal Unemployment Tax Act (FUTA) tax or Federal Income Tax Withholding purposes is not affected. See IRC sections 3306(b) and 3401(a). Because 11 U.S.C. section 1115 does not affect the application of FICA tax, FUTA tax, or Federal Income Tax Withholding wages of a chapter 11 debtor, an employer should continue to report the wages and tax withholding on a Form W-2 issued under the debtor's name and social security number.
Allocation of income and credits on information returns and required
statement for returns for chapter 11 cases of individuals filed after
October 16, 2005. For chapter 11 cases, if an employer issues a Form
W-2 reporting all of the debtor's wages, salary, or other compensation
for a calendar year, and a portion of the earnings represent post-petition
services includible in the estate's gross income, the Form W-2 amounts
must be allocated between the estate and the debtor. The debtor-in-possession
or the trustee must allocate the amounts reported in box 1 and the withheld
income tax reported in box 2 of Form W-2 between the debtor and the
estate. The allocations must reflect that the debtor's gross earnings
from post-petition services and gross income from post-petition property
are, generally, includible in the estate's gross income and not the
debtor's gross income. The debtor and trustee may use a simple percentage
method to allocate income and withheld income tax. The same method must
be used to allocate the income and the withheld tax.
Example.
If 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.
See IRC section 31(a).
If information returns are issued to the debtor for gross income, gross
proceeds, or other reportable payments that should have been reported
to the bankruptcy estate, the debtor-in-possession or trustee must allocate
the improperly reported income in a reasonable manner between the debtor
and the estate. In general, the allocation must ensure that any income
and income tax withheld attributable to the post-petition period is
reported on the estate's return, and any income and income tax withheld
attributable to the pre-petition period is reported on the debtor's
return.
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.
Note.
The debtor-in-possession or trustee must attach a similar statement
to the estate's income tax return.
Notice 2006-83 Statement
Pending Bankruptcy Case
The taxpayer,____ , filed a bankruptcy petition under chapter 11 of
the Bankruptcy Code in the Bankruptcy Court for the District of_____
. The bankruptcy court case number is_____ . Gross income, and withheld
federal income tax, reported on Form W-2, Forms 1099, Schedule K-1,
and other information returns received under the taxpayer's name and
social security number (or other taxpayer identification number) are
allocated between the taxpayer's TIN and the bankruptcy estate's EIN
as follows, using [describe allocation method]:________________________.
Year Taxpayer Estate
1. Form W-2, Payor: $ $
Withheld income tax shown on Form W-2 $ $
2. Form 1099-INT Payor: $ $
Withheld income tax (if any) shown on Form 1099-INT $ $
3. Form 1099-DIV Payor: $ $
Withheld income tax (if any) shown on Form 1099-DIV $ $
4. Form 1099-MISC Payor: $ $
Withheld income tax (if any) shown on Form 1099-MISC $ $
The above Notice 2006-83 Statement, 2006-40 I.R.B. 596, may be used
by debtors, debtors-in-possession, and trustees.