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Taxes, Bankruptcy and Insolvency


Cash flow insolvency is the inability to pay debts upon demand.  Balance sheet insolvency simply means that you have more debts than assets.  It is possible to be cash flow insolvent at the same time you are balance sheet solvent.  This happens when you have money bound up in non-liquid assets.  Many taxpayers have experienced this recently, when they have been forced into foreclosure due to the inability to pay their mortgage.

When your liabilities exceed your assets, you are insolvent.  If a lender forgives your debt under insolvency, you can file for insolvency exclusion in that amount on your income tax.  Otherwise you will have to enter the forgiven debt on your income tax report.  Recently many homeowners realized that the cost of their mortgage exceeded the value of their home.  These homeowners qualified for the insolvency exclusion on their taxes.


The amount you can exclude can be no higher than the amount by which your liabilities exceed your assets. If the debt forgiven qualifies under the tax code and is used for running a farm, it might not be income at all.

·Chapter twelve or thirteen bankruptcy

If you file a chapter twelve or thirteen bankruptcy, you will file the same income tax report.  Include your entire income, as is normal procedure.  But do not include any cancelled debt on your federal income tax return.  Losses in property must be reduced by the total cancelled debt.

·Chapter seven or eleven bankruptcy

Under chapter seven or eleven bankruptcy filings, a separate estate is created from your estate prior to filing.  You, as a taxpayer and your bankruptcy estate are two distinct entities.  Under chapter seven, a trustee is appointed to your estate.  The trustee sees to the liquidation of your non-exempt assets.  Under chapter eleven, you stay in charge of the estate.  You are given debtor-in-possession status.  All monies earned after the bankruptcy filing are yours and not part of the bankruptcy requirements.  If your bankruptcy petition is rejected, you are responsible for filing an Internal Revenue Service tax form 1040X and become responsible for your income taxes as if you had never made the bankruptcy petition.

You have to file an income tax return during the bankruptcy process.  You will not include, deductions, credits, or income belonging to the bankruptcy estate, as it is an entity separate from you.  You can choose to end your tax year the day before you file your bankruptcy petition.

If you file for bankruptcy after the first of January, any refund you receive from taxes that year, even if you have yet to file, is an asset in your bankruptcy.

Chintamani Abhyankar, is a well known expert in the field of finance and taxation for last 25 years. He has written many books explaining inside secrets of the magic world of personal finance. His famous eBook Stop donating your money to IRS which is now running in its second edition, provides intricate knowledge and valuable tips on personal finance and income tax.


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