Publication 908
Bankruptcy Tax Guide

Example.

Caution.

This publication is not revisedannually. Future changes to the forms and theirinstructions may not be reflected in this example.

On December 15, 1994, Thomas Smith filed abankruptcy petition under chapter 7. Joan Blackwas appointed trustee to administer the estateand to distribute the assets.

The estate received the following assets fromMr. Smith:

1. A $100,000 certificate of deposit,
2. Commercial rental real estate with a fairmarket value of $280,000, and
3. His personal residence with a fair marketvalue of $200,000.

Also, the estate received a $251,500 capital losscarryover.

Mr. Smith's bankruptcy case was closed onDecember 31, 1995. During 1995, Mr. Smith wasrelieved of $70,000 of debt by the court. Theestate chose a calendar year as its tax year.Joan, the trustee, reviews the estate'stransactions and reports thetaxable events on the estate's final return.

Schedule B (Form 1040).   The certificate of deposit earned $5,500 ofinterest during 1995. Joan reports thisinterest on Schedule B. She completes thisschedule and enters the result on Form 1040.

Form 4562.   Joan enters the depreciation allowedon Form 4562. She completes the form andenters the result on Schedule E.

Schedule E (Form 1040).   The commercial real estate was rented throughthe date of sale. Joan reports the income andexpenses on Schedule E.She enters the net income on Form 1040.

Form 4797.   The commercial real estate was sold onJuly 1, 1995, for $280,000. The property waspurchased in 1983 at a cost of $250,000. It wasdepreciated using straight line depreciation andthe total depreciation allowed or allowable as ofthe date of sale was $120,000. Additionally,$25,000 of selling expenses were incurred. Shereports the gain or loss from the sale onForm 4797. She completes the formand enters the gain on Schedule D (Form 1040).

Form 2119.   Mr. Smith's former residence was sold onSeptember 30, 1995. The sale price was $200,000,the selling expenses were $20,000 and hisadjusted basis was $130,000. Joan enters thisinformation on Form 2119. Joancompletes Form 2119 and enters the gain onSchedule D (Form 1040).

Schedule D (Form 1040).   Joan completes Schedule D, taking intoaccount the $250,000 capital loss carryover from1994 ($251,500 transferred to the estate minus$1,500 used on the estate's 1994 return). Sheenters the results on Form 1040.

Form 1040, page 1.   Joan completes page 1 of the 1040 andenters the adjusted gross income on the firstline of Form 1040, page 2.

Schedule A (Form 1040).   During 1995, the estate paid mortgage interestand real property tax on Mr. Smith's formerresidence. It also paid income tax to the state.Joan enters the mortgage interest, real estate taxand income tax on Schedule A.Also, she reports the estate's administrativeexpenses as a miscellaneous deductionsubject to the 2% floor.She completes theSchedule A and enters the result on page2 of Form 1040.

Form 1040, page 2.   Joan determines the estate's taxable incomeand figures its tax using the tax rate schedulefor married filing separately. She then enters theestate's estimated tax payments and figures theamount the estate still owes.

Form 982.   Joan completes the Schedule D worksheetfor capital loss carryover. Because $70,000 ofdebt was canceled, Joan must reduce the taxattributes of the estate by the amount of thecanceled debt. See DebtCancellation, later.In 1996, Thomas Smith (the individual) willassume the estate's tax attributes. Mr. Smithwill assume a capital loss carryover of$3,500 ($73,500 carryover minus the$70,000 attribute reduction).

Form 1041.   Joan enters the total tax, estimated taxpayments, and tax due from Form 1040 onForm 1041. She completes the identificationarea at the top of Form 1041, then signs anddates the return. Form 1041, page 1 for Thomas Smith Bankruptcy Estate Form 1040, page 1 for Thomas Smith Bankruptcy Estate Form 1040, page 2 for Thomas Smith Bankruptcy Estate Schedule A (Form 1040) for Thomas SmithBankruptcy Estate Schedule B (Form 1040) for Thomas SmithBankruptcy Estate Schedule D (Form 1040) for Thomas SmithBankruptcy Estate Schedule E (Form 1040), page 1 for Thomas SmithBankruptcy Estate Form 2119 for Thomas Smith Bankruptcy Estate Form 4797, page 1 for Thomas Smith Bankruptcy Estate Form 4797, page 2 for Thomas Smith Bankruptcy Estate Form 4562 for Thomas Smith Bankruptcy Estate Form 982 for Thomas Smith Bankruptcy Estate Capital Loss Carryover Worksheet

Partnerships and Corporations

A separate taxable estate is not created whena partnership or corporation files a bankruptcypetition. The court appointed trustee is, however,responsible for filing the regular income taxreturns on Form 1065 or Form 1120. IRC 1399; IRC 6012(b)(3); Sen Rep 96-10351980-2 CB 620, 633; IRC 6031

Partnerships

The filing requirements for a partnership inbankruptcy proceedings do not change. However,the filing of required returns becomes theresponsibility of an appointed trustee, receiver,or a debtor-in-possession rather than a generalpartner. Form 1065 instructions; IRC 6031 & 6036;U.S. Dept. of Justice, Tax Division

A partnership's debt that is canceled becauseof bankruptcy is not included in the partnership'sincome. It may or may not be included in theindividual partners' income.See Partnerships, laterunder Debt Cancellation. IRC 108 (d)(6); 703(b)(2); 1398(b)(2)

Corporations

The following discussion covers only thehighlights of the bankruptcy tax rules applying tocorporations. Because the details of corporatebankruptcy reorganizations are beyond the scope ofthis publication, you may want to seek the help ofa professional tax advisor.

SeeCorporations under DebtCancellation, for information about acorporation's debt canceled because of bankruptcy.

Tax-Free Reorganizations

The tax-free reorganization provisions of theInternal Revenue Code apply to a transfer by acorporation of all or part of its assets toanother corporation in a title 11 or similar case,but only if, under the reorganization plan, stockor securities of the corporation to which theassets are transferred are distributed ina transaction qualifying underIRC section 354, 355, or 356. IRC 368(a)(1)(G);

A title 11 or similar case, for thispurpose, is a bankruptcy case under title 11 ofthe United States Code, or a receivership,foreclosure, or similar proceeding in a federalor state court, but only if the corporation isunder the jurisdiction of the court in the caseand the transfer of assets is under a plan ofreorganization approved by the court. In areceivership, foreclosure, or similar proceedingbefore a federal or state agency involving certainfinancial institutions, the agency is treatedas a court. IRC 368(a)(3)(A), (B), and (D)

Generally, section 354provides that no gain or loss isrecognized if a corporation's stock is exchangedsolely for stock or securities in the same oranother corporation under a qualifyingreorganization plan. In this case,shareholders in the bankrupt corporation wouldrecognize no gain or loss if they exchange theirstock solely for stock or securities of thecorporation acquiring the bankrupt's assets. IRC 354

Section 355 generally provides that nogain or loss is recognized by a shareholder if acorporation distributes solely stock or securitiesof another corporation that the distributingcorporation controls immediately before thedistribution. Section 356 provides that in anexchange that would qualify under section 354or 355 except that other property or money besidesthe permitted stock or securities is received bythe shareholder, gain is recognized by theshareholder only to the extent of the money andthe fair market value of the other propertyreceived. No loss is recognized in this situation. IRC 355; 356

Filing Requirements

The filing requirements of a corporationinvolved in bankruptcy proceedings do not change.However, the filing of required returnsbecomes the responsibility of an appointedtrustee, receiver, or adebtor-in-possession, rather thana corporate officer. IRC 6012, 6036, 6037; Form 1120 andForm 1120S instructions, pg 15; U.S. Dept. ofJustice, Tax Division

Exemption from tax return filing.   If you are atrustee, receiver, or an assignee of a corporationthat is in bankruptcy, receivership,dissolution, or in the hands of an assignee bycourt order, you may apply to your IRS DistrictDirector for relief from filing federal incometax returns for the corporation. To qualify, thecorporation must have ceased business operationsand must have neither assets nor income. RR 84-123, 1984-2 CB 244

Your request to the District Director mustinclude the name, address, and employeridentification number of the corporationand a statement of the facts (withany supporting documents) showing whyyou need relief from the filing requirements. Youmust also include a statement that you are makingthe request and furnishing the information underpenalties of perjury. The District Directorwill act on your request within 90 days. RP 84-59, 1984-2 CB 504; TD 8172

Personal Holding

Company Tax

A corporation that is subject to thejurisdiction of the court in a title 11 orsimilar case is exempt from the personal holdingcompany tax, unless the main reason for beginningor continuing this case is to avoid paying thistax. A title 11 orsimilar case is defined earlierunder Tax-FreeReorganizations. IRC 542(c)(9)

Tax Procedures

The following section discusses the proceduresfor determining the amount of tax due from thedebtor or the bankruptcy estate, paying the taxclaim, and obtaining a discharge of the taxliability. P.L. 96 -589, sec. 7(e)

Determination of Tax

The first step in the determination of thetax due is filing a return. As an individualbankrupt debtor, you file a Form 1040 for thetax year involved, and the trustee of yourbankruptcy estate files a Form 1041,as explained earlierunder Individuals in Chapter 7 or11. A bankrupt corporation, or areceiver, bankruptcy trustee, or assignee havingpossession of, or holding title to, substantiallyall the property or business of the corporation,files a Form 1120 for the tax year. IRC 6012(b)(3)&(4)

After the return is filed, the Internal RevenueService may redetermine the tax liability shown onthe return. When the administrative remedieswithin the Service have been exhausted, the taxissue may be litigated either in the bankruptcycourt or in the U.S. Tax Court, as explainedin the following discussion.

Request for prompt determination of taxliability by the trustee.   The trustee of the bankruptcy estate mayrequest a determination of any unpaid liabilityof the estate for tax incurred during theadministration of the case by the filing of a taxreturn and a request for such a determination withthe Internal Revenue Service. Unless the return isfraudulent or contains a materialmisrepresentation, the trustee, the debtor, andany successor to the debtor are discharged fromliability for the tax upon payment of the tax:

1. As determined by the Internal RevenueService,
2. As determined by the bankruptcy court, afterthe completion of the IRS examination, or
3. As shown on the return, if the IRSdoes not:
   1. Notify the trustee within 60 daysafter the request for the determinationthat the return has been selected forexamination, or
   2. Complete the examination and notifythe trustee of any tax due within 180days after the request (or anyadditional time permitted by thebankruptcy court).

11 USC 505(b)

Making the request for determination.   To request a prompt determination of any unpaidtax liability of the estate, the trustee must filea written application for the determination withthe IRS District Director for the district inwhich the bankruptcy case is pending. Theapplication must be submitted in duplicate andexecuted under the penalties of perjury. Thetrustee must submit with the application anexact copy of the return (or returns) filed bythe trustee with the IRS for acompleted tax period, and a statement of thename and location of the office where the returnwas filed. On the envelope writePersonal Attention of the Special ProceduresFunction. DO NOT OPEN IN MAILROOM.

The IRS examination function will notify thetrustee within 60 days from receipt of theapplication whether the return filed by thetrustee has been selected for examination or hasbeen accepted as filed. If the return isselected for examination, it will be examined assoon as possible. The examination function willnotify the trustee of any tax due within 180 daysfrom receipt of the application or within anyadditional time permitted by the bankruptcy court. Rev. Proc. 81-17

Bankruptcy court jurisdiction.   Generally, thebankruptcy court has authority to determine theamount or legality of any tax imposed on thedebtor or the estate, including any fine, penalty,or addition to tax, whether or not the tax waspreviously assessed or paid. 11 USC 505(a)(1)

The bankruptcy court does not haveauthority   to determine the amount or legality of a tax,fine, penalty, or addition to tax that wascontested before and finally decided by a court oradministrative tribunal of competent jurisdiction(that became res judicata) before thedate of filing the bankruptcy petition. 11 USC 505(a)(2) (A)

Also, the bankruptcy court does not haveauthority to decide the right of the bankruptcyestate to a tax refund until the trustee of theestate properly requests the refund from theInternal Revenue Service and either the Servicedetermines the refund or 120 days pass after thedate of the request. 11 USC 505(a)(2)(B)

If you (the debtor) have already claimed arefund or credit for an overpayment of tax on aproperly filed return or claim for refund, thetrustee may rely on that claim. Otherwise, if thecredit or refund was not claimed by you, thetrustee may make the request by filing theappropriate original or amended return or formwith the District Director for the district inwhich the bankruptcy case is pending. On thereturn or claim for refund writePersonal Attention of the SpecialProcedures Function. DO NOT OPEN INMAILROOM.

The appropriate form for the trustee to use inmaking the claim for refund is as follows:

1. For income taxes for which anindividual debtor had filed a Form 1040,Form 1040A, or Form 1040EZ, the trusteeshould use a Form 1040X, AmendedU.S. Individual Income Tax Return.
2. For income taxes for which a corporate debtorhad filed a Form 1120, the trusteeshould use a Form 1120X, AmendedU.S. Corporation Income Tax Return.
3. For income taxes for which a debtor had fileda form other than Form 1040, Form1040A, Form 1040EZ, or Form 1120, thetrustee should use the same type of form thatthe debtor had originally filed, and writeAmended Return at the top of the form.
4. For taxes other than certain excise taxesor income taxes for whichthe debtor had filed a return, the trusteeshould usea Form 843, Claim for Refund andRequest for Abatement, attaching anexact copy of any return that is thesubject of the claim along with a statementof the name and location of the officewhere the return was filed.
5. For excise taxes you reported on Forms720, 730, or 2290, the trustee should useForm 8849, Claim for Refund of ExciseTaxes or Schedule C of Form 720, whicheveris appropriate.
6. For overpayment of taxes of the bankruptcyestate incurred during the administration ofthe case, the trustee may choose to use aproperly executed tax return (for incometaxes, a Form 1041) as a claim forrefund or credit.

The IRS examination function,if requested by the trustee ordebtor-in-possessionas discussed later, will examine theappropriate amended return, claim, or originalreturn filed by the trustee on an expedite basis,and will complete the examination and notify thetrustee of its decision within 120 days from thedate of filing of the claim. Rev. Proc. 81-18

Tax Court jurisdiction.   The filing of abankruptcy petition automatically results in astay (suspension) of any U.S. Tax Court proceedingto determine your tax liability as the debtor.This stay continues until one of the acts removingit occurs. The stay may be lifted by thebankruptcy court upon your request, the request ofthe IRS, or the request of any other party ininterest. Because the bankruptcy court has powerto lift the stay and allow you to begin orcontinue a Tax Court case involving your taxliability, the bankruptcy court has, in effect,during the pendency of the stay, the soleauthority to determine whether the tax issueis decided in the bankruptcy court itself or inthe Tax Court. 11 USC 362(a)(8), (c), and (d);Sen. Rep. 96-1035

Suspension of time for filing.   In anybankruptcy case, the 90-day period for filing aTax Court petition, after the issuance of thestatutory notice of deficiency, is suspended forthe time you are prevented from filing thepetition because of the bankruptcy case, and for60 days thereafter. However, even if the statutorynotice was issued before the bankruptcy petitionwas filed, the suspension exists if any part ofthe 90-day period remained at the date thebankruptcy petition was filed. IRC 6213(f)(1)

Trustee may intervene.   The trustee of yourbankruptcy estate in any title 11 bankruptcy casemay intervene, on behalf of the estate, in anyproceeding in the U.S. Tax Court to which you area party. IRC 7464

Tax assessment.   Generally, the automatic stay rules preventa creditor from taking actions to collect prepetitiondebts. However, the automatic stay does not apply to:

1. An audit to determine tax liability,
2. A demand for tax returns,
3. The issuance of a notice of deficiency to thedebtor, or
4. The making of an assessment for any tax and thesending of a notice and demand for payment of thetax assessed (for bankruptcy cases filed afterOctober 22, 1994).

IRC 6213(f); 11 USC 362

Any tax lien that attaches to the estate's propertybecause of an assessment describedabove can only take effect when the property (or itsproceeds) are transferred back to the debtor.Also, the tax must be the debtor's debtthat will not be discharged in the case.

Disclosure of return information.   In bankruptcy cases other than those ofindividuals filing under chapter 7 or 11, and inreceivership proceedings where substantially allthe debtor's property is in the hands of thereceiver, current and earlier returns of thedebtor are, upon written request, open toinspection by or disclosure to the trustee orreceiver, but only if the Internal RevenueService finds that the trustee or receiver has amaterial interest which will be affected byinformation on the return. IRC 6103(c)(4)

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