Short Tax Year Election In Bankruptcy Can Save The Day

by Kent Anderson, Esq.

July 25, 2008

Federal tax law allows an individual debtor in bankruptcy to cut off their tax year as of the date before filing a Chapter 7 or Chapter 11 bankruptcy if there are assets in the bankruptcy estate. As I discussed in a prior article, the election, allowed by 11 USC ยง1398, must be made by the 15th day of the fourth month after the month in which the bankruptcy petition is filed. This election permits the debtor in an asset case to “capture” the pre-petition tax debt in a new pre-petition year.

Without the election, the tax due will be part of a post-petition tax year and the debt will not be paid from assets of the bankruptcy estate. The debtor’s assets are transferred to the bankruptcy trustee but any accrued tax liability stays behind with the debtor. The result can be tax liability with no money to pay it.

The short year election can not be used by a business entity. However, a non-filing spouse and join in the election and share the benefits. Once the election is made, it is irrevocable. The effect is to create two tax years out of the year in which the bankruptcy is filed. The first year ends the day before the filing and the second year begins the day the bankruptcy case is filed.

Due to the way assets and tax attributes of the debtor are transferred to a bankruptcy trustee, a short year election can save the debtor from unnecessary tax liability if it is used in an appropriate circumstance.

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I was admitted to practice in 1978. I am certified as a Consumer Bankruptcy Specialist by the American Board of Certification. I regularly speak on tax and bankruptcy issues at state, regional and national conferences. Years of experience in practice before the Internal Revenue Service and Oregon Department of Revenue have given me the background to resolve a large variety of consumer tax issues.

Last modified: February 23, 2013