Two Tax Years For the Price of One

17 Jul Two Tax Years For the Price of One

Sometimes one tax year in a 12 month period is just not enough! Think of all the fun that could be had if there were two tax years in 365 days. When it comes to bankruptcy, Congress agreed with that principal. An individual is allowed to split the tax year into two short years in certain types of bankruptcy proceedings. Internal Revenue Code Section 1398 permits a natural person to elect the creation of an extra tax year when either a Chapter 7 or Chapter 11 case has been filed.

Because a new tax entity is created when a bankruptcy is filed under either Chapters 7 or 11, and because the bankruptcy estate inherits the tax attributes (Net Operating Loss, Basis in property, etc.) of the debtor as of the first day of the tax year in which the bankruptcy is filed, it is often handy to make the available election to fracture the tax law and start a new one as of the date the bankruptcy is filed. This allows the debtor to use existing tax attributes to offset income realized in the time between the end of the debtor’s prior tax year and the date of the bankruptcy filing.

The election must be made in writing on or before the date the return for the short year is due, the 15th day of the fourth month following the date of filing. Once the election has been made, it is irrevocable. When the election has been made, the pre-bankruptcy tax year ends on the day before the bankruptcy was filed and a new tax year begins on the date of filing. The election splits the 12 month tax year of the debtor into two short years. A tax return is then required for each separate year.

A “short year election” under 26 USC§1398 is only available when the bankruptcy estate has assets that can be liquidated and distributed to creditors. It can only be exercised by a debtor who is natural person. IRC §1399 limits the election of a split tax year to bankruptcy cases in Chapter 7 or Chapter 11, the two bankruptcy chapters in which the bankruptcy estate becomes a separate entity. Regardless of the limitations, this election is a useful tool not to be overlooked when a bankruptcy has been filed.

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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.
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