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The Benefits of a Short Tax Year Election to a Bankruptcy Filing

The last thing people who are considering filing bankruptcy in New York are probably interested in is filing two tax returns in one year.  Yet it is not only possible but also worthwhile to do in certain circumstances.

First, what are we talking about? Federal law allows individual debtors (i.e. non-businesses) in chapter 7 or 11 bankruptcy to split their tax years into two in a process called the “short tax year election,” which is discussed in 26 USC § 1398(d)(2) of the internal revenue code. For most New York debtors, the election is only available to those who have assets that the trustee can liquidate in the bankruptcy estate. No bankruptcy assets means no short tax year election.

How does it work? The law authorizes debtors to split their tax years between the day before they filed their petitions and the day of the filings. Spouses may join debtors if they file a joint income-tax return for the pre-petition tax year. The election is irrevocable

What does it do? Splitting the tax year into two parts creates a tax debt that is placed into the bankruptcy estate and receives a distribution from the estate’s assets before other creditors’ claims. Because income tax debts would otherwise come into being on the following January 1st (payable on April 15), without the election the tax would be a post-petition obligation the debtor would pay after the other creditors’ have received their distributions from the bankruptcy estate.

Why make the election? There are circumstances when debtors benefit from paying a tax debt out of the estate rather than waiting to pay it by April 15 of the next year. For example, it’s worthwhile to pay a certain, priority debt out of assets that are going to be liquidated anyway. In a sense, the short tax year election directs proceeds from the bankruptcy estate’s assets away from other creditors and sends them to the federal government for a future debt that in any case will have to be paid. In another example, there are times when debtors have tax credits of some kind that are worth spending now, that otherwise would  pass to the bankruptcy estate for the trustee to use.

For some debtors who have assets, it’s sometimes worth the effort to make a short tax year election, but it usually requires the guidance of an experienced New York bankruptcy lawyer to make it work.

For answers to more questions about short tax year elections, bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced bankruptcy attorney Brooklyn NY Bruce Weiner for a free initial consultation.

Rosenberg, Musso & Weiner, L.L.P
26 Court St # 2211
Brooklyn, NY 11242, USA

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