Bankruptcy & Taxes in Illinois
Bankruptcy laws in any state can be complex and difficult to understand. Debtors who manage to maneuver smoothly through their bankruptcy cases have likely spent weeks or months preparing before filing for bankruptcy protection, often with the help of an experienced bankruptcy attorney. Whether you file Chapter 7 or Chapter 13 bankruptcy, your taxes in Illinois are affected. Generally, discharged, or eliminated, debts are not included as taxable income, but you may lose tax benefits to which you would otherwise be entitled.
Bankruptcy Overview
Taxes owed are a primary reason many debtors file for bankruptcy protection. When you file for bankruptcy protection, a bankruptcy estate is created, into which all your assets are placed and may be used to pay your debts. Bankruptcy filing fees in Illinois are $299 for Chapter 7 and $274 for Chapter 13. The bankruptcy estate is managed by a court-appointed trustee. When your bankruptcy case is completed, any assets left in the bankruptcy estate are returned to you.
Tax Returns
With Chapter 7 bankruptcy, your bankruptcy estate is treated by the IRS as a distinct taxable entity, separate from you. You are required to file a Form 1040 for the tax year in which you file for bankruptcy and the trustee must file a Form 1041 on behalf of the bankruptcy estate. The bankruptcy estate is not treated separately under Chapter 13, and you must continue to file the same federal tax returns you filed before bankruptcy. Generally, you will not owe income taxes for debts discharged in bankruptcy, but you may owe taxes in Illinois if the taxes owed are payroll taxes, trust fund taxes or debt incurred from fraud penalties.
Back Taxes
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 provides that any back taxes you owe, whether due to non-filed or late-filed tax returns, cannot be discharged in bankruptcy. When you file for bankruptcy, taxes in Illinois and all other states are a priority of the bankruptcy estate. Back taxes get paid from the bankruptcy estate (Chapter 7) or must be included in the three- to five-year repayment plan (Chapter 13). The IRS holds a priority spot in the lineup of creditors waiting to be paid, behind only domestic support obligations and trustee administrative expenses.
Tax Claims
Once you file for bankruptcy in the state of Illinois, an automatic stay goes into effect, obliging your creditors, including the IRS, to cease collection actions, and any legal proceedings against you are put on hold. Generally, the IRS cannot seize your assets for payment of taxes owed within the three years of your bankruptcy filing date, while your assets continue to be under the protection of the bankruptcy court. However, if the IRS has filed its proof of claim, payment can be collected from the bankruptcy estate.
Illinois Exemptions
Certain real or personal property can be exempted (excluded) from bankruptcy proceedings in accordance with Illinois state bankruptcy laws. Personal property such as clothing, school supplies and books, Bibles and family pictures are all exempt items. A vehicle up to a value of $1,200 is also exempt, as are health and disability benefits and up to $7,500 of any real property and buildings attached to the property.
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