CBS CBS Tax Implications of Bankruptcy 2 — Questions and Answers
Question 1: What is 'cancellation of debt' (COD) income and how does bankruptcy affect it?
- Income recognized when a debt is forgiven; bankruptcy provides an exclusion from gross income under IRC Section 108 (Correct answer)
- A penalty the IRS assesses for filing bankruptcy
- Income generated by selling assets during the bankruptcy process
- A tax credit given to debtors who successfully discharge debt
Correct answer: Income recognized when a debt is forgiven; bankruptcy provides an exclusion from gross income under IRC Section 108
COD income arises when a creditor cancels a debt, which the IRS treats as taxable income; however, IRC Section 108(a)(1)(A) excludes COD income from gross income when the discharge occurs in a Title 11 bankruptcy case.
Question 2: A debtor files Chapter 7 and owes income taxes from 5 years ago — the return was filed on time and the IRS assessed the tax 3 years ago. No fraud was involved. Are these taxes potentially dischargeable?
- Yes, because the 3-year, 240-day, and no-fraud requirements are all satisfied (Correct answer)
- No, because income taxes owed to the federal government are always non-dischargeable
- No, because the assessment must occur more than 5 years before filing
- Yes, but only if the debtor also completes a tax repayment plan first
Correct answer: Yes, because the 3-year, 240-day, and no-fraud requirements are all satisfied
Income taxes may be discharged in bankruptcy when (1) the return was due more than 3 years ago, (2) the IRS assessed the tax more than 240 days ago, and (3) the return was not fraudulent — all three are satisfied here.
Question 3: What is the 'two-year rule' for income tax debt dischargeability in bankruptcy?
- The debtor must have actually filed the tax return at least 2 years before the bankruptcy petition date (Correct answer)
- The tax debt must be at least 2 years old to qualify for discharge
- The IRS can only collect for 2 years after a bankruptcy discharge is granted
- The debtor must wait 2 years between successive bankruptcy filings to discharge tax debts
Correct answer: The debtor must have actually filed the tax return at least 2 years before the bankruptcy petition date
Under 11 U.S.C. § 523(a)(1)(B)(ii), taxes are non-dischargeable if the return was filed less than 2 years before the bankruptcy petition, regardless of when the taxes were due.
Question 4: How does the automatic stay affect IRS tax collection activities after a bankruptcy filing?
- The automatic stay temporarily halts most IRS collection actions including levies, garnishments, and property seizures (Correct answer)
- The automatic stay has no effect on any IRS collection activities
- The automatic stay permanently and irrevocably prevents the IRS from collecting taxes
- The automatic stay only limits state tax collection but not federal IRS actions
Correct answer: The automatic stay temporarily halts most IRS collection actions including levies, garnishments, and property seizures
The automatic stay under 11 U.S.C. § 362 generally halts IRS collection activities, though the IRS may seek relief from the stay or continue certain permitted actions such as tax audits and assessments.
Question 5: Which bankruptcy chapter allows a debtor to repay non-dischargeable priority tax debts in a structured plan without ongoing interest penalties?
- Chapter 13 (Correct answer)
- Chapter 7
- Chapter 11
- Chapter 12
Correct answer: Chapter 13
Chapter 13 allows individuals with regular income to repay non-dischargeable priority tax debts over a 3-to-5-year plan, often halting penalty accrual and providing an organized repayment structure.
Question 6: What IRS form does a creditor use to report a cancelled debt to both the IRS and the debtor?
- Form 1099-C (Cancellation of Debt) (Correct answer)
- Form W-2 (Wage and Tax Statement)
- Form 1099-B (Proceeds from Broker Transactions)
- Form 982 (Reduction of Tax Attributes)
Correct answer: Form 1099-C (Cancellation of Debt)
Creditors must issue Form 1099-C to the debtor and the IRS when $600 or more of debt is cancelled, reporting the amount of forgiven debt.
CBS CBS Tax Implications of Bankruptcy 2
What is 'cancellation of debt' (COD) income and how does bankruptcy affect it?