Income Tax on Your Bankruptcy Estate

The effect of Income Tax on one's bankruptcy estate unfortunately is a least considered factor on the businesses after the creditors have effectively taken control of a business that has filed protection under such an Act. A situation closer or to actual bankruptcy would arise when a business entity, whether it is a sole proctorship, partnership or corporate, starts to continuously default on its payments to both secured and unsecured creditors. Intricate income tax consequences would come into play in any bankruptcy proceedings other than the liquidation proceedings. However, this article would discuss only the implication under voluntary petition by a debtor that is covered under voluntary liquidation proceedings which has implications to all types of entities.

The Estate of the Bankrupt

When a petition is filed by a debtor, the court orders the appointment of a receiver with whom the prosperities of the debtor would vest; under law, the new entity is designated as the 'estate of the bankrupt'; but the moot question whether this new entity acquires the legal liability for filing of the income tax returns. From a careful reading of the Treasury Regulations, it becomes clear the answer to this question is a ‘no’, for it states that ' The estate .... of an individual or corporation in receivership or a corporation in bankruptcy is not a taxable entity separate from the person for whom the fiduciary is acting'. This has the implication that a mere appointment of a receiver does not create a new taxable entity of the estate of the property administered by any of them.

Conclusion

The Courts in the USA has also concurred with the Regulations of the Treasury in more than one case. These rulings have two implications. The first there is no separate tax entity for the bankruptcy estate created and secondly during the course of bankruptcy proceedings under various Chapters, the federal tax lien does not operate to divest the debtor because the title and ownership still rests with the debtor. It is of critical importance to note that even in a case that is not covered under the Bankruptcy Act, but has relevance only to the foreclosing of a Federal Tax lien, in the case Heasly, 45 T.C, 448 (1966) the court without dissent had held that a receiver appointed for all the property of the debtor taxpayer was not obligated to file a separate return for the real estate of the debtor.

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