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Understanding the tax effects of personal bankruptcy

Nowadays with the sluggish economy, high unemployment, and stagnant wages, many individuals find themselves facing financial challenges. When one loses his job, has his income cut, or faces health problems, paying off debt can become difficult or, in many cases, impossible. Fortunately, these individuals may be able to find debt relief through bankruptcy. Yet, deciding whether to file bankruptcy or not, and if so what type of bankruptcy, may require a close analysis of how the bankruptcy will affect the filer's taxes.

Filing for bankruptcy may affect an individual's tax issues in many ways. The first thing to realize is that filing for bankruptcy will not stop an audit if one is already under way. Also, the statute of limitations is extended for the length of the bankruptcy proceeding, meaning that tax collection times may be extended.

Second, not all tax debt is dischargeable through bankruptcy. Student loans, child support obligations, and fines stemming from certain crimes are not dischargeable. These debts must instead be paid back through a Chapter 13 filing, which reorganizes debt into manageable payments. Though this may not be the liquidation of debt many seek, this reorganization of debt can provide debt relief and help individuals reach a fresh financial start.

Lastly, tax debt can only be discharged through bankruptcy if they stem from personal income and are at least three years old. Additionally, forgiveness of debt is sometimes considered taxable income, which should be taken into consideration before filing for bankruptcy.

Though filing for bankruptcy may have some adverse tax consequences, the liquidation and reorganization of debt may still leave an individual in a better financial position. Also, bankruptcy will seek to stop creditor harassment and reduce debt in a way that will give the filer hope that a brighter financial future is ahead of her.

Source: Fox Business, "How Bankruptcy Impacts Your Taxes," Bonnie Lee, July 25, 2013