• Navigating the waters of a bankruptcy is fraught with psychological as well as financial consequences, but little thought is given by most filers to the possible tax consequences of discharging a significant amount of debt. In some cases, that discharge can be considered taxable income. The rules are complex and everyone's situation is different, so if your bankruptcy attorney is unsure about the tax consequences of your individual filing, you should check with a CPA who knows the current rules and regulations.
  
  

Filing Your Return

• Under no circumstances is a bankruptcy filing a reason for not filing your yearly income tax return. If you are in the middle of bankruptcy proceedings at the time the return is due, you must file the return or request an extension. If no return or extension is filed, the IRS may order the court to either dismiss the proceeding or convert it to another chapter of the bankruptcy code. At the time the notice is given, if you allow an additional 90 days to pass without filing a return or extension, the court must dismiss or convert the case.
  
  

Debt Cancellation as Income

• When a debt is forgiven, the amount of the debt in some cases must be declared as income. This includes some unsecured debt and any debt owed on property that you own and retain. If the amount is more than $600, the agency holding the debt is required by the IRS to furnish you with a Form 1099-C to file with your income tax return. The rules concerning the income reporting requirement are complex and your situation is unique to you. It is quite possible to exit bankruptcy without having to report any of the discharged debt as income. Your bankruptcy attorney and/or CPA can help you figure out where you stand. IRS Publication 908 provides an overview of the current rules, while IRS Publication 525 details the exceptions to the statement of income.
  
  

Exceptions and Exclusions

• If the debt was an amount that would have qualified as a deduction on your return if it had been paid, it is excluded from the income reporting requirement. Student loan forgiveness in some cases is also excluded, though it can be very difficult to get student loan debt discharged in bankruptcy to begin with. In a bit of irony, the canceled debt is excluded from the income reporting requirement if you were insolvent at the time the debt was discharged -- if the amount of your insolvency was greater than the amount discharged. The qualified principal residence exclusion applies to all Chapter 11 cases.