Minnesota Bankruptcy Estate: Bankruptcy Estates and Taxes

Bankruptcy Estate Tax

Bankruptcy proceedings begin with the filing of a petition with the bankruptcy court.

Creation of the Bankruptcy Estate, a Taxable Entity

The filing of the petitions creates a bankruptcy estate. If the debtor is an individual who files for bankruptcy under chapter 7 or 11, the bankruptcy estate is treated as a new taxable entity, separate from the individual taxpayer.

Tax Obligations of the Debtor

The tax obligations of the person filing a bankruptcy petition (the debtor) vary depending on the bankruptcy chapter under which the petition was filed.

Generally, when a debt owed to another is canceled the amount canceled or forgiven is considered income that is taxed to the person owing the debt. If a debt is canceled under a bankruptcy proceeding, the amount canceled is not income. However, the canceled debt reduces the amount of other tax benefits the debtor would otherwise be entitled to.

The Chapter 7 Bankruptcy Trustee and Estate

The estate in a chapter 7 case is represented by a trustee. The trustee is appointed under the Bankruptcy Code to administer the estate and liquidate any nonexempt assets of the estate.

Exempt assets are determined in Minnesota by one of two set lists of exempt assets: the federal list, or the Minnesota list. There will be overlap in the two lists. Not everyone will qualify to use either list, but many Minnesotans will qualify to choose which list they wish to use to determine which assets that they own are exempt from liquidation.

The federal list of exemptions include:

  • some home equity, up to a certain value;
  • some household goods and appliances, up to a certain value;
  • some interest in a vehicle, up to a certain value;
  • some jewelry, up to a certain value; and
  • some benefits such as disability, social security, child support, alimony, some pension benefits.

There are several other exemptions in the federal list. Of importance, the federal list also contains a catch-all provision for other assets up to a certain value, unlike the Minnesota list.

The Minnesota list of exemptions includes:

  • all clothing;
  • some household goods and appliances, up to a certain value;
  • a vehicle, up to a certain value;
  • a home, up to a certain value; and
  • certain benefits.

There are several other exemptions in the Minnesota list as well. However, there is no catch-all provision in the Minnesota list.

Tax Forms

When a chapter 7 bankruptcy case is filed, the debtor, when filing taxes, will file Form 1040.

The bankruptcy trustee will also file a tax form, titled Form 1041. The bankruptcy trustee files this form on behalf of the bankruptcy estate, this new taxable entity that was created when the bankruptcy was filed.

If a husband and wife file a joint bankruptcy petition and their bankruptcy estates are jointly administered, their estates must be treated as two separate entities for tax purposes. Two separate tax returns must be filed (if they separately meet the filing requirements).