When you file an assignment in bankruptcy, you are dealing with your debts as of that date. Debts owing as of the date of bankruptcy, including tax debts, are included in your bankruptcy. Similarly assets you own as of the date of filing are to be realized on by the trustee. Those assets include any income tax refund(s) in the year you file for bankruptcy.
Practically, this has an impact on how your income tax returns are filed when you claim bankruptcy. While every trustee has their own policies, the following is a common approach.
Why Two Tax Returns in a Bankruptcy
When you file for bankruptcy, there will be a need to file two tax returns in one year. This is because an assignment in bankruptcy is the end of a period for both assets and liabilities. A tax return will be filed to the day before you filed bankruptcy. A second tax return, covering the remainder of the year is also filed.
This first return is often called the pre-bankruptcy return, and the second return the post-bankruptcy return.
So if you file on July 15, there will be one tax return filed for the period January 1 to July 14, and another for the period July 15 to December 31.
Who Files the Tax Returns?
Because tax refunds in the year of bankruptcy are an asset in your estate, practically most trustees will prepare and file your pre- and post- bankruptcy returns. You will be required to forward the required information to the trustee to prepare this tax return, including income and deduction information, on a timely basis.
Occasionally a bankrupt may have unfiled tax returns dating back several years. Most trustees will require that you file any old outstanding tax returns before your declare bankruptcy unless they expect there will be a refund they are required by law to collect.
Tax returns after the year of filing are your responsibility.
Your Tax Refunds
What this means is that any tax refund in the year you file for bankruptcy (both for the pre- and post-bankruptcy return) are turned over to your trustee. This is required under the Bankruptcy & Insolvency Act and not something your trustee can choose to do or not.
Any taxes owing on your post-bankruptcy return are your responsibility to pay, as these are not debts included as of the date of your bankruptcy (since they occurred after you filed bankruptcy).
Any debts owing on returns for years after the year you file bankruptcy are also your responsibility and any refunds due are yours to keep.
If you are expecting a large tax refund, there are options your trustee can present to you. This can include filing a consumer proposal because in a proposal you keep all your assets including a tax refund.
As this can get quite complicated, we recommend you talk to a Licensed Insolvency Trustee in Toronto.
When you come in for a free consultation at Hoyes Michalos, we will explain all aspects of what you should know regarding your tax refund and filing your income tax returns.