Here’s a question posed on Avvo.com:

I was granted a chapter 7 bankruptcy in April what tax ramifications can I expect in IL? I want to know if I will have to pay taxes on the discharged amount? Also I just got a deed in lieu an the bank is forgiving the discrepancy. Will I have to pay taxes on that? Thanks for your answers.

My answer:

If you are asking whether you have to pay income taxes on debt being discharged in bankruptcy, the answer is generally no. But, your situation is a bit more complicated than that. You had debt forgiven by a bank while giving up your house. You might owe taxes depending on all of the facts. If the debt was forgiven, it is a question of which tax year it was forgiven in, and whether you were “insolvent” at that time. You should definitely speak to an accountant about this. You may want to consult with your bankruptcy attorney as well.

You can be taxed on forgiven debt. But, you have a defense called the “insolvency defense”. This defense can be raised in your income tax return by your accountant. If you filed for bankruptcy, you are generally not liable for taxes on debts that are eliminated by the bankruptcy. However, everyone’s situation is different.

Daniel J. Winter
BankruptcyLawChicago.com
312-789-9999
Offices in Chicago, Gurnee, Oak Lawn, and Skokie, Illinois