Tax Returns & A Non-Filing Spouse In Bankruptcy

Tax returns are one of the biggest sources of revenue for trustees in the typical Chapter 7 bankruptcy or Chapter thirteen bankruptcy. Having said that, when a married debtor files bankruptcy without their spouse, the non-filing spouse’s share of the tax return could become a source of contention. Let’s take a look at some of the facts regarding a non-filing spouse’s return.

Non-Filing Spouse Is Not An Obligated Party

The most important fact regarding a non-filing spouse is that he/she’s not obligated to turn over their separate assets to the bankruptcy estate, and that includes tax returns. The debtor who filed bankruptcy is the only party who has an obligation to pay creditors and place their assets with the bankruptcy estate.

Separate Tax Returns

If the married couple filed separate tax returns then there’s no problem. The bankruptcy estate simply takes the filing spouse’s return while the other spouse is allowed to hold onto their return with no dispute.

Joint Tax Returns

One other interesting idea regarding this area of interest. The problem arises when married debtors file joint tax returns and then one of them files bankruptcy. Because a debtor’s return is part of the bankruptcy estate, the debtor, attorney and trustee must agree on what portion of the return belongs to the bankruptcy debtor and thus the bankruptcy estate. This is where most disagreements occur.

The 50/50 Rule

Some bankruptcy trustees may apply a 50/50 rule to the joint tax return. The 50/50 rule simply allows the bankruptcy estate to take fifty percent of the return. But nevertheless, this only works when all parties agree, including the non-filing spouse. Sometimes the bankruptcy trustee may balk at the 50/50 rule if he/she believes they can seize a larger share by another legitimate method. Remember, it’s the goal of the bankruptcy trustee to use as many of the debtor’s assets as possible to pay creditors so they’ve an incentive to haggle over the return.

An Equitable Not Equal Division

If the bankruptcy trustee believes that the spouse that’s filing contributed the lion’s share of tax payments, then he/she may want to calculate the exact amount. For example, if the husband files and earned the most income and paid a disproportionate amount of the tax withholdings, while his non-filing wife stayed at home and/or worked part-time, it might not be fair to apply a 50/50 formula to the return. The bankruptcy trustee may ask that the joint return is recalculated as 2 separate returns to figure out exactly how much the filing debtor would receive.

Unfortunately, there is no method which is used by all bankruptcy trustees; but the underlying principal is the same — while the non-filing spouse is not obligated to contribute their return to the bankruptcy estate, the bankruptcy estate is entitled to the filing spouse’s share of the return. The way in which that the filing spouse’s tax return is calculated might change depending on the circumstances of the bankruptcy case.

Reed Allmand, sponsoring attorney for Bankruptcy.net, is constantly looking for ways to provide the best financial information for his clients. Whether you’re considering filing for bankruptcy, or are currently going through a Chapter 7 or Chapter 13, visit http://www.bankruptcy.net for up to date news and information you need to know.