In 2005, the Bankruptcy Abuse Prevention and Consumer Protection Act not only made filing for bankruptcy more difficult, but it also increased associated costs. In addition, people who seek legal advice and assistance instead of filing pro se usually pay attorney fees as an upfront expense. Although the Internal Revenue Code does not allow for deducting most of your costs, you may qualify for one type of deduction the Internal Revenue Service allows.
Personal vs. Tax-related Expenses
You cannot deduct bankruptcy expenses that the IRS considers personal expenses for either a Chapter 7 or Chapter 13 bankruptcy on your personal tax return. This includes filing fees, credit counseling, trustee fees and most attorney expenses. However, IRS regulations allow you to deduct legal fees and accounting expenses that relate to tax issues or income tax preparation. For example, you can deduct legal fees assessed for the time your attorney spends giving you tax advice or communicating with the IRS about any tax issues you may have. You can also deduct income tax preparation costs while you are in a bankruptcy proceeding.
The Bankruptcy Estate
When you file for bankruptcy, most of the property you own at filing time goes into a bankruptcy estate. A Chapter 7 bankruptcy treats a bankruptcy estate as a separate entity, and the trustee appointed to administer the estate must file a separate estate tax return. In this case, legal fees incurred by the trustee in administering the bankruptcy estate, such as legal fees for recovering assets, are tax deductible on the estate’s tax return.
Read More: Stages of Bankruptcy
Debt Forgiveness Deduction
Under normal circumstances, you must report and pay income tax on any debt or part of a debt that a creditor forgives. Although it's not technically a tax deduction, when forgiven debts pertain to a bankruptcy, you do not have to report the forgiven amount on your individual income tax return. For example, if a creditor forgives $2,000 of a $4,000 debt, you will not have to report the $2,000 the creditor forgave as income.
Filing Requirements
To claim any deductions for which you are eligible, you must file IRS Form 1040 and itemize deductions. Report any allowable deductions as miscellaneous expenses on Schedule A of your individual income tax return. However, the total of all miscellaneous deductions, which can include other expenses besides those relating to your bankruptcy, must equal at least 2 percent of your adjusted gross income for you to claim them. If your miscellaneous deductions are below the 2 percent minimum, you can’t claim these expenses.