Can I Deduct Trustee Payments on My Bankruptcy?

by Fraser Sherman

In Chapter 13 bankruptcy, you spend three or five years paying back your creditors out of your disposable income. Instead of paying them directly, you write a check to the court-appointed trustee administering your case. The trustee then distributes the payment among your creditors. You don't get any special tax break for the payments, but you can claim any deductions you'd normally be entitled to.

Your House

Chapter 13 treats your mortgage as a priority debt you have to pay to keep your house. If you claim the mortgage interest deduction on your property, you can still claim it during bankruptcy even though the trustee actually sends the money to your lender. If you're paying off back property taxes as part of the payment plan, you can deduct them too. The interest on any home equity loans or lines of credit you took out may be a legitimate deduction, but the IRS still limits the amount you can claim.

Other Expenses

If you're spending money on deductible expenses outside the bankruptcy plan, you can keep on deducting them. If you run a sole proprietorship, for example, you can write off business expenses from your business income, just as if you weren't in bankruptcy. If you're paying off business expenses through your trustee payments, you can claim deductions that way too. The same is true for other expenses: If your medical expenses qualify for a deduction, you can write off current ones as well as back bills your trustee pays off.

Debt Forgiveness

The federal government usually treats debt forgiveness as income; if a lender writes off a $500 debt, you pay income tax on it. Bankruptcy is an exception. You don't pay tax on debts you wipe out in bankruptcy. If those debts are deductible, however, you can't deduct the part that's wiped out. For example, if you have $10,000 in deductible medical debts, pay $4,000 of them in Chapter 13 and wipe out $6,000, you can only write off $4,000.

Payments

Outside bankruptcy, you may be able to prioritize debt payments that generate a nice tax deduction. When your trustee writes the checks, that's not an option. The top priorities are debts such as spousal support, back taxes and child support that you have to pay in full. Then come debts secured by collateral, such as your mortgage or your car loan. The trustee distributes the rest of your payments equally among your unsecured creditors. You might prefer to pay off a tax-deductible expense before your credit card bill, but that's not an option.

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About the Author

A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.

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