Marital Deduction For Married Debtors Filing Individual Bankruptcy


While the bankruptcy law allows married couples to file joint bankruptcies, this is not a requirement.  A married person may also file an individual bankruptcy, and as a bankruptcy attorney  I see some cases when this is advisable.

One advantage to the individual bankruptcy is that the filing spouse might be able to lower the required payments under a Chapter 13 bankruptcy or even qualify for a Chapter 7 bankruptcy, because the other spouse is retaining his or her debts.

What usually determines the size of a debtor’s payments in a Chapter 13 plan is the “bankruptcy means test.”   This calculation is done on a household basis regardless of whether both spouses are filing.  The test takes the average monthly income for the household and subtracts out the expenses, which the bankruptcy law allows, to determine how much a debtor has available  to pay each month toward his or her debts under a Chapter 13 Bankruptcy plan.  If the available income is low enough, the debtor will qualify for a Chapter 7 Bankruptcy, which requires no monthly payments.

In the case of the married debtor filing alone the means test also includes the so called marital deduction.  This is the amount that the non filing spouse will be required to pay toward his or her debts during the next five years.  While this amount might be discharged, if the spouse joined in the bankruptcy, by opting out these debts remain a necessary household expense with the result that the individual payment toward a bankruptcy plan can be significantly smaller than a joint payment would be.

Net Operating Losses And Bankruptcy

As a bankruptcy lawyer  I often encounter people who need to file bankruptcy, because of losses incurred in the operation of a business.  Since the Internal Revenue Code allows taxpayers, whose business expenses exceed their business income, to carry unused losses backwards and forwards as deductions in other tax years, one might wonder if it is possible to discharge one’s debts in bankruptcy and then take advantage of the tax deductions for the losses that drove one to bankruptcy to reduce future tax liability .

The short answer is that this is not very likely to happen.

As a general rule the cancellation of debt creates taxable income.   Debt discharged in a bankruptcy is an exception to this rule, however, the taxpayer is required to reduce any unused net operating loss by the amount of cancelled debt that escaped taxation in bankruptcy.  And if the cancelled debt exceeds the net operating deduction the taxpayer might then have to reduce other tax attributes, such as capital loss carryovers, business tax credit carryovers, and their tax basis of property.

Of course it is possible that the net operating loss deduction could exceed the amount of debt cancelled in bankruptcy, and then some of the carryover deduction would still be available for later years.  This could happen for example if the taxpayer invested a large amount of capital in the business rather than having relied mostly on debt financing for the enterprise.