Bankruptcy basics: U.S. bankruptcy court.

• Author: Sebold, Maryellen K.

With the economy on rocky footing, bankruptcies are on the rise. What docs this mean for your clients? They will be faced with the challenges that surface from slow collections, loss of business, impending foreclosure, layoffs or a combination of these and other factors. Whether you are an auditor, tax preparer or consultant, knowing the basics of bankruptcy can help you guide your client whether they are facing bankruptcy or suffering the ripple effects of others' filings through the maze of these harsh realities.

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For the 12-month period ending June 30, bankruptcies filed under chapters 7 and 11 exceeded 920,000 in the United States, a huge leap from the estimated 620,000 filings the year prior. If you drill down into those numbers you will see that the Chapter 11 filings almost doubled. In California there were in excess of 130,000 bankruptcies filed under chapters 7 and 11 for the year ending June 30, an increase of more than 150 percent over the prior year. This docs not bode well for your clients, their customers or their vendors.

Bankruptcy Basics

A Chapter 7 bankruptcy is a method of liquidation and redistribution of assets and a discharge of debt. Conversely, Chapter I 1 typically means that the debtor--usually a company plans to continue operating and restructure its debt. Often in a Chapter 11 there will be a Plan of Reorganization filed that provides the specifics of how the claims in the estate will be treated and the plan implemented, among other things.

A bankruptcy can be voluntarily filed by the debtor or involuntarily filed by creditors that satisfy certain requirements. The period before the bankruptcy is filed is the pre-petition period, and the period from the date the bankruptcy was filed through the discharge is the post-petition period. The entity that is created through the filing of Chapter 7 or Chapter 1 1 by an individual is a new taxpaying entity; separate and apart from the debtor. There are special tax rules that apply to both the debtor (pre- and post-petition) and to the estate in individual, corporate and partnership bankruptcy cases. Tax practitioners should be well-versed in those particulars if they are retained to provide tax services in a bankruptcy setting. (Internal Revenue Code sees. 1398 and 1399).

It's important, too, to know the key players as you navigate these waters.

The debtor is the bankrupt person or entity, and the creditors are those to whom the debtor owes money...