The people who file for bankruptcy during tax season always ask us what happens to their tax refund. Does they still get it, or is it lost?
Tax refunds and Chapter 7 Bankruptcy
When you file for Chapter 7 bankruptcy, your tax refund is considered an asset – whether you’re received it or not. Just like your other assets, if your tax refund is “exempt,” it can’t be touched by the trustee. The amount of your refund that’s exempt will very from state to state, depending on the state allowed amounts. You might even be able to use the wildcard exemption (which can be used to protect any asset) if your state doesn’t have laws regarding the exemption of tax refunds.
If you’re filing during tax season, you just need to plan carefully and work with your bankruptcy attorney. If you’ve already received your refund and haven’t spent it, you need to decide if you want to use your refund or protect it. If you haven’t received your refund yet, you’ve got to decide how you want to proceed. Your bankruptcy attorney can help guide you through your options. You’ve got two viable options:
- Use your tax refund to pay your attorney fees and case costs.
- Wait until after you receive your refund to file. If you go this direction, you’ll want to be sure you use your refund responsibly – on food, clothing, or your mortgage, for example. Don’t purchase any new assets!
If you’ve already spent your tax refund, you won’t have to worry about listing it as an asset on your bankruptcy petition.
What if I file later in the year?
Filing for bankruptcy later in the year can be a bit more complicated. If you have a bit of prep time before you file, you’ve got several options for protecting your refund. If you withhold a large amount from your paycheck and expect a large return, you might want to adjust your withholding amount so that your refund amount is lower (or you don’t get a refund at all).
You could also put more of your paycheck into your office 401k or an individual IRA. Make sure you don’t deposit the refund into your bank account first – if you deposit the check and then contribute to a retirement fund, it will count as an asset.
Tax refunds and Chapter 13 Bankruptcy
In Chapter 13 bankruptcy, it’s a different situation. Since your Chapter 13 plan spans a period of time (either 3 or 5 years), your trustee will have access to your tax refunds. If your Chapter 13 plan does not pay back 100% of your debt to your creditors, your trustee has the option to keep your refunds throughout the period of your plan. Chapter 13 bankruptcy requires that all of your disposable income is applied to the plan, and most trustees will classify tax refunds as disposable income.
Your plan payment won’t be reduced if the trustee keeps your refund, though… Since the tax refund is counted as additional disposable income, it only gives your creditors a bit more percentage of your repayment.
Is it possible to keep a tax refund in Chapter 13
In certain situations, a trustee might allow you to keep your tax refund. For instance, something might have happened that has affected your ability to pay your living expenses. While it’s ultimately up to the trustee to take your refund or let you keep it, in most cases it will end up being paid into your plan.
You could use the option we listed above – reduce your withholding amount on your paycheck. If you get less money in your refund, that’s less money that your trustee will take.
Please call us with your questions
We always get questions about tax refunds and bankruptcy at this time of year. If you’re struggling with overwhelming debt and considering bankruptcy, please call us at 214-760-7777 for a free consultation. We’ll get the details of your financial situation and walk you through all of your options – including any possible tax refund outcomes.