When you file for bankruptcy, the court appointed trustee who represents the creditors is going to be looking at not only your assets, but your tax return as well. The trustee’s job is to help creditors resolve bankruptcy disputes with debtors and their lawyers by reviewing the debtor’s financial records in order to pay their debts.
The type of bankruptcy you file will decide how much, if any, of your tax refund you will be able to keep. That is why it’s important to have a basic understanding of the two common types of bankruptcy, chapter 7 and Chapter 13. In Chapter 7, debtors are unable to pay their debts and their assets are taken and sold in order to pay their creditors. Even though there usually isn’t enough money to pay creditors in full, the courts will release the remaining amount due to them. This means that after the assets are sold, the debtor will no longer owe any more money to the creditors. Chapter 13 bankruptcy is filed when individuals plan on keeping some or all of their assets and are financially able to pay off their debts. The bankruptcy court even helps restructure the debt payment plan so that the debtor can pay back what they owe.
Tax refunds and Chapter 7
If you are considering or have filed Chapter 7 bankruptcy and expect to get a tax refund, then you may be wondering if you will be able to keep all or part of the refund. Tax refunds are considered income that was earned by individuals and held by the government, and any amount that was kept by the government prior to the bankruptcy filing date is considered to be income that can be used to pay creditors. But, the debtor is allowed to keep that portion of the tax refund which was paid after the bankruptcy filing date.
If you received your tax refund prior to filing for bankruptcy then you can keep the money out of the bankruptcy estate by spending it on necessary items such as food, clothing, mortgage or rent, educational expenses, medical care, utility bills, or repairs or replacements of home appliances, etc. It’s important that you spend the money on things that are necessary, and it’s important that you document how and where the refund was spent. Otherwise, when you file for bankruptcy the court may decide that you spent the money carelessly and require you to pay it back. That money would then be paid to the bankruptcy estate and allocated to your creditor debt.
If you think that you will have to file for bankruptcy at a later date, you should consider adjusting your tax withholding so that you are paying only what you are obligated to. By having less taken out of your pay, you will have more in your pocket to pay your bills each month, and won’t have to worry about the trustee taking that money to pay creditors with it.
If you have already filed your bankruptcy and then receive a tax refund you should check with your attorney to see if you can keep some or all of it. Normally, the refund check belongs to the estate and is used to pay the creditors but there are exceptions to that. In bankruptcy, there are exemptions that allow debtors to keep a certain amount of property no matter how much is owed to creditors. Each state has different laws regulating their exemptions, so be sure to check with your attorney before turning over your tax refund.
Tax refunds and Chapter 13
If you receive a tax refund after your bankruptcy case has been filed, you are obligated to turn that money over to the trustee. Chapter 13 debtors are allowed enough money to pay for reasonable and necessary expenses such as food, housing, and transportation, and agree to put all of their disposable income into the repayment plan so that it can be used to pay creditors. The trustee will likely consider your tax refund to be disposable income since you have been paying your reasonable and necessary expenses from your paycheck and will put the refund into the repayment plan.
But, there are exceptions to that rule. You may be able to keep the refund if you can either file a plan modification which states that you have other periodic expenses that are not mentioned in the plan. Or, you can have that same requirement listed in the original plan agreement. Typically though, bankruptcy courts will only allow you to keep your tax refund if you have unexpected and necessary expenses that are not covered in your repayment plan. Some common unexpected and necessary expenses include: funeral; family medical; car repair or replacements; home repairs; and the like.
Filing for bankruptcy can be an arduous task, one that is best left to the experts. If you are contemplating bankruptcy, you may consider talking with an attorney who specializes in bankruptcy law, one that can advise and guide you through the process.