At the beginning of the year, clients always ask bankruptcy attorneys what will happen to their tax refund in bankruptcy. The answer is “it depends”.
There are a number of factors to be considered about a tax refund in bankruptcy. A tax refund if it is still owed to you at the time of filing is considered an asset of the bankruptcy estate. Some of the refund may be exempted according to the schedules depending on what other cash and money you have in your bank account(s). Other factors like what part of the refund is an Earned Income Credit also affect whether the Bankruptcy Trustee will assume the refund as an asset of the bankruptcy estate.
If you have already received your refund, it depends on what you did with the refunded money. If you still have it, we must look at the exemption amounts to protect the funds. Often, tax refund money can be used to pay your attorney fee and court costs for your bankruptcy without objection from the Trustee. Spending your refund to cover your rent, mortgage or car payment is probably the safest thing to do if you want to keep and use your refund. Keep in mind large payments to creditors are subject to review and the Trustee can file a Motion to require the refund amount to be returned to the bankruptcy estate if spent improperly. It is possible to spend your tax refund in bankruptcy, but a lot of thought and consideration into what and when the money is spent is important to discuss with a bankruptcy attorney.
The amount of your tax refund in bankruptcy will also be a consideration by the Trustee in whether it will become an asset of the bankruptcy estate. Generally, if the trustee can recover $1,000.00 it justifies the cost of administration of a bankruptcy estate; therefore, if the tax refund is greater than this amount then it is more likely the Trustee will request it be turned over to the bankruptcy estate.
The Chapter of your bankruptcy can also be a factor in whether a tax refund will be requested. In a Chapter 7 bankruptcy, the trustee will look at the factors already discussed. In a Chapter 13 bankruptcy, the trustee may not seek this year’s tax refund, but may request a percentage of your future tax refunds during the time period of your Chapter 13 Plan. So the bankruptcy chapter you file may be another important consideration for your tax refund in bankruptcy.
Another consideration is next year’s tax refund. Based on the date you file your bankruptcy, the Trustee may ask that you turn over a portion of the following year’s tax refund. The percentage is dependent on the month you file. For example, if you file in May, the Trustee may request 5/12th of your following year’s tax refund and may, at least, require you to submit copies of the next tax return you file to determine whether the bankruptcy estate is justified in asking for this portion of the refund. So, often there is a great benefit in relation to tax refunds to file early in the year to avoid the percentage increasing at the year goes on.
Since every case is different, you should never make any assumptions about whether or not you will be able to keep your tax refund in bankruptcy. A lawyer can help you in considering the timing of your bankruptcy filing and how you use your tax refund before it is spent and problems arise in your bankruptcy case. Whether you have already filed or are planning to file in the future, you should discuss your case and your tax situation with a lawyer now.