Can I Keep My Tax Refunds If I File Bankruptcy?

Tax season is here again in Kansas City, Missouri. Understandably, people filing or considering filing  bankruptcy are concerned about losing their tax refunds. The good news is that if done properly, the bankruptcy filing will most likely not cause the loss of a tax refund. Most debtors lose their tax refunds because they fail to properly disclose and exempt the tax refunds, which is common when attempting to file without an attorney or when hiring an inexperienced or careless bankruptcy attorney.

 Tax refunds are the number one asset that trustees routinely take from debtors. Exemption laws in most states only go so far to protect cold, hard cash, and anything over and above your state’s designated exemption is fair game for the trustee.

Trustees love to go after tax refunds because, unlike real estate and other assets, there isn’t the overhead and effort associated with listing the property for sale. With cash, they can get a check.

Your Tax Refund is Part of the Bankruptcy Estate

On the day the bankruptcy is filed, any assets that you own become part of the “bankruptcy estate.” Your tax refund is one of those assets. A trustee is appointed to represent your creditors, collecting assets and liquidating those assets to pay your creditors. In many Chapter 7 cases, there simply are not enough assets or cash to make it worthwhile for the trustee to take those to pay the creditors.

Unfortunately, if you are owed a large tax refund, that may be an easy target for the trustee. With a little planning, we can help you keep most, if not all, of your tax refund.

Want to Keep Your Refund? Spend it.

The best way to avoid losing your tax refund is to file your tax return, receive the refund and spend it prior to filing your bankruptcy. Your bankruptcy attorney should instruct you to keep a record of how your refund is spent.

Your refund can be used for a variety of expenses, including most of your ordinary household expenses, like:

  • Rent
  • Mortgage payments
  • HOA dues
  • Food
  • Utilities
  • Clothing
  • Educational expenses
  • Medical and dental expenses
  • Insurance
  • Home maintenance and repairs
  • Car payment
  • Car repairs and maintenance

You want to have minimal — if any — tax refund money in your bank account on the day that you file your bankruptcy. You may also be eligible to save a portion of your refund using a retirement account. Ask your attorney for more information.

If you are able to follow these steps, you will not be required to turn over your tax refund.

Caution! If you spend your tax refund on luxury goods, use it to repay a friend or family member, or pay off a credit card or other unsecured debt, you may trigger an objection from the trustee, and be required to turn over your tax refund, even if you HAVE spent the money.

If you have NOT received your tax refund on the date of filing, the trustee will be entitled to the tax refund when you receive it.

When the Tax Refund Hits While You’re in Bankruptcy…

Ideally, you’ll have very little tax refund left over by the time you’ve filed bankruptcy. There is an uncontroversial rule of bankruptcy law that applies to tax refunds:

Income tax refunds are property of a debtor’s bankruptcy estate to the extent they are derived from withholdings from the pre-petition earnings of the debtor.

To put the court’s words in plain English, tax refunds received for wages earned prior to filing bankruptcy are considered property of the bankruptcy estate and are subject to liquidation if no exemptions are available.

Part of the job of any good bankruptcy attorney is to sit down with clients, discuss their assets and come up with a plan for maximizing the exemption laws to their client’s benefit. If you’re considering filing for bankruptcy and are unsure of how a large tax refund will be treated, consult with an experienced bankruptcy lawyer before making any further decisions.

How can you avoid this problem altogether? Don’t receive a tax refund

If you had a large tax refund last year, the first thing we will ask you to do is to look at your W-4 and adjust your exemptions. You only want to have the necessary taxes withheld from your paycheck, nothing more.

When you are filing for bankruptcy you DO NOT want to receive a tax refund. At a minimum, keep the tax refund small.

Instead of receiving a tax refund and giving it to the trustee, wouldn’t you like to have a little more money coming to you in each paycheck throughout the year? I thought so! You can use the IRS’ withholding calculator to determine how many deductions you should be claiming.

Other Bankruptcy Tax Refund Issues

If we file your case later in a year (between August and December), it is likely that the trustee will ask for a copy of that year’s tax return. I know this sounds strange since it’s September and you have not filed a tax return for the current year. The trustee may request a copy of the tax return for the current year as soon as you file it. He will then review the tax return to see if you are going to be receiving any refunds. If you are, he will ask for a pro-rata portion of the refund.

Since your initial appointment with the attorney may be several months before you actually file your case, we want you to plan for your bankruptcy by adjusting your payroll deductions to avoid having the trustee take your refund.

Bottom line: You should plan to have a minimal refund if possible; or wait for the refund to be received prior to filing for bankruptcy. No refund means you get to keep your money in each paycheck and avoid turning over a big refund to the trustee.

Call Northland Bankruptcy Law for Help With Your Bankruptcy!

Are you currently struggling with debt? Are you searching for a way to put a stop to creditor harassment? Has a recent financial hardship placed you in a position where you may be facing foreclosure, wage garnishment, or car repossession? No matter your financial situation, Northland Bankruptcy Law can help guide you to a more stable financial future. For a more comprehensive list of all the questions you might have about bankruptcy, and for a free consultation, please call (816)-452-1800. If you have further questions about your case, do not hesitate to reach out to us by the phone number, through the contact form, or by emailing [email protected].