One of the most common questions bankruptcy filers ask is “what will happen to my tax refund?” This is a logical and important question to anyone who is in the midst of a bankruptcy or is considering filing. The answer will depend on a number of different factors.
First, you should understand that tax refunds are, by default, considered an asset of the debtor. Therefore, like the debtor’s other assets, a refund could be seized by the bankruptcy trustee and used to pay creditors. However, there are some options available to the bankruptcy filer, which may protect their tax refund.
The first thing that a bankruptcy debtor can do is to adjust their income withholding so that they pay only the taxes that are owed throughout the year. If done properly, this could lead to a minimal or zero tax refund. With no refund received, there will be nothing to place in the debtor’s bankruptcy estate, and therefore no refund money for the trustee to seize.
The next alternative for a debtor is to receive and spend the refund prior to filing for bankruptcy. One option under this strategy is to spend the refund on necessities such as medical expenses, utilities food, or other living expenses. Another option is to spend the refund on the costs of hiring an attorney to handle your bankruptcy. These are the types of expenses that trustees are more likely to allow, as they are seen as necessities. You will want to be sure not to purchase new assets with the money, or make luxury purchases.
If spending your refund prior to filing is not an option, another possibility would be to use state or federal exemptions to protect the money. Exemptions are protections allowed by federal or state laws, which enable bankruptcy debtors to shield portions of their property from being seized and/or distributed by the bankruptcy trustee. By properly utilizing exemptions, you may be able to shield some or all of your tax refund from the trustee. The exemptions available to debtors may also depend heavily on the individual state statutes, so be sure to check your particular state’s laws.
With careful planning in advance, most debtors considering Chapter 7 bankruptcy should be able to protect their refund from being seized by the trustee. But what about Chapter 13 bankruptcies? Chapter 13 bankruptcies are more complex than Chapter 7’s, and therefore the issue of tax refunds is not as easily resolved. Generally, debtors in Chapter 13 bankruptcies will not have as high a probability of protecting their refunds as will those filing Chapter 7. If you are considering filing for Chapter 13 bankruptcy, you should consult with an experienced bankruptcy attorney to get information based on the specifics of your case.
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NOTE
All legal references are made with respect to Indiana law. Please check the laws of your local jurisdiction if you live in another state.
The articles in this blog are for informational purposes only. No attorney-client relationship is established through the publication of these articles.
