Tax Refunds and Bankruptcy

Bankruptcy and taxes can be a difficult subject and it can have some serious consequences. One of the most commonly asked question is what will happen to my tax refund if I file for bankruptcy? There is no straight answer to that question, what happens to your tax return depends on what chapter you file your bankruptcy under. Filing under chapter 7 will probably protect the tax refunds while filing under chapter 13 could possibly mean less protection for your refund.

Tax Refunds in Chapter 7 Bankruptcy
When filing for bankruptcy your tax refund, whether already received or expected for that year, will be considered an asset. As with other exempt assets, if your tax refund is considered exempt the bankruptcy trustee will not be able to take it. Since the allowable exemption amounts for various assets vary from state to state, the amount of your tax refund that you can exempt depends on your state. If your state does not have a specific exemption for tax refunds, you may be able to use the wildcard exemption, which can be used to protect any asset. If you are still concerned about your refund during the bankruptcy, the timing of when you file is also important. Filing for bankruptcy during tax season can be a bit tricky, if you do file during tax season look into what exemptions your state offers. To get most use out of your refund consider using it to pay your legal fees for filing bankruptcy. If you file for bankruptcy at another time of the year, it could be a little more problematic if you are expecting a big refund. Another way to protect a tax refund is to defer more of your salary into an employer IRA or 401k.

Tax Refunds in Chapter 13 Bankruptcy
In a chapter 13 bankruptcy, your tax refunds will be analyzed by the trustee during the length of the plan, which can last anywhere from 3 to 5 years. If your plan pays less than 100% of your debt back to creditors, the trustee has the discretion to keep your tax refund during the life of the plan. Since chapter 13 requires that all disposable income be paid into the plan, most trustees classify tax refunds as disposable income. But keep in mind that even though your refund is being paid into your repayment plan, your plan payment will not actually be reduced.

Since determining what to do with your tax refund is largely discretionary, your trustee may allow you to keep the tax refund in special circumstances, for example the refund is needed to pay your living expenses because you find yourself in a situation. However, keep in mind that the trustee will most likely require you to contribute your tax refund as part of your plan payment. There is almost no way to keep your refund is the trustee has decided that it will go towards your repayment plan.