Bankruptcy and tax refunds

When someone files Chapter 7 bankruptcy, this means that all assets belonging to that person are established as part of the estate controlled by the trustee assigned to the case. Bankruptcy codes describe assets as being the individual’s checking and savings accounts, real estate and property (vehicles, boats, motorcycles, etc). Although tax refunds are considered assets, any refund a person earns on income made during the year after they filed Chapter 7 is legally theirs to keep. However, an unspent tax refund earned the year before filing Chapter 7 is treated like cash on hand or monies in the person’s checking account.

Chapter 7 Bankruptcy And Your Tax Refunds

When people expecting a large tax refund are considering filing bankruptcy, a bankruptcy attorney may recommend that the person try to coordinate the timing of the filing so that they can receive most, if not all, of their tax refund. Knowing some time in advance that you need to file Chapter 7 further allows you to take several courses of action to prevent creditors from seizing your tax refund. Spending the tax refund on necessary expenditures or adjusting the amount of paycheck with holdings so that the refund is minimized are several options a Chapter 7 bankruptcy filer has regarding tax refunds.

If a Chapter 7 bankruptcy filer chooses to spend their tax refund before filing bankruptcy, they should make sure they spend it on what the courts deem “approved” expenses. These include rent/mortgage, utilities, food, health care and clothing. Tax refunds used to purchase “luxury” items or for paying off debts owed to a family member or friends are not allowed and may be cause for the judge to discharge or invalidate the bankruptcy.

Your Tax Refund And Chapter 13 Bankruptcy

Tax refund guidelines for Chapter 13 bankruptcy are less complicated than those associated with Chapter 7 because none of the filer’s assets need to be liquidated. However, any anticipated tax refunds need to be listed and also exempted, since a filer may decide to convert to Chapter 7 in the future. This also means that nonexempt assets could have a significant impact on the amount of a payment plan established by completion of a Chapter 13 bankruptcy.

Unlike Chapter 7 bankruptcy, which essentially “wipes the slate clean” for filers who wish to start fresh, Chapter 13 allows filers to pay back creditors within two to five years. This means that filers must use their disposable income to repay debtors according to payment plans established by the court. Since tax refunds are considered disposable income, the court can require Chapter 13 filers to use anywhere from 50 to 100 percent of their tax refunds until all debts are paid.

Bankruptcy attorneys suggest filers decrease paycheck withholding’s to maximize earnings and prevent the accumulation of large refunds that will only be used to pay creditors. However, if you expect to be eligible for the Earned Income Tax Credit over the time it takes to fulfill a Chapter 13 bankruptcy repayment plan, be aware that this type of refund will not be incorporated in a payment plan. The IRS provides forms called W-5 Advanced Payments for EIC filers to use in a situation involving bankruptcy and tax refunds provided by the Earned Income Credit federal tax rule.

Successful Navigation

Successfully filing a Chapter 7 or 13 bankruptcy requires the assistance of a professional bankruptcy attorney capable of expertly navigating the complex rules and regulations governing state bankruptcy courts. In addition, facilitating the process of filing bankruptcy by hiring a specialized attorney removes the stress of making sure that all proper documentation is submitted to the court while alleviating the uncertainty involved with managing unexpected financial struggles.