Many families view their annual income tax refund as a personal bonus or a means to fund an annual vacation or make a large purchase. If you are in personal bankruptcy proceedings, however, your tax refund may be taken by the bankruptcy trustee to pay your creditors. In some circumstances, all or a portion of your tax refund can be protected through careful planning and use of bankruptcy exemptions.
Your assets at the time you file bankruptcy are considered the bankruptcy estate -- the pool of resources the bankruptcy trustee will divide up to pay off your creditors. The bankruptcy trustee will include in the bankruptcy estate any portion of your tax refund that arose from income earned before filing the bankruptcy petition. If you file bankruptcy on June 30th, for example, and worked all year, the trustee will consider one-half of the tax refund you receive the following spring to be part of the bankruptcy estate because that portion of the tax refund arose from the six months of wages earned from January to June.
Earned Income Credit
Most people considering bankruptcy, especially those who are filing personal bankruptcy under Chapter 7, have low income relative to their family size. These debtors are likely to qualify for the Earned Income Tax Credit on their federal income tax returns. When this credit exceeds the amount of taxes owed, the remaining credit amount is returned to the taxpayer as a refund. In many states, any portion of the refund that's attributable to the Earned Income Tax Credit is immune from creditors and the debtor can keep this segment of the refund without using an exemption.
Read More: Federal Income Tax Refund Garnishment Laws
Chapters 7 and 13
In both Chapter 7 and Chapter 13 bankruptcy, you are entitled to certain exemptions -- categories of property you can retain rather than turn over to the bankruptcy trustee. Filing your taxes in a timely fashion so that you know how much your tax refund will be allows you to include the anticipated tax refund amount in your claimed exemptions. In a Chapter 13 bankruptcy, your tax refund will most likely be considered part of the assets from which you are expected to make payments in your repayment plan. However, depending on the size of the refund and whether the debtor is able to repay most of his debts under the repayment plan without using the funds from the tax refund, some bankruptcy trustees might allow the debtor to keep the refund and spend it outside of the repayment plan.
Protecting Your Refund
Planning ahead when you are anticipating bankruptcy may help to protect your tax refund and allow you to make maximum use of it. If you can delay your bankruptcy filing until after your tax return has been received, you can spend the money on necessities, including bills as well as groceries and other living expenses. Some people considering bankruptcy wait until they receive their tax refund so they can use this money to pay the bankruptcy filing fees. Another option is to adjust your withholding amounts with your employer so that less money is removed from your paycheck each pay period. If your place of employment allows it, you could also have your employer transfer more of your income to your retirement program, where it is more protected from the bankruptcy process.
- Dwayne Dawson: Tax Refunds and Bankruptcy
- Duncan Law Online: Is My Tax Refund Protected in Bankruptcy
- Bloomberg BNA: Income Tax Refunds and Bankruptcy
- Northwest Georgia Bankruptcy Attorney: Bankruptcy--Can I Keep My Tax Refund If I File?
- Orlando Bankruptcy Law Blog: Chapter 7 Bankruptcy Consequences For Earned Income Tax Credit and Child Tax Credit
A freelance writer since 1978 and attorney since 1981, Cindy Hill has won awards for articles on organic agriculture and wild foods, and has published widely in the areas of law, public policy, local foods and gardening. She holds a B.A. in political science from State University of New York and a Master of Environmental Law and a J.D. from Vermont Law School.