If your debts are out of control, you have the option of filing for personal bankruptcy. A bankruptcy trustee, appointed by a federal court, will take possession of your assets and sell them for the benefit of your creditors or enroll you in a three to five year debt repayment plan. At the end of the process, the court will discharge, or cancel, your debts. Some debts, including federal taxes, cannot be discharged in bankruptcy -- they must be paid in full. If the IRS owes you a refund, it might be subject to seizure by the trustee.
Tax Refunds and Bankruptcy
When you file for bankruptcy, you create a bankruptcy estate. This is all of your personal property that is available, by law, to settle your debts. When you file a petition for bankruptcy protection, you must list all of these "non-exempt" assets, including any tax refund you were due for the tax year in which you file. Those refunds are considered part of the bankruptcy estate; while the case is in progress, the bankruptcy trustee has the right to seize refunds when they arrive and use the funds to pay your creditors.
Read More: What Can Happen if I Don't Give My Income Tax Refund to the Trustee After Bankruptcy?
Tax Refunds and Chapter 13
It's important to note that the trustee of any bankruptcy case has discretion to handle your assets as he sees fit. For example, the trustee may make an exception regarding tax refunds for those filing bankruptcy under Chapter 13. In a Chapter 13, you agree to a full or partial repayment of debts out of your income over a period of several years. Normally, the trustee will seize all tax refunds due over the course of a Chapter 13 repayment plan. If you agree to a full repayment of your creditors, however, the trustee can waive this provision and allow you to keep the refunds.
Although your tax refund is non-exempt, in the state of Nevada, the law allows you to claim a "wildcard" exemption, with which you can keep a limited portion of your assets out of the bankruptcy estate. The wildcard is limited to cash or goods with a value of $1,000 for single filers and $2,000 for married couples. You can use the wildcard to keep your IRS refund out of the bankruptcy estate and off-limits to the bankruptcy trustee.
Earned Income Credit
Nevada and federal law also exempt any part of a federal tax refund that is due as a result of the earned income credit. The EIC is a feature of the federal tax code that allows individuals or couples earning a limited income to take a credit against taxes owed to the IRS. You must meet the IRS guidelines to claim the earned income credit.
You might be able to exempt the refund if you use it for certain purposes. You must make a specific request to the trustee, and the expense must be for an urgent matter or an emergency, such as an unexpected hospital bill or the repair of your home or property after a storm. The general goal of bankruptcy law is to protect debtors from homelessness and destitution; if you can show that using your tax refund is needed for this purpose, you may be able to exempt it.
Refunds and Back Taxes
Recent overdue taxes are non-dischargeable; the three year "look back rule" states you can't get rid of IRS debt that is less than three years old in bankruptcy. So, even after the bankruptcy discharge, the IRS may use any refund due to you for repayment of back taxes.
Founder/president of the innovative reference publisher The Archive LLC, Tom Streissguth has been a self-employed business owner, independent bookseller and freelance author in the school/library market. Holding a bachelor's degree from Yale, Streissguth has published more than 100 works of history, biography, current affairs and geography for young readers.