With tax season coming up, many people who are considering filing for bankruptcy or have already filed have to think about how their tax refund (or burden, if you owe) will affect their personal financial status. If you have already filed for bankruptcy, will the trustee assigned to your bankruptcy case take your refund? Is your tax refund safe at any point if you will file for bankruptcy before the year is over? This blog will answer those and other questions you have about taxes and personal bankruptcies.
Will I Be Able to Keep my Tax Refund in a Chapter 7 Bankruptcy?
The key to determining whether or not you will be able to keep your refund is the date you filed. The part of your tax return that applies to any income you earned BEFORE you filed for bankruptcy is considered part of your bankruptcy estate. In a Chapter 7 bankruptcy (liquidation bankruptcy), any item in your bankruptcy estate that isn’t exempted may be used by the appointed trustee to satisfy your debts. You will be awarded your full tax refund in the full year after you file bankruptcy.
For example, let’s say Jane filed for bankruptcy on October 1, 2019. She was employed for the entire year. In the spring of 2020, she does her taxes and receives a $1,200 return. Because she filed in the beginning of October after ¾ of the year had passed, ¾ of her $1,200 return becomes part of her bankruptcy estate. Therefore, she only gets to keep $300, unless she is eligible for an exemption. Now, in all likelihood, Jane will be eligible to use the North Carolina wildcard exemption, allowing her to exempt (or keep) up to $5,000 in value of any property. She can use $1,200 to keep her full tax refund and still have $3,800 for use on other property.
If I Want to Keep my Tax Refund, When Should I File for Bankruptcy?
It may be a good idea to file bankruptcy after you have received your tax refund. In fact, you may want to use a portion of your tax refund to pay for the costs to file bankruptcy. That is not uncommon. You also may want to spend your tax refund on other necessary expenses, such as food, shelter, or transportation. If you decide to go this route, don’t forget to keep receipts showing how the money was used.
How Does my Chapter 13 Bankruptcy Affect my Tax Return?
Much the same way as it does in Chapter 7 -- at least for the first tax refund you receive after filing a Chapter 13 bankruptcy. However, for future tax refunds, because of the nature of Chapter 13 bankruptcies, it can be difficult to keep your entire refund. You're often able to keep at least $1,000 of those future refunds, so the key is to adjust your tax withholdings so that you keep more of your money in your pocket during the year and have less of a large tax refund.