Will My Chapter 7 Bankruptcy Affect My Tax Refund?

It is the time of year that some people love and some people dread… tax time.  Some individuals can’t wait to file their taxes because they anticipate receiving a refund which they may desperately need.  For others, tax time is an unpleasant period of uncertainty and anxiety as they determine how much they owe the government.  But, what happens if you are expecting a refund and also plan to file for bankruptcy in the near future?

In a Chapter 7 bankruptcy, the bankruptcy Trustee collects the debtor’s non-exempt assets and liquidates them (reduces them to cash) in order to pay the debtor’s creditors. By statute, debtors who file a Chapter 7 bankruptcy are entitled to protect or “exempt” some of their property from being included in the property that the Trustee liquidates.  Tax refunds are considered an asset, even if the debtor has not received the refund yet, or even if the debtor has not filed their tax return prior to filing for bankruptcy.  It is very important to inform your bankruptcy attorney whether you expect to receive a refund.  It may be that the amount you anticipate receiving can be easily protected by using an available exemption.  However, if it appears as though the amount of the refund will not be able to be protected, there may be other things to do in order to avoid having the refund being included in the pool of assets taken by the Trustee in order to pay creditors.

In some instances, it is better to file your taxes and receive your tax refund prior to filing for bankruptcy.  That way, you will potentially have consumed the refund prior to your bankruptcy filing.  It is important to note, however, that tax refunds should not be used to purchase other assets.  Instead, it is perfectly acceptable to use the tax refund for necessary and ordinary expenses such as paying your mortgage, car payment, groceries, gas, etc.  Additionally, it is acceptable to use your tax refund to pay for the attorney’s fees for your bankruptcy filing.

The possibility of receiving a tax refund should not deter you from filing for bankruptcy.  Ideally, you will have enough exemptions to cover the anticipated refund.  However, if you do not have available exemptions and need to file the bankruptcy before you are able to receive and consume the refund on ordinary expenses, potentially having to turn over a tax refund in order to settle or eliminate your responsibility to pay most or all of your other debts is still a good deal in the grand scheme of things.



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