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Will I Lose My Tax Refund by Filing for Bankruptcy?

Will I Lose My Tax Refund by Filing for Bankruptcy?

It is no secret that filing for bankruptcy will cause you to lose some of your assets. These assets are taken by the bankruptcy trustee to pay off debts owed. Unprotected assets, such as a tax refund, are susceptible to becoming part of the bankruptcy estate. Yet, whether the trustee can reach these funds largely depends on the timing of the bankruptcy filing. In some cases it is possible to file bankruptcy, and keep your refund all to yourself.

When Tax Refunds Are at Risk

Your tax refunds are absorbed by the estate if they are available at the time of the bankruptcy filing. The most common situation where tax refunds are taken by the trustee involves a prior year's refund. Any unspent refund that exists when you file for bankruptcy automatically becomes an asset controlled by the estate.

If you file taxes the same year that you file for bankruptcy, you may get to keep part of your refund. Bankruptcy law dictates that the portion of the refund which emanates from income earned prior to a Chapter 7 filing is reachable. However, the part that is generated from income earned after the bankruptcy filing can be retained by you.

Don't make the mistake of thinking you can prevent the first scenario by spending the funds before filing for a Chapter 7. Bankruptcy laws impose strict penalties on those who try to evade paying into the estate. The only legitimate way to spend a tax refund (immediately before filing for bankruptcy) is to pay necessary expenses. This may include reasonable expenses for food, clothing, insurance and other debts. There are national standards that dictate what amount is considered reasonable. A business law attorney can assist you in determining if the expenses are legitimate.

Have Your Cake and Eat it Too

With proper planning, it is possible to keep most (or all) of your refund while filing for bankruptcy. Some legal avenues to achieve this include declaring the refund in your exemptions, or reducing your tax liability ahead of time. The latter is made possible by modifying your withholding amount. By doing so, you will only pay enough to cover your expected tax liability. The result is that the refund may be so small that it will not be collected by the trustee. Working out a plan like this is only effective in Chapter 7 cases, and usually requires the help of a business attorney.

Chapter 13 Cases Are Different

In Utah, the trustee has a right to future refunds depending on your income level. Those with high incomes may have relinquish a portion of their refund for five years. Filers in the middle or low income bracket may only have to do so for three years.

You can get help with bankruptcy problems by contacting the law firm of T.R. Spencer Law Office. Let Terry Spencer or Gavin Jensen assist you in the areas of family law, business law or estate law.

wills and trusts, bankruptcy, tax season, chapter 13