Keeping Your Tax Refund In Bankruptcy

For people in financial trouble, the promise of a receipt of a tax refund can be a lifesaver. Many rely on that money to pay essential bills or to afford things that they need in their everyday life. But if you file for bankruptcy, will you lose that tax refund? If so, are there ways that you can avoid the refund from being taken by the bankruptcy court?

Exempting Your Tax Refund

Unless you are expecting an extraordinarily large tax refund, you should be able to fit the refund under what is known as their wild card exemption.

This is an exemption that allows you to apply (protect) between $1,000-$4,000 to any property or money that you choose (the higher number is for people who do not own a home, the lower is for people who own a home, and will claim a homestead exemption).

It is always best to apply this exemption to money—like a refund—and not to property. This is because you can always argue that your property has little value (or at least less than what the bankruptcy trustee says it’s worth), whereas, money is money, and its value is not arguable.

If your exemption fits in the $1,000-$4,000 window you are fine, and your refund will be protected. If it does not, there are still other ways to protect your refund.

Not All of the Refund Can Be Taken

The trustee cannot automatically take every dollar of your tax refund. The trustee can only take whatever part of your refund relates to income that was earned before the bankruptcy filing.

Let’s pretend that you file for bankruptcy on October 1, 2021. Your expected refund, to be paid in March 2022, will be from the previous calendar year (2021). The trustee could only take refunds that were earned on income from before October 2021 (January – October 2021). Any part of the refund that is from income earned from October 1, 2021 (October – December 2021)  would be yours.

In many cases, the trustee may not even bother figuring this out, if it is a small amount of money. Even if the trustee does claim a part of your refund, you now do not have to exempt the entirety of your refund—only 6-7 months of the refund. That means that your refund is likely to fit in your exemption limit, and you will even have extra exemption money, to apply to other property.

Spending Refund Money

You can spend your exemption money before you file for bankruptcy. However, it is always best to use this money for necessities, like food, gas, medical expenses, vet expenses, necessary repairs for your home or car, school supplies for kids, or anything that is both necessary, and which does not have significant value.

This first reason is to avoid impropriety or looking like you’re trying to evade bankruptcy laws, but also so that you aren’t replacing one asset (your refund) with another asset (whatever property you buy with your refund).

Contact the Boca Raton bankruptcy attorneys at the Law Offices of Stephen Orchard at 561-455-7961 today for strategies to protect your property when and if you file for bankruptcy.

Resource:

irs.gov/businesses/small-businesses-self-employed/chapter-7-bankruptcy-liquidation-under-the-bankruptcy-code