What happens to a tax refund in bankruptcy?
If a person files for Chapter 7 or Chapter 13 bankruptcy, any assets in the bankruptcy estate are available for creditors to take. A tax refund is automatically considered the property of the bankruptcy estate. However, when expecting a tax refund, there are ways to keep the refund from going directly into the hands of creditors.
Placing the Refund in the Bankruptcy Petition
Immediately upon learning of a tax refund, it's important to talk to a bankruptcy attorney about putting it in the bankruptcy petition. Like other assets, tax refunds can be exempted, either partially or fully, which will keep the refund from being lost to creditors. Many states have there own system of exemptions, and there are federal exemptions as well. If a debtor is unsure of the amount of the expected refund, a bankruptcy attorney will be able to help list an unknown amount. If an attorney determines that listing an unknown amount will interfere with the exemption limits, it may be a good idea to wait to file the tax refund in the petition until after receiving the money. Since a debtor is only allowed a certain amount of exemptions, filing a tax refund as one of them can mean they are not able to exempt other assets, such as bank accounts or jewelry, so it is important to weigh all of the options before making a final decision.
If the Bankruptcy Has Not Been Filed
If the bankruptcy has not yet been filed, and it is feasible to wait a few months before doing so, it may be the best option to hold off on filing if the refund is expected to be significant. Most bankruptcy professionals would advise that once the refund comes through, the funds are spent primarily on necessities. This includes expenses such as mortgage payments, medical expenses, or clothing. In most cases a debtor is allowed to use a refund for these purposes, and it is doubtful that the court will object to using the refund this way when eventually filing for bankruptcy. However, it is important to talk to a bankruptcy attorney about all available options, as not to risk losing hundreds or even thousands of dollars in tax refund money to creditors.
Address the Problem Sooner Than Later
Another thing to consider when filing for bankruptcy is to remedy the tax refund problem before it appears. This can be done by talking to employers to make sure that the least amount of taxes possible are withheld from incoming paychecks.