Does My Tax Refund Have to Go to the Bankruptcy Trustee?
- When you file for bankruptcy, you are required to list all of your assets, income and debts as part of the petition. Upon filing, a bankruptcy estate is created, Both your assets and any income not yet received are considered part of the bankruptcy estate. Any tax refund you are due at the time you file for bankruptcy protection are considered part of the bankruptcy estate. Furthermore, you are required to file all tax returns that become due while the bankruptcy is pending.
- How a tax refund will be handled will depend, to some extent, on which chapter you file. Most individuals file under chapter 7, 12 or 13 of the bankruptcy code. Chapter 7 is frequently referred to as a "liquidation" and is used by low-income debtors with relatively few assets. A Chapter 12 is for family farmers or fisherman, while a Chapter 13 is for individuals with regular income and/or non-exempt assets that they wish to keep. Under a Chapter 7 bankruptcy, the refund can be used by the trustee to pay off creditors. Under a Chapter 12 or 13, some, or all, of the refund may be kept by the debtor and used toward repayment of debts under the repayment plan entered into as part of the bankruptcy process.
- One way to potentially prevent your tax refund from being taken by the trustee in your bankruptcy is to list it as an exemption when you file the petition. While bankruptcy falls within the jurisdiction of the federal courts, individual states are allowed to provide exemptions for residents above and beyond those allowed under federal law. As such, state exemptions will differ. Some states specifically exempt all or part of tax refunds. Other states may allow a general exemption for a certain dollar amount. Check your state exemptions to see if any can be used to protect your refund.
- If your state does not allow any exemptions, you may still be able to prevent your refund from being taken by the trustee with a little planning. One way is to change your W-4 to reflect the correct number of exemptions. By doing that, you should receive all your income throughout the year and will not be owed a refund on your return. You may also wait until you receive your refund before you file your bankruptcy petition. If you have already spent the refund on necessities, then you may not be required to repay it; however, if you spend the refund on frivolous or luxury items, then the bankruptcy trustee may object.