Millions of Americans count on their tax refunds each year to pay down debts, get caught up on bills, or simply to make ends meet. With an estimated 1.5 million personal bankruptcies to be filed in 2011, bankruptcy lawyers around the country are being asked the same question: “What will happen to my tax refund if I declare bankruptcy?”
Income tax refunds are basically interest-free loans to the government, and are therefore considered assets of debtors who declare bankruptcy. The trustee assigned to your case may be able to seize your income tax refund, depending upon two main factors: first, what type of bankruptcy you file, and second, whether your refund is fully exempted.
• According to the IRS, the average tax refund for 2009 was $3003 per person.
• Early filers usually get larger refunds.
• There were $1.2 trillion in personal taxes in the 2009 tax year.
The two main types of personal bankruptcy cases are Chapter 7 and Chapter 13. In a Chapter 7 case, debtors are essentially allowed to walk away from their debts.
In a Chapter 13 case, debtors must repay their unsecured debts over 3 to 5 years.
Most Chapter 7 cases are considered “no asset” cases, and for those assets that the debtor does possess, there are federal and state exemption laws, which prevent the bankruptcy trustee from seizing and selling the debtor’s property.
Just like the debtor’s household goods, clothing and automobile, in most Chapter 7 cases the debtor’s tax refund can be fully exempted, which means the bankruptcy trustee cannot even consider seizing the refund. However it is very important to use the full and correct exemptions to protect the refund.
BEFORE YOU FILE BANKRUPTCY
• Tweak your withholdings to produce more immediate income throughout the year, which will reduce your refund return at the end of the year
WHEN YOU FILE
• You must disclose all of your assets and all of your debts, and your tax refund is an asset. Bankruptcy fraud is a serious crime.
• Maximize the bankruptcy exemptions on your refund and in most cases, you will be able to keep it.
AFTER YOU FILE
• If your refund is exempt, the money is yours to keep.
• If your return must be surrendered, the trustee in your case will directly notify the IRS, and you will likely never even see the money.
Chapter 13 cases can be a bit more complicated. If you have a confirmed Chapter 13 Plan that requires repayment of only a percentage of your debt, your trustee will likely seize your refund every year over the course of your bankruptcy, using the proceeds to increase the payout to unsecured creditors. Income tax refunds in Chapter 13 are considered “property of the estate,” so your trustee will want to apply this money toward payment of your Plan.