How Filing Chapter 7 Can Impact Your Tax Refund
The average tax refund—the amount you receive because too much was withheld from your paycheck— is nearly $2,000. As such, tax refunds are a fairly dependable form of annual income for many individuals in the United States. Many Americans use it to pay down their debt, build emergency savings, and more.
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If You File Chapter 7 Bankruptcy, Will You Still Receive a Refund?
The answer is complicated. Tax refunds are often a part of the bankruptcy estate, which is the collection of assets the trustee may use to repay your creditors (unless you can protect them through state or federal exemptions). Your bankruptcy estate may include your tax refund even if you haven’t received it yet.
The reason why the answer to this question is not a straight “yes” or “no” is because it depends on when you earned the income that was overtaxed and, therefore, refundable.
The bankruptcy estate only includes:
- Assets
- Equity
- And wages earned and acquired up until the date of your petition
In other words:
- For work you did BEFORE filing your bankruptcy petition, your refund is part of the bankruptcy estate, and you can only keep it if you can protect it with an exemption.
- For work you did AFTER filing your petition, your refund will not be included in the bankruptcy estate.
Let’s say, for example, you file bankruptcy in September of 2020. The government may overtax the income you earned from January to August, but the refund for this amount would belong to the bankruptcy estate because it was for work you did before filing your bankruptcy petition. Any amount the government owes you for taxed income from September to December, however, will NOT be part of the bankruptcy estate.
How to Protect Your Tax Refund from Bankruptcy
If all or a portion of your tax refund will be included in your bankruptcy estate, you may be looking for ways to keep the money you earned.
Here are just a few ways you may be able to protect your refund:
- Protect it through bankruptcy exemption laws. People generally use the wild card exemption (either state or federal) to protect tax refunds, but your ability to do so will depend on whether your state has a wild card exemption or allows you to use federal exemptions.
- Adjust your tax withholding. One way to keep your tax refund out of the hands of the trustee is to simply avoid receiving a refund. You can do this by adjusting your withholding so the IRS takes less from each paycheck. This puts you at risk of owing the IRS at the end of the year, however, which is why we recommend putting money away to cover a potential tax bill.
- Delay your bankruptcy. If you cannot protect your refund through a state or federal exemption, you may consider waiting to file bankruptcy until you receive your refund. It’s possible to spend the refund to keep it out of the bankruptcy estate. We recommend spending your refund on essentials (like rent, groceries, or car payments) rather than unnecessary expenses, which could attract attention and potentially trigger an objection.
Generally, trustees are highly motivated to take tax refunds because, unlike assets that must be sold, tax refunds have no overhead cost. As such, you will need to plan ahead if your goal is to keep as much of your refund as possible.
Personalized Guidance From the Buchalter Law Group
Looking for more information and customized recommendations? Our attorneys are ready to help. In every case, our goal is to help clients maximize the benefits of bankruptcy while reducing the costs and risks. We have nearly half a century of bankruptcy experience, which we look forward to putting to work for you.
Give the Buchalter & Pelphrey Attorneys At Law a call at (321) 320-6088 or reach out to us online today.