Are you expecting a tax refund?
Are you expecting a tax refund? As in life, timing is everything. If you're considering filing for bankruptcy in Chapter 7 to eliminate debts and you're expecting an income tax refund, you have some thinking to do.
If you file Chapter 7 before you receive the tax refund, that right to future income is an asset that becomes part of the bankruptcy estate under control of the bankruptcy trustee. In general, unless it qualifies as exempt under a "wildcard" type of exemption, the trustee can use it to pay off your creditors. That's probably not what you would want. So, it's often better to delay filing Chapter 7 until you receive your tax refund. That way you retain control over the refund and have an opportunity to use it in a way that benefits you. A few of those ways might be to spend it on normal living expenses and/or catch up on mortgage payments (of course before filing Chapter 7), or put it into an "exempt" place, like an ERISA-qualified plan within IRS limits. Note also that applying a refund amount to your future taxes still leaves that amount available as an asset to the bankruptcy trustee.
When do you acquire that right to the tax refund, the right that the bankruptcy trustee wants for the benefit of creditors? The general rule is that the right to receive a tax refund accrues every day taxes are withheld from your paycheck. That right doesn't wait to exist, for example, until you file a tax return. How might that play out in specific situations? Let's assume that you will get a refund for 2009 income taxes after the taxes are filed in 2010, and you want to file a Chapter 7 bankruptcy to discharge debts.
- If the bankruptcy is filed in 2009, the portion of the tax refund that becomes part of the bankruptcy estate is pro rated based upon the amount of income earned before bankruptcy filing compared to the total year's income. Of course, if you're still working, you might be able to reduce your withholding for the remainder of 2009 so there would either be no refund for the bankruptcy estate to get or a refund so small it wouldn't be worth the trustee's time to go after it.
- If the bankruptcy is filed in 2010 but before the tax refund is received, the entire amount of the refund would become part of the bankruptcy estate.
- If the bankruptcy is filed in 2010 but after the tax refund is received, the refund received becomes just another asset and may be used for normal living expenses or as described above prior to filing bankruptcy. Of course, if you will get a refund for 2010 taxes then the trustee can get the pro rated part of that, but there should be only very few months in 2010 before you file bankruptcy so that part of the refund should be small.
Delaying your bankruptcy filing may have other consequences, possibly worse than losing a part or all of a tax refund, especially if the refund is small. Because of these and other issues beyond this discussion, you should really consult a qualified bankruptcy attorney to discuss these issues as a part of your bankruptcy process.
I understand the above. Will have just a small return coming next spring, so would like to file now as you said it takes about three months? Then I could file for 2009 nine after that time, but before the April deadline. Correct?
Lynn, you need to consider that by filing bankruptcy late in 2009, the trustee in bankruptcy may be able to take most of your 2009 tax refund and make it a part of the bankruptcy estate for the benefit of your creditors. Read the newly-expanded article above and I think the issue will be clear to you.
I have retained a bankruptcy attorney, and have made my final payment to him to retain his services, but I haven't finished all the necessary paperwork he has requested, so I assume he hasn't officially filed bankruptcy for me just yet. I am expecting to receive a $4500 federal tax return next week. Most of it comes from having purchased a home in January of 2009 and getting some of the interest back, as I understand it. Do you think this refund is safe from my creditors because I haven't officially filed for bankruptcy yet? I am depending on that money to help me pay my mortgage after I get laid off from my teaching job (which I got the notice for 2 weeks ago). Thank you for your time.
Krista, on the limited facts available, your tax refund itself seems safe if it arrives before filing. You would also need to use it in a "permissible" way, meaning a way that makes it not available to creditors (like paying your mortgage), before filing. BUT, this is something that you should ask your own bankruptcy attorney who knows your situation in much more detail than I do.
I have read the above article but want to make sure i am correctly applying it. I had 0 income prior to filing my ch 7 in march 2009. I finally got a job in may 2009 and had the bk discharged in june 2009. I just recvd my tax return. Will it then be pro-rated for 3 mos or am I at a loss of the entire check? All income was received/earned after the filing. Also what happens if you do not send the check in to the trustee ? Thanks
Sharon, from the facts you stated, I don't see that you owe the trustee anything. When you filed your Chapter 7 in March 2009, it would have been the tax refund you were owed (if any) from your 2008 tax return that the trustee would have been interested in and that would have already been taken care of before your discharge. Anything you earned after filing the Chapter 7 is yours to keep. The only thing you were "on the hook" for after filing Chapter 7 was income received from the death of someone (inheritance or life insurance proceeds) for 180 days. You're in the clear!
If a person filed a Chapter 7 in 2009 and received a discharge in 2010 before filing the 2009 tax returns – then received a federal refund that was only for Earned Income Tax Credit – no income tax was paid in during 2009 from employment and there was no income tax due for 2009 due to the standard deduction and exemptions – would that refund of the Earned Income Tax Credit be available to the Trustee or can the debtor keep it?
Rob, I'm going to give you an "it depends" answer but it's really because there is no definitive answer. The answer is it depends on the particular court and trustee. Different courts have held both ways and the trustee may or may not claim that it's part of the estate. If the trustee does claim that credit, then you and your attorney would have to litigate the issue with the judge if you want to keep it away from the trustee and, as I said earlier, judges in different courts have held both ways.