Learn whether you'll lose your tax return if you file for Chapter 7 or Chapter 13 bankruptcy.
Updated by Cara O'Neill, Attorney · University of the Pacific McGeorge School of Law
Some individuals filing for Chapter 7 or 13 bankruptcy will be able to protect a tax refund—but not all. Whether you can keep your return will depend on the laws of your state and the prebankruptcy precautions you take to protect your refund.
Tax Refund Assets in Bankruptcy
A tax refund is an asset in both Chapter 7 and Chapter 13 bankruptcy. It doesn't matter whether you've already received the return or expect to receive it later in the year. If you still have it in your bank account, if it's being processed, or if you'll get it once you file, it's an asset. You can expect the appointed bankruptcy trustee to ask you whether you've received or expect to receive a return.
As with all assets, when you file for bankruptcy, you can keep your return if you can protect it with a bankruptcy exemption. Each state decides the type and amount of the property you can exempt, and so protections vary widely. As a rule, a tax refund isn't always easy to protect. Most states don't have a specific tax refund exemption.
However, you might have a wildcard exemption available to you. The wildcard exemption protects any asset of your choice. Also, your state might allow you to choose between the state and federal exemption systems. The federal wildcard exemption is usually larger than that of the state. Find out the current amount of the federal wildcard exemption.
Planning for Chapter 7
Here are some ways to increase your chances of keeping your tax refund in Chapter 7 bankruptcy.
If you file during tax season. Individuals who file bankruptcy during tax season often have to figure out what to do with the tax refund they have just received. You can use any available tax refund or wildcard exemption to protect it. But if your state doesn't offer these exemptions, or you want to save your wildcard for other assets, consider these strategies:
If possible, file for bankruptcy after receiving and spending your tax refund. If you choose to do this, be sure to use your refund on necessities (living expenses such as your mortgage, medical expenses, clothing, or food) and not to purchase new assets.
Use your tax refund to pay your bankruptcy attorney for the fees and costs of your case.
These strategies have been found to pass muster in most bankruptcy cases because you're allowed to use your assets to pay expected living expenses. Neither option involves an attempt to avoid paying a creditor, which is considered fraudulent in bankruptcy.
Adjust withholdings. If you expect a significant return because of amounts deducted from your paycheck, the fix is to adjust your tax withholding early in the year. Keep in mind that this tip won't be as helpful if you change your withholding later in the year such as from October through December.
Contribute to retirement. You might want to defer more of your salary into an employer IRA or 401k. However, depositing the tax refund into your bank account before making a retirement fund contribution won't work. Once the return hits your account, it will become an asset.
Tax Refunds in Chapter 13 Bankruptcy
When you initially file for Chapter 13, you'll need to protect your tax refund with an exemption to keep it, or use it for necessary expenses before filing, as discussed above. If you can't, you'll pay it to your creditors.
During your three- to five-year repayment plan, it works a bit differently. You're required to contribute all disposable income to your Chapter 13 plan. If your plan pays less than 100% to creditors, the trustee can keep your tax refund. It won't reduce your plan payment, however. Your creditors will receive the percentage of your total disposable income, which will include your tax return, that they're entitled to under your plan.
Possible Ways to Keep a Tax Refund in Chapter 13
Determining what to do with your tax refund is mainly discretionary, so your trustee might allow you to keep the tax refund. An unforeseen event or need that has affected your ability to pay living expenses might sway the trustee. For instance, it's common for a debtor to need car repairs or a new vehicle at some point during the plan.
Even so, in most cases, the trustee will require you to contribute your tax refund as part of your Chapter 13 plan. As a practical matter, one of the only available preventive options in Chapter 13 is to adjust your employment tax withholding to decrease your tax refund. The smaller your refund, the less the trustee can take. But it's best to do this before filing for Chapter 13. You wouldn't want it to later appear as an attempt to hide bankruptcy income owed to your creditors.
Individuals who reside, have a place of business, or own property in the United States may file for bankruptcy in a federal court under Chapter 7 ("straight bankruptcy", or liquidation).
https://en.wikipedia.org › wiki › Chapter_7,_Title_11,_United...
and Chapter 13 bankruptcy. It doesn't matter whether you've already received the return or expect to receive it later in the year. If you still have it in your bank account, if it's being processed, or if you'll get it once you file, it's an asset.
Any surplus money goes to your creditors. Your tax refund is considered surplus money unless you can convince the bankruptcy court otherwise. The bankruptcy trustee and your creditors can object to any part of your plan, and likely would rather see that money be used to pay what you owe.
Income tax (with some restrictions) is the only kind of tax debt that can be discharged in a Chapter 7 bankruptcy filing. In Chapter 13 bankruptcy, you can't generally discharge your tax debts but instead you can repay them through the life of your Chapter 13 repayment plan.
For example, you can't discharge debts related to recent taxes, alimony, child support, and court orders. You may also not be allowed to keep certain assets, credit cards, or bank accounts, nor can you borrow money without court approval.
The court could see your case as fraud if you look like you are overspending before filing. It's fine to stock up on grocery items or household goods like toilet paper or cleaning supplies before your file. In some cases, it may even make sense for you to purchase a car if the court will seize your current vehicle.
The Fresh Start program is open to any taxpayer who owes taxes and is struggling to pay them. There are no income requirements. The first step in applying for the IRS Fresh Start program is to complete our contact form, contact your tax attorneys, or contact your accountants to see if you qualify.
Allowable expenses include administrative expenses. Administrative expenses can only be deducted by the estate, never by the debtor. The bankruptcy estate is allowed deductions for bankruptcy administrative expenses and fees, including accounting fees, attorney fees, and court costs.
There are only four types of debt for which the federal government will withhold your tax refund or send it to one of your creditors. These debts include past-due federal taxes, state income taxes, child support payments and amounts you owe to other federal agencies, such as federal student loans you fail to pay.
Or somewhat more accurately, Chapter 13 can give you more power over and flexibility with certain kinds of creditors, and if you have non-exempt assets. However, if you do not have those kinds of debt or assets, or not much in terms of tangible assets, then Chapter 7 would likely be the faster and easier option.
Under Chapter 13, you also have the $550 cash exemption along with a wildcard exemption up to $1,475, allowing you to keep $2,025 in cash under Chapter 13. However, when filing for Chapter 13 bankruptcy, you can claim and exempt 75 percent of the wages you earned in the preceding 30 days.
Your Creditors (and Trustee) Would Object to Chapter 13 Early Payoff. If you want to pay off your plan early, you must notify your creditors and get court approval. Creditors and the bankruptcy trustee will have the opportunity to object to your early payoff—and you should expect them to do so.
They have a right to perform a full audit of your accounts or check them any time it is necessary. However, it is rare for them to keep close tabs on every account.
Trustees do not monitor your income during the course of your repayment. However, a trustee possesses what Ginter terms “broad powers” and responsibilities. They include: Determining if you qualify for Chapter 13 bankruptcy.
For the average individual consumer, filing bankruptcy and discharging debts has no tax consequences. In contrast, if your debts are forgiven or settled outside of bankruptcy, the forgiven amount may be added to your income and subject to tax. That's called cancellation of debt income.
Tax debt can be discharged by filing for protection using any of the options available under the federal bankruptcy code. These include Chapters 7 and 13 for most individuals, Chapter 12 for family farms and fishing operations, and Chapter 11, which is mostly for businesses and larger debts.
Personal expense: Bankruptcy payments are considered personal expenses and are not eligible for tax deductions. Debt repayment: Payments made under a Chapter 13 bankruptcy plan are essentially repayments of your debts, which are not tax deductible.
That means that the one paying for those bankruptcy discharges is the companies and creditors who debtors owed in the first place. So, do taxpayers pay for people's bankruptcies? The answer is no – and anyone who tells you otherwise is probably just misinformed.
Introduction: My name is Francesca Jacobs Ret, I am a innocent, super, beautiful, charming, lucky, gentle, clever person who loves writing and wants to share my knowledge and understanding with you.
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