Attorney at Law
Will I Lose My Tax Refund in Bankruptcy?
Probably the most common piece of property I see seized in a Chapter 7 bankruptcy is an income tax refund that you have yet to receive. This is because your upcoming income tax refund is, legally speaking, your property even though you haven’t received it yet so it doesn’t feel like your property. Fortunately in most cases a little planning makes it possible to save all or part of your refund, but I do see cases from time to time where it is necessary to file bankruptcy immediately to stop creditor action and there is no real opportunity for planning.
As I said, even if you do lose part of your refund, it’s exceedingly unlikely that you’re going to lose all of it. This is due to a number of factors, but especially due to properly applied bankruptcy exemptions. Bankruptcy exemptions are laws that I use in your bankruptcy petition in order to protect your property as much as I can. For instance, in the case of income tax refunds I can usually exempt any funds that you receive from the Earned Income Credit or the Additional Child Tax Credit, two types of income tax credits that apply to people who have children. If you expect to receive a large tax refund, it is usually because of these two credits.
Another way I might be able to help you is through proper application of the wildcard exemption. In Ohio, the wildcard exemption allows me to protect $1,150 worth of whatever I want, and double that in a joint bankruptcy filing between husband and wife. If you have had substantial funds withheld from your paycheck over the course of the year then we are probably going to want to use the wildcard exemption to protect those funds. However, there are cases—such as when you have a high bank account balance or a paid-off car worth $3,450 or more—where I need to use the wildcard exemption to protect your bank account or car instead. This is why, in the case of a higher bank account balance than usual, I sometimes advise my clients to “spend down” the money they have in the bank on ordinary and reasonable living expenses and free up the wildcard exemption to help protect their tax refund.
Another tactic I commonly use is to just have you wait until you’ve received your tax refund so you can spend it on ordinary and reasonable living expenses prior to the date we actually file your case. After all, if the money is gone, then creditors cannot take it from you in bankruptcy. However, there are some very important rules that you must follow if we are going to pursue a strategy of this kind. Specifically, you ABSOLUTELY MUST NOT use the money to pay back debts that you owe to friends or family members. Paying money to friends or family members in the year prior to bankruptcy will get your friends and family members sued.
Another common no-no is to make catch-up payments towards your rent, mortgage or car payment if you’ve gotten behind. In ordinary circumstances it’s obviously a good idea to catch up on your obligations, but when you do this just prior to bankruptcy it can mess up your case. Specifically, the court doesn’t like these kinds of payments because they are favoritism—you are paying off the people you feel like paying and declaring bankruptcy on the rest. If you make these kinds of payments in the 90-day period prior to filing it is likely that the bankruptcy trustee is going to sue the person you paid, putting you right back into the position you were in before you paid the money. For instance, you might make $2,000 in catch-up payments to your landlord, file bankruptcy the next day, and then watch in horror as the bankruptcy trustee sues your landlord, gets the $2,000 back, and distributes the money to your other creditors. Obviously this is the kind of situation that is going to make your landlord very angry and probably trigger an eviction or other action against you.
There are a half-dozen other ways that an upcoming income tax refund can complicate your bankruptcy, but they apply only on a case-by-case basis and I don’t have time to explain them all here. The bottom line is if you need to file bankruptcy but expect to receive a large income tax refund then you need to work very closely with your attorney to make sure everything goes smoothly. Most bankruptcy attorneys do not run their business in a way that allows for that level of teamwork and planning, but I am proud to say that I do.