A tax refund can be a godsend when you’re running low on cash. If you’re thinking about going into bankruptcy, though, the prospect of receiving a tax refund may well be a pertinent one. Will you still be able to keep it?
The answer depends on your circumstances – when you file and what type of bankruptcy you use.
Tax refunds can at times become part of the bankruptcy estate so planning in advance can make a real difference.
Why Tax Refunds Matter in Bankruptcy
When you file for bankruptcy the property and financial interests in question become part of the so-called bankruptcy estate. A tax refund may be included in that estate as the right to the refund can accrue prior to the filing of the return or prior to the actual receipt of the refund.
For instance, a person who files Chapter 7 late in the year may have already earned the bulk of the income that will be reflected in the following year’s tax refund. The bankruptcy trustee could well regard the pre-filing portion of that refund as property of the estate.
Federal bankruptcy courts have recognized that the pre-filing portion of a tax refund can be property of the estate.
That doesn’t necessarily mean the whole refund is going to be lost.
What Happens to a Tax Refund in a Chapter 7?
Chapter 7 bankruptcy generally looks at the debtor’s financial position at the date you filed. If you’re already entitled to a tax refund when you file that refund generally must be disclosed as an asset. The same would be true if you haven’t filed your return yet but have already accumulated part of the refund via wage withholding or estimated tax payments.
When a bankruptcy is filed part way through the tax year the refund may be split between the amount earned prior to the filing and the amount earned after the filing. Courts have used various methods, depending on the timing of the bankruptcy filing, to make that split.
Bankruptcy exemptions can also have an effect on whether some or all of the refund is protected. MA filers have exemption options which can make the treatment of property a bit more complicated so the outcome should be considered on a case by case basis rather than be assumed in advance.
Tax Refunds Work Differently in Chapter 13
Chapter 13 bankruptcy normally lasts several years and involves the debtor making payments under a court approved repayment plan.
As the case remains open for such a long period of time, tax refunds received during the period of the repayment may be applied to the amount owed to the creditors. The way in which a particular refund is dealt with will be determined by the terms of the plan and the circumstances of the case.
Courts in certain jurisdictions will require a Chapter 13 debtor to contribute qualifying refunds to their plan. The bankruptcy process can also provide a mechanism by which a debtor can ask to be permitted to keep a refund where the refund is needed for reasonable expenses.
Your bankruptcy attorney will be able to explain how those rules apply to your Chapter 13 plan and whether or not an anticipated refund is required to be reported.
Timing Your Bankruptcy Filing Can Matter
The date you file bankruptcy will affect how your upcoming refund is treated.
Suppose you normally get a fairly substantial refund each spring. Filing shortly prior to getting that refund may give you a different outcome than receiving the refund first and then using it appropriately before you file. That said, you do need to be very careful about spending a refund prior to bankruptcy.
Using the money for day to day living may be very different from transferring it to another person or paying certain creditors immediately prior to the filing. The bankruptcy laws are very much concerned with certain transactions that take place prior to the commencement of the case.
This is one of the reasons why you should talk to an attorney about an anticipated refund prior to deciding when to file.
Always Disclose an Expected Tax Refund
Trying to leave a tax refund off your bankruptcy paperwork is going to create far more problems than the refund is worth.
Bankruptcy requires you to disclose your assets and financial interests accurately. You don’t need to know the precise amount of an anticipated refund, your lawyer can advise you on how that should be disclosed.
Transparency helps your lawyer assess available exemptions and whether the filing date will affect the outcome.
Speak With a Massachusetts Bankruptcy Attorney Before Filing
A tax refund could be the cash you were going to use for your household and other essential needs. Knowing how bankruptcy could impact that refund prior to filing is a chance to make the right decisions.
At Hines Law Offices, we help Massachusetts residents navigate Chapter 7 and Chapter 13 bankruptcy, including questions about tax refunds, exemptions, and the timing of a filing.
If you are considering bankruptcy and expect to receive a tax refund, contact our office for a free consultation. We can review your financial circumstances and help you understand what to expect before your case is filed.