This is the time of year when many of us look forward to receiving a little extra pocket money in the form of an income tax refund. If you’re in a situation where you need to file for relief under Chapter 7 of the Bankruptcy Code, you can probably use that refund money now more than ever. With the proper planning, it is possible to save your tax refund and still get relief from your debt.
A tax refund is an asset that belongs to you regardless of whether you have received it yet or even filed your income tax return. As a result, upon filing a bankruptcy petition, your interest in a future refund becomes property of the bankruptcy estate. This means that a Chapter 7 bankruptcy trustee can require you to turn over the refund for distribution to your unsecured creditors unless it is protected by an exemption.
The trustee can take all non-exempt refunds owed to you for prior tax years. For example, should you file for Chapter 7 relief this year (2018) without first receiving and appropriately spending a non-exempt tax refund for the year 2017, the trustee can require you to turn over the entire 2017 refund. Additionally, the trustee may hold your case open to collect a portion of your non-exempt tax refund for the year 2018 once you have filed a return for that tax year. The portion of the 2018 refund that belongs to the bankruptcy estate is the amount earned between January 1, 2018 and the date of your bankruptcy filing. For example, a Chapter 7 filed in the month of October allows for a trustee to take approximately 80 percent of the total non-exempt refund.
The trustee may close your Chapter 7 case without first administering a non-exempt refund for the tax year in which you filed the bankruptcy. It is possible for the trustee to re-open the case at a later date, however, for the purpose of administering the refund after you have filed a tax return. For example, in the year 2019, months following the closure of your case filed in 2018, the trustee could assert that you are required to turn over the bankruptcy estate portion of your 2018 refund. Whether the trustee is entitled to the refund depends on the circumstances of your case.
The reason for specifying that the above applies to non-exempt tax refunds is because it is possible for a tax refund to be protected by an exemption in certain situations. If you have lived in Arizona for at least two years prior to filing Chapter 7, then Arizona state law governs your exemptions and your tax refund is unfortunately not protected by an exemption. However, should your exemptions be based on federal law because the law of the state that governs your exemptions provides as such, you may be able to protect your tax refund with the federal “wildcard exemption”. The federal wildcard exemption is currently $1,250 plus up to $11,850 of any unused portion of the federal homestead exemption. This enables a single filer who does not own a home, or have any equity in a home, to protect up to $13,100 in tax refund money.
The bottom line is that if you’re entitled to a non-exempt tax refund, you should consider waiting to file a Chapter 7 bankruptcy until you have received and spent it on necessary living expenses. That is not always the best course of action for your circumstances, as you may need to file the bankruptcy before then for various reasons, such as to stop a wage garnishment. But when your particular situation allows for it, preserving a tax refund that can be put to good use prior to filing bankruptcy makes sense.
Thank you for taking the time to read this article. Please keep in mind that it is general information only, which may not be appropriate for your specific situation, and is not intended to constitute legal advice or create an attorney-client relationship. You can also see our page about Myths About Bankruptcy. If you have any questions, please feel free to give me a call at 480-344-0981, or email me at email@example.com.