You received your W-2’s. You filed your taxes. You have a big tax refund coming. This year you are tired of using the whole thing to pay bills. Chapter 7 Bankruptcy is a serious option.
You want to keep your refund. You worked hard, you earned it. Why should you have to give it away? Have you heard from friends that if you file for bankruptcy, the Trustee might take it for your creditors?
Let’s talk about your tax refund for a minute. Exactly what is a tax refund? For most working people a refund represents additional income that you had taken from your pay to insure that you will not owe money to the government. The official term for this is deferred income. If your refund is significant it can best be described as poor planning.
What do you normally do with your tax refund each year? If like most people you use it for your bills.
What happens to a tax refund if you file a Chapter 7 bankruptcy?
First, your case Trustee has to decide it he is interested in the refund as an asset of the bankruptcy estate. In doing so, he will first determine what the refund consists of. In Ohio, the state legislature recently changed the exemptions with regard to tax refunds. There is now an exemption for the entire amount of a tax refund that is due to child tax credits and earned income credit. You need both.
After deducting these amounts, the Trustee will then prorate the amount of the refund to the date of filing. Sounds complicated doesn’t it? It is just simple math. If you filed your bankruptcy case prior to the end of the calendar year the refund represents, the Trustee will include only that portion of the year prior to the case filing date. That means that if you filed the case on September 30, only 9/12 of the refund will be as asset he can claim. If the tax returns are joint returns, and both had income, and only one of you filed for bankruptcy, the refund will be further reduced by the share of your non filing spouse. If it is a joint bankruptcy filing the whole prorated balance is in play. If you filed bankruptcy during the first months of the year there will be no proration.
Once the Trustee arrives at the prorated figure, he then determines how much cash on hand there was at filing of the case, and how much was held in bank accounts at the time. The remaining exemptions that might be available are applied. These are:
- $425 for individual for cash or bank deposits
- $850 for joint case for cash or bank deposits
- $1,150 per filer as a wild card exemption if not already applied to another asset
There always is a chance that the Trustee will want to take your tax refund for the benefit of your creditors. Normally, that is what you were going to do with it anyway, right? The best part is, this will only happen once, and from here on out when you get your tax refund it will be yours. But from what you have seen, although the trustee will may take the refund, in more cases than not, you will still receive at least some of the refund. If you either owe child support, or non-dischargeable taxes you won’t get your refund anyway. The Trustee might even intercept your refund. If so, he will determine how much is for the bankruptcy and then mail you your refund balance.
The best way to look at this whole process is to take the amount of the refund that the Trustee will either keep or intercept from the IRS. Compare that figure to the total amount of debt that you will be eliminating with a Chapter 7 Bankruptcy. If you just used the refund yourself to pay bills, you likely would still owe money to someone if not everyone after you went through the money. In a Chapter 7, you will be paying pennies on the dollar with the tax refund, and the debt will be gone.
Special Warning!
People who come to me for help with their finances generally are not great with numbers. Sound familiar? It is very common to use any one of a number of tax preparation services. One of the “benefits” they claim to provide is a tax refund anticipation loan. These go by a whole bunch of names. I bet you know some of them. Probably used one or more of them. These loans come with some really high fees and costs that come right out of your tax refund. They give you a check on the spot less all the fees, costs and interest. If you are in a chapter 7 bankruptcy, and you use one of these services, the fees, costs and interest will come out of your share of the refund, not the part the Trustee keeps for your creditors.
What do you need to do now?
If you need to file for bankruptcy protection and know, or expect that you have a big tax refund coming, your best bet is to find an experienced bankruptcy attorney. That way you can plan the use of the refund to maximize the benefit to you and the amount you can keep before you file your case. Another alternative is that unless there is another reason for filing now, Why not wait 3 or 4 months to file for bankruptcy. You can keep it from becoming an issue in the first place.
Picture by iStockPhoto
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