Can I Keep My Tax Refund in a Chapter 7?

Many people who are interested in filing for Chapter 7 Bankruptcy are interested to know if they are able to keep their tax refunds if they decide to file.  The answer to this question depends on when your case is going to be filed in the bankruptcy court.  Starting in the month of September of each year, our attorneys begin to ask prospective filers what they expect to receive as a tax refund for the upcoming year.  If the debtor is expecting to receive a tax refund, the attorney will want to know how much they expect to receive.  This is due to the fact that at about this time of year, the trustee begins to take an interest in tax refunds as an asset that is to be included in the bankruptcy estate.  This means that your trustee will potentially want you to turn over your refund, so he or she can distribute the funds to your creditors.  With that being said, your trustee may not be entitled to your whole tax refund.  In fact, depending on when your case is filed, they may only be entitled to a small percentage of it.

The portion of your tax refund that the trustee is entitled to is dependent on when your case is filed with the court.  If you have a case that is filed between September 1-December 31st of the year prior to when your tax returns are due, the trustee will be entitled to a percentage of the tax refund you are expecting to receive the following year.   The court also gives you certain exemptions to keep property, including money in a bank account or an expected tax refund.  The amount of these exemptions vary case by case depending on what state your case is filed in, whether you are head of your household and/or married, and whether you have dependents under the age of 21.  This is something that you will need to consult your attorney about to determine for your specific case how much could be protected.  Additionally, there were recent changes that also allow Earned Income Credits to be 100% protected as well.  If you receive Earned Income Tax Credits, the entire amount received will be protected in the bankruptcy.

As an example, if a debtor is planning to file for Chapter 7 bankruptcy and expects a $4,000 tax refund, and they want their bankruptcy filed on September 1st (the 244th day of the year), we explain that 244/365 about 67% ($2,673.97) of the tax refund for the next year is part of the bankruptcy estate.  Does this mean the trustee automatically gets over $2600 of this client’s refund? No.  The attorney would then determine what exemptions are available to the client depending on their household size and dependents, and the attorney would help determine if any of the refund is going to be Earned Income Credit.   If the client is not head of household, does not have any dependents, and will not be receiving an Earned Income Credit, the amount that could be protected would be limited to a $600 wildcard exemption in the state of Missouri.  Factoring in the information above, this would mean that the trustee could require the client to turn over $2,000 of their $4,000 refund.  This client may want to wait to file the bankruptcy until after they have received and spent their tax refund. Once it is spent, it no longer needs to be listed as an asset, and the trustee will not be able to require you to turn it over to the bankruptcy estate.

However, if you choose to wait to file for bankruptcy for the purpose of retaining your full tax refund, it is important to be cautious of what you are spending the money on. You cannot make payments to family members or friends that you owe money to, and you do not want to pay certain creditors more than $600.  This is because the trustee can void these transactions and require your family and friends or your regular creditors to pay back the money you gave them to the bankruptcy estate.  Additionally, you should not spend the money on extravagant items or unnecessary expenses.  You can, however, pay normal expenses: rent/mortgage payment, utilities, necessities for yourself or dependents, etc.   If you are not sure whether the bills you plan to pay with your tax refund are acceptable, contact your bankruptcy attorney BEFORE you spend the money so they can help let you know.   It is always best to be cautious with how you spend the money than to wind up in a situation where you need to pay money back, etc.   Additionally, you should keep record of what you spent the money on just in case your trustee requests to see documentation of where the money was spent.

If you have questions about how much of your tax refund you can keep, it is important to discuss your options with a bankruptcy attorney.

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