What Happens to Tax Refunds in Bankruptcy?

A tax refund is money that the government owes you because you paid in more (usually withheld from your pay) than what you owe in taxes. Since someone else owes you money, a tax refund is an “asset” like your bank account or your car, and it must be disclosed in the bankruptcy petition.

In a Chapter 7, if you have not yet received your refund, you should disclose it, and then your lawyer will claim an “exemption” in it so that you keep it. You can exempt up to $5,600.00 per debtor, but this same amount must be used to protect bank accounts and other miscellaneous property.

If you have already received the tax refund before you file bankruptcy, then it is not an asset at the time you file, and you would not need to disclose it or to use your available exemptions to protect it as a tax refund. However, if the money was simply deposited in your bank account, you would then exempt that money as a bank account, but not as a tax refund. The same $5,600.00 limit would apply.

A Chapter 13 lasts a period of years. In some Chapter 13 plans, you are required to pay future tax refunds into the plan, but that is not true for all plans. If your plan is a “100%” plan where you are repaying your unsecured creditors in full, you will not be required to pay in tax refunds for distribution to creditors. However, if your are paying less than 100% to your unsecured creditors, you will be required to pay in refunds unless you file a motion with the Court requesting to keep all or part of the refund to meet specific and unusual needs. This type of motion is usually granted, but the Trustee sometimes requests documentation to prove that your need is real and necessary.

A Chapter 13 plan where you are paying unsecured creditors less than 100% is called a “composition plan”. In composition plans, the Court will require you to send a copy of your tax return to the Trustee each year so that the Trustee can know whether or not you are due to receive a refund. If you are supposed to receive a refund, and if you have a specific reason as to why you need to keep it, you should contact your lawyer to explain. He or she will make the necessary motion or request if it appears that the request is one that the Court would grant. Otherwise, you will be obligated to pay the refund money to the Trustee.

Local bankruptcy courts and trustees do not always treat these matters in the same way. Please call us at 770-683-3303 today to discuss your specific situation.