Tax Refunds and Chapter 7 Bankruptcy

When you file Chapter 7 bankruptcy, a Trustee is appointed to your case. The Trustee’s job is to look for assets. One asset a lot of clients or their attorneys overlook is a tax refund.

A tax refund is money that you overpay to the government through the previous year. Taxes are taken out of your pay each pay period and sent to the government to cover your tax debt at the end of the year. When the amount that accumulates is more than what you owe for the year, you receive a refund of what you overpaid. This refund will be taken from you by the Trustee unless you can exempt the money or prove that it is not an asset of the bankruptcy estate.

Any money that you pay to the government before filing the Chapter 7 bankruptcy case is an asset of the bankruptcy estate. Any money you pay after you file is not. Example: On July 31, 2011 you file for Chapter 7 bankruptcy protection. This is day 182 of a 365 day year. Any money paid up to this point is an asset of the estate and can be taken by the trustee unless it can be exempt with a State or Federal exemption. (Please see the Exemptions blog for a detailed explanation of this subject.)

On April 15, 2012, you will file your taxes and provide the Trustee with a copy of the return. The Trustee will see that you received a refund. Let’s say it was $4,000.00. The Trustee will then ask for the portion that was earned prior to filing. To determine this amount the Trustee or your attorney will divide the $4,000.00 tax refund by 365 days and then multiply this number by the number of days accumulated prior to filing. $4,000.00 / 365 = $10.95 x 182 days = $1,992.90 is an asset and will be taken from you.

Strategically, people who get larger refunds will file in the first quarter of each year to deter the Chapter 7 Trustee from going after the tax refund. The amount of the refund that would be an asset of the estate is so small that it may deter the Trustee from going after it as they would have to hold the case open for an entire year and produce paperwork for very a small amount of money. Generally, Trustees will not go after a tax refund if you file a Chapter 7 bankruptcy case prior to August or September.

Earned Income Creditis not a part of the tax refund that can be taken. It is automatically protected if it has not been received or comingled with other money. Who qualifys for earned income credit?

Some people that receive large tax refunds will try and file at the beginning of the new year right after they have just received their large tax refund. When this happens the Chapter 7 Trustee will require proof of where the money went. Proof will be and explanation with receipts. If the money was spent on frivolous things that are not necessary for your household or you can’t provide prove where it went, the Chapter 7 Trustee will object to your case.

If you’re considering filing Chapter 7 bankruptcy, it is important that you get legal advice from an experienced bankruptcy attorney so that you will be aware of how and when you file affects your tax refund.