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Bankruptcy and My Tax Refund: Can I Lose My Tax Refund if I File for Bankruptcy?

tax refund

Yes, you CAN lose your tax refund when you file for bankruptcy. But what are the rules that govern when and how you can lose your tax refund? Let’s discuss the rules for when you can lose your tax refund in bankruptcy.

Losing Your Tax Refund in Chapter 7 Bankruptcy

You can lose either part or the entirety of your tax refund when you file Chapter 7 in Indiana or other states that do not have a large “cash” or “general intangibles” exemption.  The idea is simple: many states do not allow you to keep a lot in cash accounts or other monies owed to you when you file for bankruptcy. Therefore, if you have a tax refund that is going to be due to you in the future, it may exceed this low amount that your state allows you to keep. Therefore, they can take your tax refund in order to pay back some of your creditors.

How Does the Bankruptcy Trustee Calculate the Amount That I Will Lose of my Tax Refund in Chapter 7?

If your assigned Bankruptcy Trustee believes that you will have a tax refund that is large enough to repay some of your creditors, then he will plan to do a future calculation of your upcoming tax refund to see how much will be owed to your creditors. The Trustee will then return back to you the amount that is not due to your creditors.

The calculation is simple: it merely is a fraction of how far (how many days) you’re into the current tax year. Therefore, if you are approximately one half the way through the current tax year when you file, then the fraction may look something like this: 182/365. If you are only one month into the year, it may look like this 31/365. Whatever “fraction” or percentage is due to the creditors will depend on how far you are into the current tax year.

The above calculation is very simple, but there are a few more things to keep in mind when calculating tax refunds owed in bankruptcy. First, the Trustee must subtract any bankruptcy exemption from their calculation also such as your cash exemption or earned income credit. You’ll get to keep those exam portions of your tax refund also.

Second, the trustee may take the entirety of your tax refund(s) for either old year’s tax refunds due to you or if you file at the beginning of the tax year before you receive and spend your that tax refund. The idea behind taking all the refunded is also simple: these years are calculated as 365/365 because those years have already entirely passed.

Lastly, it is also important to remember that your Trustee may not take your tax refund at all. If your tax refund is not going to generate a dividend to creditors that exceeds $1000-$1500, then it may be too little of a payment for creditors to justify the hassle and expense of collecting it. If your Trustee decides that it is not worth the administrative expense, he may “abandon” your tax refund entirely. “Abandon” simply means that the Trustee does not want it and you can keep it all.

Tax Refunds and Chapter 13 Cases

Chapter 13 cases are usually not as interested in tax refunds as chapter 7 cases. However, it is important to note that you may lose anywhere from one half to 100% of your tax refund every tax year during the life of your chapter 13 plan.

Chapter 13 trustee’s, however, many times do not desire any amount of your tax refund to be turned over to the chapter 13 plan. In such cases, it is because you are most likely paying a sufficient dividend to your creditors before the Trustee is taking part of your tax refund. In addition, the administrative effort of monitoring the turning over tax refunds is very burdensome for the Chapter 13 Trustee.

Also, studies show that chapter 13 participants that able to keep part or the entirety of their tax refund are more likely to successfully finish their chapter 13 case. The tax refund allows the debtors to catch up with their finances during the life of the plan. Therefore, many Chapter 13 Trustees avoid the turning over of tax refunds whenever possible.

Keep in mind that if you dramatically over withhold for taxes, you will be more likely to asked to turnover your refund during the life of the chapter 13 case.

Conclusion: You Can Lose Your Tax Refund in Bankruptcy

With the knowledge that you can lose your tax refund when you file for bankruptcy, perhaps you can file at an optimal time of the year to not lose your tax refund. Other times, such a plan is simply impossible: you will simply have to deal with the realities of losing your tax refund. If you have any other questions about bankruptcy or tax refunds, our office is ready to help.