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Tax Refund Season

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It is that time of year again: tax filing season! For some that means the joy of getting a tax refund and for those who are expecting a tax refund and also contemplating a bankruptcy filing, there are some important things to consider.

If you file bankruptcy now you may forfeit your tax refund.

Let’s say you file a bankruptcy in February but you have not yet filed your tax returns. A month later you get around to filing your tax return and learn that you will be getting a $1500 refund for the prior tax year. Great news, right? Wrong! Because that tax return is for the prior tax year (for instance 2010 if you are filing bankruptcy now in 2011) that refund is 100% attributable to income you earned prior to the bankruptcy filing. That means it is 100% part of your bankruptcy estate. You will have to turn over that refund to your bankruptcy Trustee and they will pay your creditors with it.

If you want to spend your tax refund you should wait to file your bankruptcy.

Now let’s imagine that you came to my office prior to filing your case in February and told me you might be getting that $1500 tax refund in March and that you planned on using it to buy a new living room set because the old one is falling apart. I would say, great! But you cannot file your bankruptcy just yet. You would have to first file your taxes, get your tax refund, and then spend that tax refund on that wonderful living room set. The day after you bought the living room set, if you filed a bankruptcy now you would not have to turn over the $1500 refund and your living room set could be claimed as exempt property. Of course that old living room set would be part of your bankruptcy estate because you can only claim so much furniture as exempt, but hey, you don’t want it anyway (and in all likelihood no one would ever buy it from the Trustee). That is a great result.

If you already filed your bankruptcy you cannot endorse or sign your tax refund check.

Now let’s get complicated. Let’s say that you already filed a Chapter 7 bankruptcy on September 1, 2010.  At that time, the 2010 tax year was 8/12 completed (August is the 8th month). Let’s say your bankruptcy was completed, discharged, and closed in December of 2010. Now let’s imagine that you just filed your 2010 tax returns and are owed a whopping $10,000 tax refund for the 2010 tax year. Even though your bankruptcy is over, your tax refund is partially attributable to pre-Bankruptcy income. Therefore, you will have to mail your tax refund check directly to your Trustee. Since only 8/12 of your refund is attributable to pre-filing income, your Trustee should send you back 4/12 of the refund amount (or around $3,333.33).

In Chapter 13 cases, tax refunds are considered diverted or deferred compensation and the Trustee will take them into account in determining your available disposable monthly income. Depending on language in your Chapter 13 plan, you may be required to turn over all refunds as additional payments under the plan.


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Hamid Jabbar

Hamid Jabbar

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