Depending upon when you file your Chapter 7 petition and how much, if any, exemption you have available, you may not be able to keep all of your tax refund for the current or prior year.
When you file your petition after a tax year has closed, but before you receive your refund, you’ll be expected to forfeit that money to the trustee when it comes —unless there is an exemption available for it.
Bankruptcy Attorney Gregory Oberhauser will be able to crunch the numbers and advise you on how many exemptions you can take, where you might want to take them, and whether your tax refund can be covered.
Here is an example of what would happen to your 2019 refund.
If you filed your Chapter 7 on March 1st, 2019, then 2/12 of the tax year had already run, and the trustee will expect that portion of your refund be turned over to your bankruptcy estate once you receive it.
That’s because under the bankruptcy code, the estate of a petitioner includes debts, assets and rights to assets (or potential assets); such as the right to debts owed to you, the right to sue someone, and your right to wages earned, including tax refunds.
In short, the trustee gets to include your interests in any and all possible assets which existed before you filed your petition in your bankruptcy estate.
Getting The Most of Your Full Tax Refund
The laws provide Massachusetts exemptions for residents filing under Chapter 7, but these do not cover a tax refund or the estate’s authority to retain your right to it.
One sound strategy is to simply ensure you do not overpay your taxes by changing your withholding status with your employer. In real terms, much of a person’s tax refund is merely a loan made to the federal government, and not a monetary gain.
It is also possible to use a wildcard exemption, where there is enough of this state allowance, toward protecting your refund. This may or may not be the best strategy for everyone, however.
Another option is to file your Chapter 7 petition as early in the year as possible. So, February 1st, for instance. You’d only need to turn over 1/12 of your expected refund to your bankruptcy estate when it comes in.
You might also try a hybrid method of both filing your petition early in the year and lowering your W-4 withholdings. That may be most advisable.
Caution: Filing For Bankruptcy After Spending Your Refund
If you want to wait until after you’ve received your tax refund and have spent it, that may work, but only if you do not spend the cash in a way that can be perceived as “frustrating creditors.”
You might use your tax refund to pay for your bankruptcy filing.
You will be safe as long as you don’t purchase a luxury or unnecessary item, give it away, OR use it as repayment of any debts you owe, you’re probably going to be okay.
As your bankruptcy lawyer we can see if a “no asset report” will be submitted by the trustee after your discharge. If so, you can rest easy about your refund once that report is filed and your bankruptcy is closed.
Consult With Gregory Oberhauser, A Skilled Bankruptcy Lawyer in The Lowell Area
The bankruptcy and tax codes are separately complex —taken together they become very complicated. For example, after your bankruptcy is accepted, an estate is created which the IRS views as a separate tax entity.
Typically, this translates to filing a few more forms, but for certain taxpayers it can require strategic planning and insight from an experienced, well-qualified bankruptcy lawyer such as Gregory Oberhauser.
If you are considering filing for Chapter 7 bankruptcy and need guidance and insight, please feel free to call our office to set up a free consultation to start planning for your financial wellness.