The Role of Tax Refunds in Bankruptcy

A commonly overlooked issue when it comes to bankruptcy is what happens to the debtor’s tax refund. Income tax refunds are treated like any other asset owned by the debtor except that it is still being held by the government. The Trustee has an interest in a pro-rata share of the refund based on the month you file because the refund has been earned up to that point. If you file at the end of April, the trustee could have an interest in 4/12ths of your next year’s tax return. When someone files for bankruptcy protection, they are only allowed to keep a limited amount of assets, called exempt property. These exemptions are limited and are declared at the time of filing the petition. If the trustee has any objections to these exemptions, he or she must formally announce those objections within thirty days of the filing of the bankruptcy.
There are a few different strategies on how to deal with refunds. Some attorneys suggest that the debtor wait until they get their refund, spend the refund on reasonable and necessary living expenses such as gasoline, groceries, healthcare etc. and then file for bankruptcy. Others suggest that the debtor adjust their deductions (if there’s enough time to do so) so that the return will be smaller or non-existent. If possible, I prefer to use the debtor’s remaining exemption amounts to cover the trustee’s interest in the return. If the trustee would get $400 and the client is eligible to keep $400 due to their exemptions, I can use the exemption to let the client keep the money.
Although it’s not often an attractive option, the debtor can also simply give up the whole tax return if they feel their exemptions are better used elsewhere.
If you have questions about keeping your tax return in a bankruptcy, or some other kind of bankruptcy question, contact a Jacksonville Beach Bankruptcy Attorney or call us at (904) 685-1200 for a free consultation.