Will I lose my tax refund if I file for bankruptcy?

 Posted on February 22, 2024 in General Bankruptcy Topics

Understanding how tax filing and refunds work during bankruptcy can be confusing. The rules differ for Chapter 7 and Chapter 13 bankruptcy filings, and they are complex.

Whether you have already filed for bankruptcy or think it may be in your future, you need to understand your tax obligations and how the refund process works. Learning what happens to your refund may help you decide which filing works best for you, but seeking a bankruptcy lawyer's assistance will provide the best information.

Bankruptcy estate

A bankruptcy estate refers to all the property, assets and interests that a debtor possesses at the time of filing for bankruptcy. This includes tangible assets like real estate, vehicles and personal belongings, as well as financial assets like bank accounts, investments and potential legal claims. A court-appointed trustee manages and administers the bankruptcy estate.

In Chapter 7 bankruptcy, a bankruptcy estate comprises the debtor's non-exempt assets, including property and financial holdings. A trustee liquidates these assets to repay creditors.

A Chapter 13 bankruptcy estate includes the debtor's property and earnings. However, the debtor retains possession and control of these assets while adhering to a court-approved repayment plan. Any disposable income generated during the repayment period becomes part of the bankruptcy estate.

Advantages of Chapter 7

In Chapter 7 bankruptcy, income tax refunds earned before the bankruptcy filing date are typically part of the bankruptcy estate. The bankruptcy trustee may use these refunds to repay creditors. However, Chapter 7 filers only lose their refund once.

If a debtor qualifies to receive a tax refund after filing for bankruptcy, they may be able to claim exemptions to keep a portion of it.

After a Chapter 7 filing, income earned belongs to the debtor and is not part of the bankruptcy estate. The debtor can use this income freely, but any debts discharged in the bankruptcy remain unaffected.

Advantages of Chapter 13

Whether you must surrender your tax refund in Chapter 13 depends on your specific circumstances. Creditors should receive any extra or "disposable income," so expect to turn over your tax refund to the court-appointed trustee annually for creditor payments.

Certain factors may allow you to retain your refund, such as if your repayment plan incorporates refund retention, you qualify for an exemption or you are paying a significant portion of your debts.

In many cases, Chapter 13 filers do not receive tax refunds until they fully pay their bankruptcy obligations. Still, Chapter 13 is sometimes the better option because you get to keep other assets, such as your home.

Consult an attorney

Bankruptcy is a complicated process, with tax refunds being only one confusing issue. Work with a competent lawyer to decide whether Chapter 7 or 13 is best to protect your interests.