Your tax refund is an asset in bankruptcy. This is true whether you file Chapter 7 or Chapter 13. Your refund is treated differently in each chapter, but generally, you can keep your tax refund in bankruptcy.
In Chapter 7, your bankruptcy assets are any assets you already own or reasonably expect to own. A tax refund is a great example. If you have not filed your taxes yet, but you know that you will receive a refund, that refund is part of your bankruptcy estate. Because the refund does not represent income earned in the last 60 days, it cannot be exempted under N.C.G.S. 1-362. It can, however, be exempt under N.C.G.S. 1C-1601(a)(2). This is commonly known as your “Wild Card” exemption. It can be applied to any assets.
By claiming an exemption, you are exercising your right to protect certain assets. Your Wild Card exemption is available to cover up to $5,000 of assets. So, as long as your refund is $5,000 or less, you can use your Wild Card exemption to protect it. If you’re filing with a spouse, you both have a Wild Card exemption, for a total of $10,000 in Wild Card exemption available.
By protecting your tax refunds in bankruptcy with an exemption, your bankruptcy case can move forward without the bankruptcy trustee taking that asset. You will receive your discharge, and when you receive your tax refund, it’s yours to keep.
Another option is to receive and spend your tax refund in bankruptcy before you file. So long as you spend the refund on normal living expenses, you are not running afoul of the bankruptcy rules. Additionally, if you purchase household goods like furniture, you can still protect42those new purchases with your household exemption under N.C.G.S. 1C-1601(a)(4).
Tax Refund Already Received—A tax refund you have already received prior to filing, but have not yet spent, is part of the bankruptcy estate and treated like cash. You may be able to use exemptions to protect the money.
Tax Refund Expected—A tax refund expected but not yet received is also part of the bankruptcy estate to the extent it relates to income earned prior to the date you filed your Chapter 7 bankruptcy. As a worst-case scenario, you will be required to turn over the return to the trustee. However, your bankruptcy attorney can also use exemptions to protect the expected tax refunds in bankruptcy, the same way you can protect the money that is in a savings account. The important thing is to disclose the expected return and exempt it in the bankruptcy filing.
Tax Refund For Years After The Filing—A tax refund received for income earned during a tax year after the year you filed bankruptcy (and all future returns) is yours to keep. They are not part of the bankruptcy estate.
If you are in Chapter 13, the same rules apply as outlined above for Chapter 7. However, these rules are only applicable to the year in which you are filing your Chapter 13. Because a Chapter 13 case runs for three to five years, you need to be concerned about future tax refunds in Chapter 13.
If you receive tax refunds in Chapter 13 in a year beyond your first year, you must disclose this refund to the Chapter 13 bankruptcy trustee. Generally, you are allowed to keep $1,000 per debtor each year. Additionally, if you have any unused Wild Card you can apply it to your tax refunds received in subsequent years. Lastly, if your tax return shows that your refund is due to an earned income credit or a child tax credit, the refund is yours to keep.
If you cannot protect your tax refund in Chapter 13 in the above manner, you can also petition the court to keep your refund due to the fact it is necessary for living expenses. An example would be that you have been putting off repairs to your home or vehicle, and the non-exempt tax refund will be used for those repairs. Quite often, clients are making ends meet but putting off normal and routine household expenditures to do so. For this reason, the court entertains a request to use your tax refund in Chapter 13 to get ‘caught up on household expenses.
Tax Refund Already Received—A tax refund you have already received will be treated as an asset. While the trustee may not take the tax refunds in bankruptcy, any assets you own play a role in determining the amount you will ultimately pay to creditors in Chapter 13. The refund, if it can not be exempted, may bump up your Chapter 13 payment.
Tax Refund Expected—The safe assumption regarding tax refunds in an ongoing Chapter 13 is that they will become the property of the trustee. While you may use exemptions to protect an expected return, the typical Chapter 13 plan is 36 to 60 months.
Tax Refund For Years After The Filing—The same answer as directly above applies here. The tax refund is yours to keep and is not part of the bankruptcy estate.
Adjusting Your Withholding In Bankruptcy
One allowable way to help ensure you don’t lose any money in Chapter 13 is to adjust your tax withholding. This way, rather than receive a large refund in bankruptcy at the end of the year, you receive more income each month. Your Schedule I and J filings in Chapter 13 should reflect this, and your overall budget will change slightly; however, it will help you avoid the annual chore of trying to prove to the Chapter 13 court that you should be allowed to keep your tax refund.
What Can I Do To Plan Around This?
In Chapter 7, you can spend your tax refund prior to filing. Or, make sure to put your attorney on notice that you expect to receive a return and be sure to exempt it or postpone filing until the asset has been spent on allowable items.
In Chapter 13, tax refunds in bankruptcy represent an ongoing issue, and the easiest way to manage it is to reduce your withholdings so that you’re receiving more in your paycheck on an ongoing basis rather than ‘storing’ up money with the IRS which will result in a large return.
If you do receive a refund in Chapter 13, disclose the return each year to the trustee. Each trustee’s policies (in different districts) differ. If you can show that you need some or all of the return for necessary expenses like home repairs or vehicle repairs, you may be able to keep some or all of the return. Your bankruptcy attorney should assist you in making this disclosure to the court, together with the argument that you have a need to use the return vs. it going to the trustee.
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