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How to Keep Your Tax Refund While Filing For Bankruptcy

It’s that time again...Tax Season! You are looking forward to receiving a big tax refund check and you may be contemplating getting your bankruptcy case filed. What do you do when you are expecting a sizable tax refund and you don't want to lose it to the bankruptcy trustee?

On the day the bankruptcy is filed, any assets that you own become part of the “bankruptcy estate”. Since you are entitled to receive your tax refund, that refund is part of the bankruptcy and if you do not do some pre-petition planning you may lose that refund. With a little planning I can help you keep most, if not all, of your tax refund.

If you do not have a house or your home has no equity then you may be able to elect the federal bankruptcy exemptions and keep the entire refund and not have to spend it. The federal exemptions can allow you to keep up to almost $12,000 in any personal property, which would include your tax refund.

The best way to avoid losing your tax refund if your house has equity, and therefore you cannot take the generous federal personal property exemptions, is to file your tax return, receive the refund and spend it prior to filing your bankruptcy. The Brooke Law Firm can instruct you as to what you can spend the money on and to keep a record of how your refund is spent. Your refund can be used for a variety of permissible expenses, including most of your ordinary household expenses, such as:

  • Rent
  • Mortgage payments
  • Food
  • Utilities
  • Clothing
  • Educational expenses
  • Medical and dental expenses
  • Insurance
  • Home maintenance and repairs
  • Car payments
  • Car repairs and maintenance

Just as long as you use the money for permissible living expenses and spend the money through the 'normal course of living' you should be fine when it comes to filing your bankruptcy. If you follow these steps, you will not be required to turnover your tax refund.

Caution! If you spend your tax refund on luxury goods, use it to repay a friend or family member or pay off a credit card or other unsecured debt, you may trigger an objection from the trustee, and be required to turn over your tax refund, even if you have spent the money. The trustee may also go after the creditor or family member for giving them preferential treatment. All creditors must be treated equal under the bankruptcy laws and you are not allowed to give preferential treatment to one creditor by paying him or her back at the expense of others. Imagine the look on aunt Beth's face when she gets a call from a bankruptcy trustee asking her to hand over the money you paid her a month before filing for bankruptcy!

How can you avoid this problem altogether? Answer: Don’t Receive a Tax Refund

If you had a large tax refund last year, the first thing we will ask you to do is to look at your W-4 and adjust your exemptions. You only want to have the necessary taxes withheld from your paycheck, nothing more. This is also the case if you are filing a chapter 13 bankruptcy with only a partial repayment to creditors. The bankruptcy trustee will be entitled to your tax refunds every year you are in a ch. 13 bankruptcy. Instead of receiving a tax refund and giving it to the trustee, wouldn’t you like to have a little more money coming to you in each paycheck throughout the year? I thought so! You can use the IRS withholding calculator to determine how many deductions you should be claiming.

Since your initial appointment with the Brooke Law Firm may be several months before you actually file your case, you should plan for your bankruptcy by adjusting your payroll deductions to avoid having the trustee take your refund. The bottom line is that you should plan to have a minimal refund if possible; or wait for the refund to be received prior to filing. Not getting a refund means you get to keep more money in each paycheck and avoid turning over a big refund to the trustee. Give yourself some peace of mind and call my office today to discuss your tax refund issues and make sure you get to keep as much as possible.