How to Protect Your Tax Refund in Bankruptcy

As a W-2 employee, your tax refund may be a predictable source of income you rely on to boost your savings every April. In 2019, the average refund was $2,725. If you’re like 73 percent of workers, you might be expecting a refund on this year’s return, which begs the question—when filing for Chapter 7 bankruptcy, is your tax refund yours to keep?

The answer depends on when you file for bankruptcy and whether your tax return is exempt. Follow these tips to help you protect your tax refund in bankruptcy.

Defining Your Bankruptcy Estate

When you file for bankruptcy, your assets become part of your bankruptcy estate. A trustee controls these assets, some of which are sold to repay your debt. In most situations, you are permitted to keep any assets you acquire after filing for bankruptcy.

However, tax refunds work a little differently. You might not receive your refund until months after filing for Chapter 7, but the refund accrued during the previous tax year. Therefore, any portion of the refund tied to your pre-bankruptcy income is part of your bankruptcy estate. This means, unless it’s exempt, your tax refund belongs to your trustee and may be used to repay your debt.

Protecting Your Tax Refund

Adjust your withholding

Plan on filing for Chapter 7 in the next year? Avoid receiving a refund at all by changing your withholding. This way, the correct amount you owe in taxes comes out of each paycheck, leaving you with more money every month and avoiding the need to protect a refund.

Use an exemption

Under the right circumstances, it may be possible to protect your tax refund with a bankruptcy exemption. For instance, you might choose to apply your wildcard exemption to your tax refund, protecting this cash asset, at least in part, from your bankruptcy trustee.

Spend your tax refund before filing for bankruptcy

If it looks like you won’t be able to use an exemption, consider delaying your bankruptcy filing. You can spend your tax refund on essential expenses—including mortgage or rent, home repairs, utilities, food, clothing, medical costs, insurance, or car repairs—before filing without creating problems in your bankruptcy case. By doing so, there is no tax refund to protect because you already spent it.

However, don’t be tempted to spend the refund check if you already filed for bankruptcy, and your refund is not exempt. Failure to turn over a non-exempt refund could lead to you being denied a bankruptcy discharge. Your complete honesty during the bankruptcy process is the best way to speed up your financial recovery in the long run.

The best time and method of filing for bankruptcy depends on your specific situation. To help you create a fresh start for yourself, contact Cutler & Associates. Our Chicago bankruptcy attorneys can answer all your questions and give you the information you need to make the best decisions for your financial future. Call (773) 360-5802 today to schedule your free consultation.