Since tax season just ended and people should be receiving their refunds, we decided to address one of the most popular questions asked around this time each year. “If I am eligible for a tax refund, but I filed for bankruptcy, can I keep the refund when it arrives? This is a valid question, but it doesn’t have just one answer. In fact, the answer to this question depends on the timing of your filing. This article will examine this hot topic and hopefully answer your questions regarding your tax refund.
Before we get started, just for fun – do you know the number one question posed regarding bankruptcy reported by bankruptcy attorneys? We’ll tell you at the end of this article.
How Chapter 7 Works
To answer the tax refund question, it is necessary to understand how the Chapter 7 process works. Chapter 7 bankruptcy is the simplest form of bankruptcy and is also referred to as a straight or liquidation bankruptcy. Unlike other forms of bankruptcy, a Chapter 7 filing does not involve or require developing a repayment plan to pay all creditors back the monies they are owed.
Instead of mandating a repayment plan, the bankruptcy court appoints a trustee to oversee the bankruptcy petition. The trustee will repossess and sell any of your property that is not considered exempt. The proceeds from the sale of your assets will then be distributed to your creditors.
Fast Fact: State law identifies some assets as exempt from being sold off. Read more about Florida Bankruptcy Exemptions here.
Can You Keep Your Tax Refund?
Now that you understand the general process involved with Chapter 7 bankruptcy, let’s address the question at hand – can you keep your tax refund? Is your tax refund exempt?
The timing of your filing is relevant for determining your refund status. There are three stipulations related to the timing of tax returns.
1. You received your refund before filing: Typically, any money in your possession is considered part of your estate and subject to surrender. Your trustee will use this money to pay your creditors. You can legally keep the entirety of your tax refund if you spend it before filing – but only on approved expenses such as mortgage payments, food, and clothing for you or your family, your car or truck payment, or medical and educational expenses. Although it seems counterintuitive, if you use your refund to pay off a single creditor, that is considered an unapproved expense. The bankruptcy process is designed to give equal treatment to your debtors. Buying luxury items or repaying a personal debt to a friend or family member is not allowed.
2. You intend to file bankruptcy soon: The money you receive from your tax refund, as stated above, is considered a part of your estate and is subject to distribution to your creditors. One way to mitigate this issue is to adjust your tax deductions in your paycheck. Many people “overpay” taxes in each paycheck to receive a tax refund once a year – a type of “forced saving.” You can adjust the amount deducted from your weekly or monthly paycheck to ensure that your eventual taxes are covered but significantly reduce your tax refund.
3. You received your tax refund after filing for bankruptcy: Your bankruptcy was based upon pre-filing income. You may be allowed to retain a portion of your refund in this scenario. You’ll want to speak with an experienced Florida bankruptcy attorney to understand your options in this situation.
What About the Most Popular Question?
At the beginning of this article, we promised to reveal the question most asked of bankruptcy attorneys regarding paying back creditors. So here it is. “If I win the lottery, do I have to use my winnings to pay off all my creditors?”
The odds of winning a life-changing amount of money are astronomically against you – about 1 in 176 million, and you are 250 times more likely to be killed by a lightning strike than win millions. And while there is always a possibility, we recommend that you improve your odds of financial success by hiring an experienced bankruptcy attorney to help you navigate through the process and begin a new life free of debt.
Richard V. Ellis is a Sarasota bankruptcy attorney who has helped hundreds of individuals and families return to financial freedom.
