In Utah the answer is almost always no. A tax refund is a valuable asset to both and your bankruptcy creditors and you’ll likely want to keep as much of it as possible. Maximizing your portion in bankruptcy takes careful planning and will depend on the bankruptcy chapter you file, the timing of your filing, and the state in which you live. If you’re considering filing for Chapter 7 bankruptcy and you’re expecting to receive (or have received) a tax refund, you probably want to know what will happen to that refund. The answer will depend on several factors, including when you receive it, the timing of your bankruptcy, and whether you can protect the funds with a bankruptcy exemption. If you’re in a situation where you need to file for relief under Chapter 7 of the Bankruptcy Code, you can probably use that refund money now more than ever. With the proper planning, it is possible to save your tax refund and still get relief from your debt. A tax refund is an asset that belongs to you regardless of whether you have received it yet or even filed your income tax return. As a result, upon filing a bankruptcy petition, your interest in a future refund becomes property of the bankruptcy estate.
This means that a Chapter 7 bankruptcy trustee can require you to turn over the refund for distribution to your unsecured creditors unless it is protected by an exemption. The trustee can take all non-exempt refunds owed to you for prior tax years. The trustee may close your Chapter 7 case without first administering a non-exempt refund for the tax year in which you filed the bankruptcy. It is possible for the trustee to re-open the case at a later date, however, for the purpose of administering the refund after you have filed a tax return. If you have lived in Utah for at least two years prior to filing Chapter 7, then Utah state law governs your exemptions and your tax refund is unfortunately not protected by an exemption. However, should your exemptions be based on federal law because the law of the state that governs your exemptions provides as such, you may be able to protect your tax refund with the federal “wildcard exemption”. The federal wildcard exemption is currently $1,250 plus up to $11,850 of any unused portion of the federal homestead exemption; however, this doesn’t work in Utah. This enables a single filer who does not own a home, or have any equity in a home, to protect up to $13,100 in tax refund money. The bottom line is that if you’re entitled to a non-exempt tax refund, you should consider waiting to file a Chapter 7 bankruptcy until you have received and spent it on necessary living expenses. That is not always the best course of action for your circumstances, as you may need to file the bankruptcy before then for various reasons, such as to stop a wage garnishment. But when your particular situation allows for it, preserving a tax refund that can be put to good use prior to filing bankruptcy makes sense.
Keeping a Refund in Chapter 7 Bankruptcy
If you worried that you’d lose a refund in bankruptcy, there are things you can do to protect it. In most cases, you’ll be able to keep your tax refund if you:
• have enough time to adjust your withholding to reduce the refund to a minimal amount
• spend the refund on necessary expenses, or
• protect (exempt) the refund with a bankruptcy exemption.
Adjust Your Tax Withholding
If you think that you’re going to file for bankruptcy, you can avoid the refund issue by adjusting your tax withholding so that you only pay the tax you owe. You’ll get more money in each paycheck that you can use to pay for necessary expenses. It’s important to make sure, however, that you continue to withhold a sufficient amount to cover the taxes you do owe.
Spend the Refund on Necessary Items
If you’ve received your tax refund and haven’t yet filed for bankruptcy, you can spend it on necessary items that you currently need, such as:
• mortgage payment, rent, or home repair
• medical care
• car payments and maintenance, or
• education costs.
Expenses that aren’t allowed include:
• luxury goods
• repayment to a friend or family member
• expenses paid in advance (for instance, you can’t make multiple rent payments), or
• repayment of one credit card.
If you buy luxury goods, the trustee could seek to deny your discharge because of bad faith. If you pay back one of your creditors and ignore the others, the trustee may find that you have made a preferential payment that favors one creditor over another. The trustee can force the person or company who received the money to return it to the estate. Therefore, if you spend your tax refund, you’ll likely want to do so on necessary expenses that you need currently. Also, you’ll want to keep good records of how you used the money. However, be aware, that some districts might have different practices. A local bankruptcy lawyer can tell you what you can expect in your area.
Use an Exemption to Protect the Refund
When a debtor files for Chapter 7 bankruptcy, all of the person’s assets become part of the bankruptcy estate, which is administered (controlled) by the Chapter 7 bankruptcy trustee. In Chapter 7 bankruptcy, the trustee can use the assets you have when you file for bankruptcy to pay your unsecured creditors (those creditors holding debt that isn’t secured by property). That doesn’t mean that you’ll lose everything that you own. You’re entitled to keep (exempt) the property that your state believes you’ll need to work and live. Most states don’t let you protect much cash or money in a bank account. However, some state exemption systems have generous wildcard exemptions that cover any property of your choice that you could use to cover a tax refund. Some individuals filing for Chapter 7 or 13 bankruptcies will be able to protect a tax refund but not all. Whether you can keep your return will depend on the laws of your state and the pre-bankruptcy precautions you take to protect your refund. A tax refund is an asset in both Chapter 7 and Chapter 13 bankruptcy. It doesn’t matter whether you’ve already received the return or expect to receive it later in the year.
If you still have it in your bank account, if it’s being processed, or if you’ll get it once you file, it’s an asset. You can expect the appointed bankruptcy trustee to ask you whether you’ve received or expect to receive a return. As with all assets, when you file for bankruptcy, you can keep your return if you can protect it with a bankruptcy exemption. Each state decides the type and amount of the property you can exempt, and so protections vary widely. As a rule, a tax refund isn’t always easy to protect. Most states don’t have a specific tax refund exemption. However, you might have a wildcard exemption available to you. The wildcard exemption protects any asset of your choice. Also, your state might allow you to choose between the state and federal exemption systems. The federal wildcard exemption is usually larger than that of the state. Find out the current amount of the federal wildcard exemption.
Planning for Chapter 7
Here are some ways to increase your chances of keeping your tax refund in Chapter 7 bankruptcy.
• If you file during tax season: Individuals who file bankruptcy during tax season often have to figure out what to do with the tax refund they have just received. You can use any available tax refund or wildcard exemption to protect it. But if your state doesn’t offer these exemptions, or you want to save your wildcard for other assets, consider these strategies: If possible, file for bankruptcy after receiving and spending your tax refund. If you choose to do this, be sure to use your refund on necessities (living expenses such as your mortgage, medical expenses, clothing, or food) and not to purchase new assets.
• Use your tax refund to pay your bankruptcy attorney for the fees and costs of your case. These strategies have been found to pass muster in most bankruptcy cases because you’re allowed to use your assets to pay expected living expenses. Neither option involves an attempt to avoid paying a creditor, which is considered fraudulent in bankruptcy.
• Adjust withholdings: If you expect a significant return because of amounts deducted from your paycheck, the fix is to adjust your tax withholding early in the year. Keep in mind that this tip won’t be as helpful if you change your withholding later in the year such as from October through December.
• Contribute to retirement. You might want to defer more of your salary into an employer IRA or 401k. However, depositing the tax refund into your bank account before making a retirement fund contribution won’t work. Once the return hits your account, it will become an asset.
Tax Refunds in Chapter 13 Bankruptcy
When you initially file for Chapter 13, you’ll need to protect your tax refund with an exemption to keep it, or use it for necessary expenses before filing, as discussed above. If you can’t, you’ll pay it to your creditors. During your three to five year repayment plan, it works a bit differently. You’re required to contribute all disposable income to your Chapter 13 plan. If your plan pays less than 100% to creditors, the trustee can keep your tax refund. It won’t reduce your plan payment, however. Your creditors will receive the percentage of your total disposable income, which will include your tax return that they’re entitled to under your plan.
Possible Ways to Keep a Tax Refund in Chapter 13
Determining what to do with your tax refund is mainly discretionary, so your trustee might allow you to keep the tax refund. An unforeseen event or need that has affected your ability to pay living expenses might sway the trustee. For instance, it’s common for a debtor to need car repairs or a new vehicle at some point during the plan. Even so, in most cases, the trustee will require you to contribute your tax refund as part of your Chapter 13 plan. As a practical matter, one of the only available preventive options in Chapter 13 is to adjust your employment tax withholding to decrease your tax refund. The smaller your refund, the less the trustee can take. But it’s best to do this before filing for Chapter 13. You wouldn’t want it to later appear as an attempt to hide bankruptcy income owed to your creditors
How Are Tax Refunds Affected In A Bankruptcy?
• Years prior to filing bankruptcy: If there are unfiled tax returns for years prior to your bankruptcy, your bankruptcy trustee will ensure that the tax return is filed with CRA. CRA will send the refund to your trustee. If there is an amount owing on the tax return, it becomes a debt that is dealt with as part of your personal bankruptcy.
• Year that bankruptcy is filed: Any refunds for the year in which bankruptcy is filed are sent to your trustee from CRA.
There are two tax returns for this time period: a PRE-bankruptcy and a POST-bankruptcy tax return.
• The pre-bankruptcy tax return dates from January 1st to the date that you file bankruptcy. If there is a tax debt for this period it becomes part of your bankruptcy. If there is a refund, it is sent to the trustee.
• The post-bankruptcy tax return begins from the date of bankruptcy to December 31st of that year. If there is an amount owing for this post period, it will need to be paid by you because it is a new debt after bankruptcy was filed. If there is a refund, it will be sent to the trustee.
• Pre and post returns are filed by your bankruptcy trustee.
• Years after bankruptcy filed: Any tax years after your bankruptcy has started are not affected by bankruptcy. If there is a refund for these years, you will receive it. If there is an amount owing for that year, you are required to pay that amount.
Losing Your Tax Refund in Chapter 7 Bankruptcy
You can lose either part or the entirety of your tax refund when you file Chapter 7 in Utah or other states that do not have a large “cash” or “general intangibles” exemption. The idea is simple: many states do not allow you to keep a lot in cash accounts or other monies owed to you when you file for bankruptcy. Therefore, if you have a tax refund that is going to be due to you in the future, it may exceed this low amount that your state allows you to keep. Therefore, they can take your tax refund in order to pay back some of your creditors. If your assigned Bankruptcy Trustee believes that you will have a tax refund that is large enough to repay some of your creditors, then he will plan to do a future calculation of your upcoming tax refund to see how much will be owed to your creditors. The Trustee will then return back to you the amount that is not due to your creditors. The calculation is simple: it merely is a fraction of how far (how many days) you’re into the current tax year. Therefore, if you are approximately one half the way through the current tax year when you file, then the fraction may look something like this: 182/365. If you are only one month into the year, it may look like this 31/365. Whatever “fraction” or percentage is due to the creditors will depend on how far you are into the current tax year. The above calculation is very simple, but there are a few more things to keep in mind when calculating tax refunds owed in bankruptcy. First, the Trustee must subtract any bankruptcy exemption from their calculation also such as your cash exemption or earned income credit. You’ll get to keep those exam portions of your tax refund also. Second, the trustee may take the entirety of your tax refund(s) for either old year’s tax refunds due to you or if you file at the beginning of the tax year before you receive and spend your that tax refund. The idea behind taking all the refunded is also simple: these years are calculated as 365/365 because those years have already entirely passed. Lastly, it is also important to remember that your Trustee may not take your tax refund at all. If your tax refund is not going to generate a dividend to creditors that exceeds $1000-$1500, then it may be too little of a payment for creditors to justify the hassle and expense of collecting it. If your Trustee decides that it is not worth the administrative expense, he may “abandon” your tax refund entirely. “Abandon” simply means that the Trustee does not want it and you can keep it all.
Tax Refunds and Chapter 13 Cases
Chapter 13 cases are usually not as interested in tax refunds as Chapter 7 cases. However, it is important to note that you may lose anywhere from one half to 100% of your tax refund every tax year during the life of your chapter 13 plan. Chapter 13 trustee’s, however, many times do not desire any amount of your tax refund to be turned over to the chapter 13 plan. In such cases, it is because you are most likely paying a sufficient dividend to your creditors before the Trustee is taking part of your tax refund. In addition, the administrative effort of monitoring the turning over tax refunds is very burdensome for the Chapter 13 Trustee. Also, studies show that chapter 13 participants that able to keep part or the entirety of their tax refund are more likely to successfully finish their chapter 13 case. The tax refund allows the debtors to catch up with their finances during the life of the plan. Therefore, many Chapter 13 Trustees avoid the turning over of tax refunds whenever possible. Keep in mind that if you dramatically over withhold for taxes, you will be more likely to asked to turnover your refund during the life of the chapter 13 case.
Chapter 7 Lawyer
When you need a tax refund chapter 7 attorney in Utah, please call Ascent Law LLC for your free consultation (801) 676-5506. We want to help you.
8833 S. Redwood Road, Suite C
West Jordan, Utah
84088 United States
Telephone: (801) 676-5506