The next few months are known as "tax season". Organizing, completing, and filing income taxes is no treat, but the positive is that you may get a nice tax refund. Some people use it to splurge. Some save it. Some live off it. But, regardless of what you do with your tax refund, it is important that you understand its significance in bankruptcy.
First, you will need to exempt your tax refund this time of year. Exemptions in bankruptcy allow you to protect your personal property from your creditors. Your income tax refund is considered "property" in bankruptcy, so it must be protected. The federal "wildcard" exemption can be used to exempt your tax refund, so it shouldn't be a problem unless you have other significant savings or cash (which often eat up much of the "wildcard" exemption). If need be, your refund can be used for living expenses over a period of time, but if the amount is too significant, you will need to discuss the situation with your bankruptcy attorney. Bankruptcy trustees are all aware of tax season and tax refunds, so they will ask about yours.
You will need to file your taxes this time of year before filing your bankruptcy so that the amount of the return can be determined and exempted. If your taxes are not filed, the bankruptcy trustee may hold open your case to see if the refund will provide money for the bankruptcy estate. This won't stop your case from being completed, but it will be a major hassle, and believe me, you'll be happy to have everything wrapped up. If the trustee is going to want to see your tax returns, you may as well do them beforehand.
Particularly large refunds can also be an issue in Chapter 13 bankruptcy. The Chapter 13 trustee may insist that very large refunds be applied to the payment to creditors. This is an unlikely scenario, but it is best to let your bankruptcy attorney know of any large refund. Typically, it is best to save your refund in a Chapter 13 bankruptcy to account for emergencies and unforeseen expenses. It is difficult to get credit in Chapter 13, and you are not allowed to use credit cards, so it is wise to keep a safety net in the bank. Keep your bankruptcy attorney informed about unusually large refunds during the course of your case.
Your tax refund may be applied to your legal fees and costs in both Chapter 7 and Chapter 13 bankruptcy. This makes it a good time of year to file. Spending your refund on a large non-essential purchase can potentially cause problems. But, using it to pay your bankruptcy fees can mean you do not need to set up a payment plan, and you can stop your creditors from contacting or suing you, or foreclosing/repossessing your property. It makes wrapping up your case quickly possible.
One final note... if you are facing the possibility of losing your federal tax refund due to a federal garnishment, let your attorney know. This situation will be the subject of another post, but it suffices to say bankruptcy may protect your refund in some of these situations.
If you are considering bankruptcy, and are expecting a large tax refund this spring, contact us to make sure you maximize what you get to keep.