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I Filed Bankruptcy. What Happens to My Tax Refund?

At this time of year the question of what happens to a tax refund when I file bankruptcy is an important consideration in any bankruptcy case and something that will be discussed should you take advantage of my free bankruptcy consultation.

A prior year tax refund, state and/or federal, is not exempt (more on exemptions in a future blog). This means that the bankruptcy trustee will demand turnover of the refund to benefit the bankruptcy estate i.e., money to be used to pay your creditors. For example if your case is filed in 2011 and you have a refund coming for 2010 or other prior year taxes that refund will be taken by the estate. It gets worse. Using the example of a 2011 filing the estate has a claim against a prorate share of your 2011 taxes. If you filed your case in June of 2011 the estate’s claim would be for 6/12ths of any 2011 tax refund.

The next question is what can I do to protect my refund? If you file and you have not received the refund you will lose the refund, period. The flipside would be to wait until you have received the refund, spend the money on exempt assets and then file. At least in that situation you will have the use of that money not your bankruptcy estate. Sometimes you cannot wait for the refund to arrive before you file which then becomes a cost of doing business analysis. As to a potential future refund immediately change your withholdings to minimize the refund. This is also good practice from a non-bankruptcy financial point of view in that using a tax refund as a savings account does not make financial sense. Save the money yourself. At least you will get the interest of the account. One caveat, do not under withhold as that will result in you owing money to Uncle Sam, a very unsympathetic creditor.

There is also a practical component to the whole tax refund issue. If the refund is small enough the trustee may find it to be of insignificant value to the estate and decide not to administer the refund. Each trustee has his or her own criteria as to the administration of tax refunds so a determination will be by the luck of the draw. Administration of a tax refund will not affect your discharge however the case will remain open pending the administration.

The issue of tax refunds is one of many considerations comprising the decision to file for protection under the Bankruptcy Code. This is why retaining the services of an experienced bankruptcy lawyer is so important and will save you money in the long run. Taking advantage of my free bankruptcy consultation will start you on the road to a financial fresh start.

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