Can You Keep Your Tax Refund After Filing Chapter 7 Bankruptcy?

Written by James Hirby | Fact checked by The Law Dictionary staff |  

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First of all, Chapter 7 and Chapter 13 bankruptcies have very different rules. This article is only dealing with Chapter 7 bankruptcy. On the question, it is always good to check with the lawyer who filed your bankruptcy. That is why you pay the lawyer. Essentially, it goes to the trustee. A refund is an asset, just like any other asset. Also, Chapter 7 will not allow you to just walk away debt-free, making no payment at all. The law excludes only so much. Anything in excess likely goes to the trustee and creditors. Anything left after payoff comes back to you. The court will decide how much of any tax refund you can keep. The amount of equity in your home that you and your spouse can retain varies from state to state and depends if you file Federal or State rules, and so on with other assets.

A number of sources stated that one way of dealing with this issue is to file your bankruptcy after you receive your tax refund and spend it on family needs. Once you have filed, it is essential that you disclose the tax refund to both your lawyer and the trustee. A bankruptcy trustee can attach and garnish the refund with a simply letter to the Internal Revenue Service, who will send the tax refund directly to the trustee. A deliberate failure to disclose refund information can lead to being denied a discharge.

Another way of dealing with this issue is to not have a refund. Adjusting your W4 so that your refund is very small or so that you owe a small amount reduces, even minimizes the difficulties of this situation. When your refund is $4,000 or higher, a Chapter 7 trustee typically argues the point in court that you have a kind of savings account. If you did not report this to the trustee, the point of unrevealed “disposable income” now arises, complicating things.

[http://www.irs.gov/publications/p908/ar02.html] This IRS content states that Bankruptcy courts have jurisdiction and authority to decide how much or the legality of any tax on the debtor or debtor’s estate. This includes any fine, penalty, or addition to tax, and if a tax was previously assessed or paid. This is important as it can directly impact any expected tax refund amount. This content also stated that bankruptcy courts do not have authority to do the following:
1. to reverse any other court’s decision on taxes before the date of filing the bankruptcy petition
2. to decide if a tax refund goes to the estate until the trustee properly files a request on the refund to the IRS. At that point, the IRS must:
• make a determination about the refund,
• wait 120 days to pass since the date of the trustee's request,
• wait on the decision by another governmental unit on such requests.
Note that the trustee can lay claim on the refund if the debtor already claimed a refund or credit for tax overpayment based on a properly filed return. If the credit or refund is not yet claimed by the debtor, the trustee can file a request on behalf of the bankruptcy estate.

FYI: [http://www.irs.gov/pub/irs-pdf/p908.pdf] is the current to-date IRS online content for bankruptcies, but has nothing about refunds.

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