In the United States, individuals who come under financial strain and become insolvent have two options for discharging their debts: Chapter 7 and Chapter 13 bankruptcy filings. Under the former bankruptcy type, debtors convert their liquid assets into cash and conform to a plan to pay off as much as their debts as possible; the latter filing allows debtors to hold on to certain assets such as vehicles while they attempt to settle with creditors.
Both Chapter 7 and Chapter 13 bankruptcy filings provide some relief, but not all debtors qualify for the former. Individuals who earn more than the median income in their state of residence are not able to file for Chapter 7.
Tax Refunds Under Chapter 13
One of the provisions of Chapter 13 bankruptcies is that debtors are expected to use their disposable income to settle their debts in accordance to the court-ordered repayment plan. Since tax refunds are considered disposable income, the bankruptcy trustee will demand the full amount of tax refunds to be turned over so that they can be distributed among creditors; however, debtors can petition to make modifications to their Chapter 13 plans for the purpose of holding on to a greater portion of their money.
Any money that debtors in Chapter 13 earn beyond what they need for food, clothing, shelter, transportation, and other basic living expenses must be turned over to the bankruptcy trustee. Debtors who wish to retain their tax refunds as they work their way out of Chapter 13 are better off petitioning the court in advance of their repayment plan being approved. Otherwise, they would have to file for a modification to excuse their refund.
Bankruptcy trustees and judges are more likely to approve a Chapter 13 repayment plan modification that calls for a one-time, immediate excuse than for several. There must be at least one good reason to justify retaining some or all of the tax refund; for example, a death in the family, sudden job loss, urgent car repairs, unexpected medical expenses, etc. If, however, the debtor sees a long-term or permanent reduction of income, this could justify a request to excuse all future tax refunds until the employment situation improves.