Making the decision to file for bankruptcy is an important first step in improving your financial future. You may be wondering about the fate of your tax return. Will the bankruptcy process take it away from you to help pay your debts? The answer to that question depends on the amount of money you receive from your return and the source of the return you receive.
When you file for Chapter 7 bankruptcy, you should be able to protect a portion of your tax return. The majority of your personal property can be protected by claiming exemptions. However, if you are receiving a return, there are limitations with respect to what you can protect. You can exempt the portion of your tax return that comes from a Child Tax Credit as well as Earned Income Credit. Anything outside of that can potentially be taken by the trustee. The good news is that if you are receiving a fairly small return, under $2,000, it is possible the trustee will not take an interest in your return.
If you file for Chapter 13 bankruptcy, you can potentially lose your tax return. In a Chapter 13, a budget is prepared that tells the court how much your necessary expenses cost. What is left over is what you are paying to the court. It is the position of the trustee that because you can afford to make monthly payments with your normal monthly income, the additional funds from a tax return should be classified as a surplus and should be turned over to the trustee. There are certain situations where you will be able to excuse part of your return, but it requires specific reasons for the need of the money. (Example: Car needs repairs, it costs X amount of dollars, without repairs, won’t be able to get to work, won’t be able to make payments to the court).
Many clients want to use their tax return to pay for a bankruptcy lawyer. If this is the case, then don’t file for bankruptcy until after you receive your return. You can offer your attorney a lump sum payment with the cash you have so that you can get your case filed immediately. You can also use the money from your return on necessary expenses such as rent or a mortgage payment, utilities, insurance, etc. However, if you use your return to pay a relative or a creditor like a credit card, the court will view this as a preference payment and it could pose problems with your filing.
If you were to file for bankruptcy before receiving your return, you must wait for the court to determine what portion of your return belongs to you and what portion of the return belongs to the court.