If you are considering filing for Chapter 7 bankruptcy and you are expecting to receive or have received a tax refund, you probably want to know what to do with tax refund money. You can use it to pay for attorney fees and other costs associated with the filing of your bankruptcy. Whether you can keep your tax refund from income earned before you file banktruptcy depends onhow you manage the timing of your bankruptcy and receipt of your tax refund.
What To Do if You Receive a Tax Refund Check After Filing for Bankruptcy
A tax refund you receive after the petition is filed will be part of your estate if it is based on income you earned before the bankruptcy. You may, however, be able to keep it.
In bankruptcy, every debtor is allow to keep (exempt) a certain amount of property regardless of how much the person owes to creditors. The amount a person can exempt depends upon the state where the bankruptcy petition will be filed. Some states have a generous amount for exemptions that could cover a tax refund. More information can be found with a free consultation with one of O’Bryan Law Office attorneys. They will inform you of the exemptions for your personal situation.
Coordinating the Timing of Your Bankruptcy and Your Tax Refund
Whether you can keep your tax refund from income earned before you file bankruptcy depends on how you manage the timing of your bankruptcy and receipt of your tax refund. In most cases, if you plan ahead you’ll be able to keep your tax refund, or use the money for other expenses.
Depending on how far in advance you know you will be filing for bankruptcy, there are three things you can do to keep your tax refund from creditors:
- adjust your withholding to reduce your refund to a minimal amount
- spend the refund on necessary expenses, or
- include the refund in your bankruptcy exemptions.
What to Do If You Think You May File for Bankruptcy Within a Year
If you think that you are going to file for bankruptcy in the next year, you can avoid the refund issue by adjusting your tax withholding so that you only pay the tax you owe. You will get more money in each paycheck and your refund that will be too small to provide any meaningful payment to your creditors. The trustee may abandon the refund, meaning that you will be able to keep the money. It is important to make sure, however, that you continue to withhold a sufficient amount to cover the taxes you do owe.
What to Do if You Receive a Tax Refund Check Before Filing for Bankruptcy
If you have received your tax refund and have not yet filed for bankruptcy, you can keep the money out of your bankruptcy estate by spending it. The trustee cannot use money to pay your creditors that you no longer have.
If you spend your tax refund before you file for bankruptcy, make sure you spend it on necessary items. Approved expenses include:
- mortgage payment, rent, or home repair
- utilities
- food
- clothing
- medical care
- car payments, maintenance, or
- education.
Expenses that are not allowed include:
- luxury goods
- repayment to a friend or family member, or
- repayment of one credit card.
If you buy luxury goods, the trustee could seek to deny your discharge because of bad faith. If you pay back one of your creditors and ignore the others, the trustee may find that you have made a preferential payment. This means that you have favored one creditor over another. The trustee can force the person or company who received the money to return it to the estate. Therefore, if you spend your tax refund, make sure to spend it on necessary expenses. In addition, keep very good records of how you used the money.
Caution: In some districts, you must be careful if using your tax refund for normal living expenses.
