Carucci Di Lorenzo Articles Tax Refund and Bankrutpcy

Tax Refund and Bankrutpcy

By Carucci Di Lorenzo  May. 14, 2012 12:20p

One frequent topic of discussion this time of year is the way bankruptcy will affect tax refunds. Some people assume that all future refunds may somehow be set off against what they owe; others assume that the government may keep it for some period of time. It is important to make sure that you know what can happen to a tax refund, both to minimize the impact, and so you can plan accordingly.

When a Chapter 7 bankruptcy is filed, the court appoints a trustee whose job is to collect assets, turn them into cash, and use that to pay creditors. The pool of assets that can be reached by the trustee, called the “estate” is created on the day that the bankruptcy petition is filed with the court, and consists of everything the debtor owns as of that day. Bankruptcy courts have held that a tax refund, or a portion of it, can be an asset, even though you may not receive it, or even file your tax return, until after the bankruptcy petition has been filed.

Just because it is considered an asset does not mean you will lose it in a bankruptcy. In fact, most assets remain yours without any interference from the Court. There are other issues to consider, like any exemption you are entitled to claim, or whether your spouse has filed bankruptcy with you. The impact will depend upon those factors, and especially how you time your filing. A little planning and legal counsel can go a long way.

Some people are dismayed to learn that their tax refund might be taken by a trustee, but it shouldn’t drive the decision to file bankruptcy, or even determine when a bankruptcy is filed. Here’s why: First, in most cases your tax refund will not be taken from you. Second, if the court determines your tax refund should be used to pay off some of your debt you are essentially settling all your outstanding debt for that amount of money and nothing more. Third, most people in financial distress use their tax refunds to catch up on bills anyway. Bankruptcy will take care of that whether you get to keep it or the Court uses it to pay debts.

Many people go year after year, slowly falling behind on mortgages and other debts during the year, and using tax refunds to catch up again; thus starting the cycle all over again. Perhaps the best use of your tax refund if you are considering bankruptcy is to use your tax refund to pay fees and the costs of filing bankruptcy…and end the debt cycle for once and for all!

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