Tax Refunds and Bankruptcy: What You Need to Know
Hi, Matt McArthur, bankruptcy attorney at Clear Counsel Law Group. This time of year, tax season, a very common question that I receive is how will filing bankruptcy affect the status of my tax returns and any tax refund that I may be entitled to if I file?
This is a somewhat important issue for people filing for bankruptcy because people filing for bankruptcy typically don't have a lot of disposable income and tax refunds are often treated like a nice little bonus that you can use to catch up on bills, pay for the bankruptcy itself, or do some other needed things because it's money that wasn't really being counted on that's now available to you.
The problem is, specifically if you're filing a Chapter 7 bankruptcy, is that when you file for bankruptcy anything valuable that you own is potentially part of the bankruptcy estate and even the right to receive a refund can be considered a valuable asset.
In other words, if you filed your bankruptcy in January and you filed your tax return in February and you're entitled to receive a certain amount of money as part of your tax refund, then the bankruptcy case that was filed in January is going to possibly include part of that refund as property in the bankruptcy estate.
What does that mean?
That means if it's property in the bankruptcy estate the court has the power to take that money, make it available to your creditors and make distributions to your creditors.
For example, a person filing in January that files their tax return in February, let's suppose that they're entitled to a refund of $2,000. If this person didn't have any protections available to protect that refund the court has the power to take that $2,000.
They can either intercept it directly from the IRS or require you to pay that amount to the bankruptcy court and then they take that money and give it to your creditors. That's considered fair price to pay for wiping out all the other debt that you may have.
The important question is do you have protection that's available to exempt the refund from being part of the bankruptcy estate? In the State of Nevada there are 2 main types of protections that we typically use to protect the tax refund.
The Income Credit Exemption
The first is the earned income credit exemption. In the State of Nevada, if you receive earned income credit as part of your tax refund, that is 100% exempt and is yours and is not part of the bankruptcy estate. This is kind of a confusing issue and if you're concerned or not sure whether you received earned income credit it's going to be important to take a look at your tax return.
An experienced bankruptcy attorney should be able to find this with you, or a qualified tax professional should be able to help you determine whether or not your entitled to earned income credit. Generally speaking, if you get earned income credit it's protected though, and that's a good thing for filing bankruptcy and protecting your tax refund.
The Wildcard Exemption
The other protection that we have available in most cases in a Chapter 7 bankruptcy in the State of Nevada is what we call the wildcard exemption. This is $1,000 or $2,000, depending if it's an individual or a couple filing jointly, that is available to be applied to any asset, any personal property, so it can be applied to a tax refund in other words.
In the optimal situation, a person filing for bankruptcy would have some earned income credit that would be 100% protected and any remaining portion of the refund that might not be covered by the earned income credit would be covered by the $2,000 wildcard or the $1,000 wildcard. Anything over that amount and that's technically part of the bankruptcy estate, that may be required to be turned over to the court for your creditors to make a claim against.
If you have any questions about your ability to protect your tax refund, especially this time of year, in tax season, and you're thinking about filing for bankruptcy please come and see me before you file for bankruptcy. I'd be happy to walk you through this and make sure that we're being able to protect your tax refund to the extent possible. Hope to hear from you soon and be part of your path back to a fresh start. Take care.