Tax Time! What happens to your tax refund in bankruptcy?

The number of bankruptcy filings tends to decrease during the first quarter of the year (January through March) and then pick back up again through the rest of the year until the Holidays. The theory behind this is that people do not want to file for bankruptcy in the first few months because they do not want to lose their tax refund. Clients sometimes use their tax returns to pay attorney fees and filing fees for bankruptcy, which explains why the filings increase in the second quarter of each year.

So let’s take a look at what happens to your tax refund in bankruptcy.

Tax refunds in Chapter 13 bankruptcy: anything over $1,000 goes to your creditors.

Treatment of tax refunds in Chapter 7 bankruptcy and Chapter 13 bankruptcy are different. We’ll take a look at Chapter 13 cases first because they’re less complicated. So, how do tax returns work in Chapter 13 bankruptcy?

(If you’re not familiar with how Chapter 13 plans work, you may want to take a look at my previous posts about Chapter 13 bankruptcy, and Chapter 13 plans before reading on.)

If you are receiving a refund at tax time, then it is usually “extra money” in the sense that it is not included in the budget you filed with the court when you entered Chapter 13 bankruptcy. And because it is “extra money” it is sometimes subject to seizure by the trustee, and will be put towards repaying your creditors.

However, treatment of tax returns under Chapter 13 is relatively advantageous. In Utah, Chapter 13 plans generally include a provision that the debtor must show the trustee her tax returns each year, and must surrender any return over $1,000. So the good news is, you get to keep up to $1,000. And the other good news is that, even if you do have to give a portion of the refund up, it goes toward the arrearages, and other debts you owe in the bankruptcy, and it could help you complete the plan sooner!

Tax returns in Chapter 7 bankruptcy: the trustee is entitled any tax refund you would have accrued prior to filing, but sometimes it’s not worth it for them to bother taking the refunds.

As I mentioned, treatment of tax refunds in Chapter 7 bankruptcy is more complicated than Chapter 13. In short, what happens to your tax refund when you file under Chapter 7 depends on the time of year, amount of the refund, and part of the state you’re in, and trustee assigned to your case. I’ll try my best to demystify everything for you.

(Also, I should quickly remind everyone that this information applies only to bankruptcy in Utah. That is where I practice, and where I have experience dealing with tax refunds. This is one area of bankruptcy law where there can be really big differences between jurisdictions. So please keep that in mind as you read.)

First off, take a look at my previous posts discussing Chapter 7 bankruptcy if you are unsure of the difference between Chapter 7 and Chapter 13. A short summary is: when you file under Chapter 7, everything you own is transferred into a “bankruptcy estate”. The bankruptcy estate includes tax refunds, since it is money that would go to you – and then maybe to your creditors – if you had not filed bankruptcy.

So technically, the trustee has a right to your tax refund from last year, if you haven’t received it yet. And the trustee also has a right to any portion of the tax refund you would have accrued prior to filing bankruptcy. So, for instance, if you make a regular salary, and you file bankruptcy in July, half-way through the year, the trustee has a right to keep half of your tax refund.

In practicality, however, the trustee will sometimes not bother keeping track of you in order to claim her portion of your tax return. If you are waiting to receive a tax refund, but it is small, the trustee may not bother keeping it. If the trustee believes that your upcoming refund will be small, based on looking at your recent tax returns, then she will probably not require you to show her your upcoming tax returns.

Treatment of tax refunds in Chapter 7 is a judgment call for trustees, and different trustees will be more or less stringent about collecting them. That is why it makes a difference where you’re filing and which trustee is assigned to your case. (An aside: Chapter 7 trustees are appointed from a pool of dozens of attorneys, as opposed to Chapter 13, in which the same trustee’s office handles all Chapter 13 cases in the state. This makes things in Chapter 7 less predictable.)

The good news is, if it’s the first quarter, and you’ve already received (and spent) your tax refund, the trustee will not be able to take it from you (with some notable exceptions). On the other hand, if you filed chapter 7 during the time between filing your tax return and receiving your refund, you will probably have to turn it over to the trustee.

If you’re filing bankruptcy in the middle part of the year, then it will depend greatly on the trustee and the amount of the refund. If you’re expecting a large refund, then you should prepare to be giving at least some of it to the trustee at tax time.

That’s all for today, but be sure to check the rest of the posts on this site for more information about Utah bankruptcy law. Click here to visit my website, or call (801)200-3795 to discuss your financial trouble, I’m glad to help!


Car Trouble? Ask a Salt Lake City Bankruptcy Lawyer

There are two very common problems that my clients have: unmanageable medical bills, and car problems.  It makes perfect sense, many Americans are living paycheck to paycheck in today’s economy, and medical bills or car problems can come out of the blue, completely unexpected to throw your family budget into a downward spiral.

Cars can be just as essential as medical care for people in Utah.  While Salt Lake City has an excellent public transportation system, for some people that live in the suburbs or rural areas of Utah, public transportation is not an option, they need a car to get to their job, because if they can’t get to work, they can’t earn money, and they can’t afford essentials such as food, shelter, and clothing – let alone extras like telephone service, christmas gifts, and date nights.

There is one thing you may be able to do to fix your car situation when filing for Chapter 7 bankruptcy. If your car is not paid off, and it breaks down, throwing you into financial chaos, you could just let it go. The legal term for this is “surrender”. You can simply surrender the car to the lien holder, and stop your monthly payments. You do not have to keep a broken-down car and try to figure out how to pay for repairs and car payments, you can just start over.  After all, any Utah bankruptcy attorney will tell you that “starting over” is what Chapter 7 bankruptcy is all about.

I can promise you, based on personal experience with my clients, that offers for car loans will be some of the first mail you receive after filing for Chapter 7 bankruptcy with an attorney. One former client counted over a dozen credit offers within a week or so after filing her chapter 7 bankruptcy petition, and most of them were offers for car loans. Another former client was able to finance a new car on the same day that her bankruptcy petition was filed. As long as the creditor can verify the time at which your petition was filed, any loans entered into after that time are post-petition loans that won’t scare creditors in the least.

In fact, creditors love to loan to people what have just filed bankruptcy, and there is a good reason for that: they know that because you have just filed for Chapter 7 bankruptcy, you won’t be able to do it again for 8 years – so they have a good chance of recovering their money.

The down side, of course, is that these credit offers will come with very high interest rates.  It is important that you mind your budget after filing bankruptcy, because you will not be able to have a second bite at the bankruptcy apple for years to come. If you mess up, you’re stuck!

For that reason, this solution is not for everyone. It can be risky, and will definitely carry a very high interest cost. But if you find yourself stuck between a rock and a hard place (as my clients often do) with a broken down automobile, and you don’t know how you’re going to pay for auto repairs and car loans, on top of all the other bills you have piling up; then it could be a worthwhile move for you to surrender the car and start over.

Koehler Bankruptcy PLLC is a law firm that helps people like you fix their financial problems. If you need help, don’t suffer a minute longer – call us for a free consultation at 801.200.3795.