Am I Forced to Give Up My Tax Refund?

Am I Forced to Give Up My Tax Refund?

The season has mostly passed, but for future reference, I thought I better give some information about tax refunds and bankruptcy.

Under bankruptcy law, all tax refunds owed to you are part of the bankruptcy. If you are entitled to receive a tax refund while the bankruptcy is open, then you are required to turn it over to the Trustee in bankruptcy. Usually the IRS and State of Idaho send your refund directly to the Trustee anyway, but if you receive it, you better not cash it and contact your attorney immediately. You do not even have to sign your refund check, the law allows the Trustee to take it. If you have an automatic deposit and it goes in your account, be ready to write a check to the Trustee immediately. Whatever you do, don’t spend it until you know what is going on. You will have to turn the money over immediately and if you have spent it, you may be forced to scramble to save your bankruptcy and find the money.

There is a positive side to this scenario. Various parts of your income tax refund may be exempt, meaning the Trustee will have to return those funds to you. Or, he may lessen the amount you have to write a check to the Trustee. Earned Income Tax Credit is the most common part returned to individuals in a Chapter 7.

Be aware that in a Chapter 13, your Plan Order will dictate whether you get the exempt amount back. Most attorneys do not write in anything about the exemptions and therefore, the Trustee gets to keep the entire refund while your 13 is still open (the generic plan language only indicates “tax refunds” have to be turned over).

Some have argued that this money is earned wages that the government had extra and should not be able to take it. Consider it a payment to the government for their providing the bankruptcy service. After all, for a few $$ the government is forgiving you $$$.

One thing you will definitely wish to consider is that within a Chapter 13, you will have years of losing your tax return. Therefore, you will want to visit with your payroll to change your deductions to remove as much of the refund as possible. Be careful though, you do not want to owe taxes within a Chapter 13 either, that makes for a real problem for you and your attorney. Most Chapter 7’s do not coordinate far enough in advance to adjust deductions sufficiently.