As April 15 draws closer, I am getting quite a few phone calls and emails from people who are considering filing Chapter 7 bankruptcy but are worried that they may lose their income tax refund if they do.
Most of these people are depending on their income tax refund for necessary living expenses or are planning to use it to catch up on mortgage payments or car payments. Some are even wanting to use their income tax refund to pay their bankruptcy attorney’s fees and filing fees.
The answer to this question depends on the specific facts of your situation and where you file your case. The exemption laws that are available to protect an income tax refund vary dramatically from state to state.
Like everything else in bankruptcy, it is very important that you be completely open and honest with your bankruptcy lawyer about your income tax refund. I ask every client of mine whether or not they have filed their tax return and whether or not they have already received or are expecting an income tax refund.
In Oklahoma, if you file your bankruptcy case AFTER you get your income tax refund, and you spent your refund on exempt property, then your worries are over. It’s not an issue.
It would be all right to spend the tax refund on things such as food, clothing, household goods, home and vehicle repairs, catching up on your house payments, and contributing to retirement accounts.
But you could spend your tax refund in such a way as to create a problem.
For example, if you used the tax refund to repay a relative money you owed them, or to pay off one of your credit cards, that’s considered a “preferential transfer” where one creditor was treated more favorable than the others. And when that happens, the Chapter 7 trustee can force your relative or the credit card company turn over that money.
However, if you file your bankruptcy case BEFORE you get your income tax refund, you must disclose the tax refund in your bankruptcy documents as an asset.
And in Oklahoma, except for any portion of the tax refund that is attributable to the earned income credit, the tax refund is a non-exempt asset which means that it can be taken by the Chapter 7 trustee to be paid to your unsecured creditors.
Whether or not the Chapter 7 trustee will take an income tax refund usually depends on two things: 1) how large the refund is, and 2) what percentage of your unsecured debts would be paid by the refund. If the total amount is small and the percentage paid back would be insignificant, the trustee is likely to abandon the tax refund and allow you to keep it.
If you filed a joint tax return with your spouse, but only one of you filed bankruptcy, your tax refund will be prorated according to the ratios of you and your spouse’s incomes and the trustee would only be able to take the refund belong to the spouse who has filed bankruptcy.
If you file your bankruptcy after January 1, but before you received your refund, the Chapter 7 trustee can take your share of the entire refund.
If you file your bankruptcy petition before January 1, the Chapter 7 trustee may take a pro-rata portion of the refund attributable to the months before you filed your bankruptcy case.
For example, if you file bankruptcy on September 30, nine months of the year (January – September) is considered pre-petition (before the bankruptcy case is filed) and three months of the year (October – December) is considered post-petition (after the bankruptcy case is filed). In this example, the Trustee can take 75% of your refund, while you get to keep the other 25%.
Lastly, future tax refunds beyond the year in which you file your bankruptcy petition are not subject to being taken by the Chapter 7 trustee.
If you are considering filing bankruptcy but are worried about losing your income tax refund, contact me today to schedule a FREE initial consultation. Just fill out the Contact Dan form on the far right side of the page and click the Submit button and I’ll get back with you as quickly as I can. Or just pick up the phone and give me a call at 918-615-8260. I’ll answer all of your questions in plain English so that you’ll have the information you need to make the decisions that will help you the most.