When you file for bankruptcy, your tax refund—like all of your property—will become part of your bankruptcy estate. If you have an earned income credit (EIC), your refund can be significant—and you won’t want to lose it.
Whether the bankruptcy trustee—the official appointed by the court to manage your case—can take your EIC will depend on the bankruptcy chapter you file and whether you can protect the funds with a bankruptcy exemption.
A tax refund represents a repayment of your earnings—usually as a result of too much tax being taken out of your paycheck during the prior year. But a tax refund can also include credits—a financial benefit the government gives by reducing the amount of tax that you owe. An EIC is a credit given to working parents with low wages and can result in a substantial tax refund.
Your property goes into what’s known as a “bankruptcy estate” when you file for bankruptcy. You’re allowed to exempt particular property out of the estate (more below). A Chapter 7 trustee sells nonexempt property for the benefit of creditors.
All tax refunds are property of the bankruptcy estate, even if you haven’t received the refund yet. In fact, it’s easy for a trustee to get ahold of a tax refund because the trustee can direct the IRS to pay it to the bankruptcy estate instead of you.
You might be able to protect your tax refund (and your EIC) in a Chapter 7 bankruptcy. But you’ll need an exemption to do so.
Ultimately, your state determines the property you’ll be able to exempt. While all states have a list of exemptions, some states allow the filer to choose between the state exemption list and the federal bankruptcy exemption list. You’ll pick the list that best protects your assets. (If you’ve moved recently, you’ll want to talk with an attorney about which exemption scheme you’ll be entitled to use.)
If you have an EIC exemption available, you’ll be able to protect the amount allowed by the exemption even if you haven’t received the EIC funds yet. You could also use a wildcard exemption (an exemption that can be used to protect any property of your choosing) or a cash exemption to protect your EIC.
If your EIC is more than the amount you can exempt, you’ll likely lose a part of your EIC. In that case, you might want to talk with a bankruptcy lawyer about other options. For instance, you might be able to decrease your withholdings before filing for bankruptcy. Or, you might want to spend the EIC on necessities, such as rent, utilities, food, and clothing before filing a bankruptcy case.
An EIC is also an asset in a Chapter 13 bankruptcy, and the guidelines above apply. However, although you might be able to protect EIC funds when you file, you might not be able to do so for EIC funds received in subsequent years.
Here’s how it works.
Chapter 13 bankruptcy lasts from three to five years. During that time, you must pay all disposable income into your repayment plan. The exemption for an EIC doesn’t apply to an EIC that you get after your case is filed (only EIC you’re entitled to receive before you file). Most courts and trustees consider each tax refund that you get during your case as disposable income, including the portion from an EIC.
If you expect to receive EIC benefits, you should talk with your attorney about what you can do to keep your EIC or at least plan for the possibility that you might not have those funds available to you.