How to Keep Your Tax Refund After Filing for Bankruptcy

Here’s what you’ll need to do to protect your tax return in bankruptcy.

By , Attorney

A tax refund is a valuable asset, and you'll likely want to keep as much of it as possible when filing for bankruptcy. But because your creditors also want it, the trustee appointed to your case will ask whether you're expecting a tax refund at the 341 meeting of creditors, the hearing all filers must attend.

Unfortunately, preserving a tax refund in bankruptcy isn't easy. Not only will maximizing your refund take careful planning, but it also will depend on:

Check out our quick ten-question bankruptcy quiz for targeted information about your bankruptcy case. It can help you spot potential bankruptcy issues fast. Also, consider learning about the downsides of bankruptcy.

How Planning Can Protect a Tax Refund in Bankruptcy

If you're planning on filing for bankruptcy and want to protect a tax refund, here are three approaches to consider:

  1. Adjust your withholdings so you won't be entitled to a tax refund.
  2. Spend the tax refund before filing for bankruptcy.
  3. Protect your refund with a bankruptcy exemption.

Keep reading for details about each strategy.

Protect Your Tax Refund by Adjusting Your Withholdings

Ensuring you aren't owed a tax refund at the end of the year is the best way to avoid having a refund the trustee appointed to your case can take. Here's why.

You're essentially setting up a savings account if you pay more in taxes than needed each month. The problem? Protecting any cash or money you're entitled to receive when filing for bankruptcy is difficult. You'd need to either spend it before filing or be able to protect it with a bankruptcy exemption, and doing so isn't always possible.

Protect Your Tax Refund by Spending It Before Bankruptcy

If you receive your refund before you file for bankruptcy, consider spending it before filing. But be sure to keep track of your expenditures and use the funds for necessary expenses, such as:

  • rent or mortgage payments
  • utilities
  • food
  • clothing
  • medical expenses (including glasses and contacts, braces, and dentures)
  • car payments, maintenance, and repairs
  • education expenses, and
  • attorney's fees and costs for your bankruptcy filing.

You don't want to pay bills in advance, and you'll want to avoid paying a significant amount to a family member, friend, or a particular creditor because the Chapter 7 trustee appointed to oversee your case could try to get the money back. Learn about preference payments and the clawback provision.

Protect Your Tax Refund With a Bankruptcy Exemption

You lose property you can't exempt in Chapter 7 bankruptcy. If you can't adjust your withholdings or spend your return before bankruptcy, check whether your state offers a bankruptcy exemption you can use to protect your refund. But don't be surprised if your state doesn't provide one because most states don't have an exemption for a tax refund.

Instead, look for a wildcard exemption. A wildcard exemption lets you protect any property of your choice within limits set by the state. Also, an earned income credit exemption or a cash exemption might work, although you won't be able to preserve much cash in most states.

If your state exemptions aren't helpful, check whether your state will allow you to use the federal bankruptcy exemptions instead, which include a substantial wildcard exemption.

How Do I Keep My Tax Return in Chapter 7 Bankruptcy?

Here's a simplified explanation of how the above strategies work in Chapter 7 bankruptcy.

  • Adjust your withholdings. People who adjust earning withholdings to avoid receiving a tax refund won't have a tax refund to lose in Chapter 7.
  • Spend the money. If you spend your tax refund on necessities before filing, you won't lose the refund to the bankruptcy trustee.
  • Protect with an exemption. If you can protect the funds with a bankruptcy exemption, you'll keep it. Remember that if you're owed a refund but haven't yet received it, you'll still need to protect it with a bankruptcy exemption

Learn more about keeping your property in bankruptcy.

How Can I Keep My Tax Refund in Chapter 13 Bankruptcy?

The strategies discussed above will apply to tax refunds in Chapter 13 as well. However, if you aren't able to protect the funds, you won't turn them over to the trustee. Instead, you'd pay nonexempt funds through the Chapter 13 plan.

Also, an additional wrinkle exists because a Chapter 13 case takes three to five years to finish.

Chapter 13 files pay all disposable income to creditors through a Chapter 13 repayment plan. A potential income tax return you didn't exempt when you filed could be problematic if your Chapter 13 trustee argues it's extra disposable income and expects you to hand it over for creditor payment.

To avoid this problem, consider adjusting your withholding to minimize your refund before filing your bankruptcy case. Otherwise, your bankruptcy lawyer will be in the best position to explain the Chapter 13 practices in your local court.

Find out what to do if you can't afford a bankruptcy attorney.

Navigating Your Bankruptcy Case

Bankruptcy is essentially a qualification process. The laws provide instructions for completing a 50- to 60-page bankruptcy petition, and because the rules apply to every case, you can't skip a step. We want to help.

Below is the bankruptcy form for this topic and other resources we think you'll enjoy. For more easy-to-understand articles, go to TheBankruptcySite.

More Bankruptcy Information

Bankruptcy Forms and Document Checklist

Schedule A/B: Property

Schedule C: The Property You Claim as Exempt

Chapter 7 and 13 Bankruptcy Forms

Chapter 7 Bankruptcy Document Checklist

More You Might Like

Can I Keep My House If I File for Chapter 7?

Will I Lose All My Property If I File for Bankruptcy?

Bankruptcy Exemptions: What Do I Keep When I File for Bankruptcy?

We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.

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