A tax refund is a valuable asset to both and your bankruptcy creditors—and you'll likely want to keep as much of it as possible. Maximizing your portion in bankruptcy takes careful planning and will depend on the bankruptcy chapter you file, the timing of your filing, and the state in which you live.
You receive a tax refund when you've paid more than you needed to pay in taxes. Although it might be nice to get a significant return at the end of the year, you might not be so happy about your savings plan if you find yourself filing for bankruptcy. Why? Because instead of using that money for your expenses, you might end up turning it over to your creditors.
It isn't easy to preserve a tax refund in Chapter 7 bankruptcy. Here are your options.
Another approach is to spend your refund before you file your bankruptcy case. A good practice is to keep track of your expenditures and to use the funds for necessary expenses, such as:
You'll want to avoid paying money to a family member or friend because the trustee could try to get the money back. The same applies to paying a significant sum to a creditor, such as for a credit card balance. Again, you'll want to make sure to keep good records, including receipts, documenting how you spent the money.
The bankruptcy code requires that you pay all disposable income received during a Chapter 13 bankruptcy into the plan. Most Chapter 13 trustees treat a tax refund received during your case as extra disposable income. Therefore, you'll likely want to adjust your withholding before you file your case to minimize your refund.
It's important to remember that everyone's situation is different. Because another approach might be best for you, a prudent approach is to consult with a knowledgeable bankruptcy lawyer.