If you file for Chapter 7 bankruptcy around tax time, Chapter 7 trustees will be on the lookout for tax refunds. Why? Because bankruptcy trustees know protecting money in bankruptcy is challenging, making tax refunds an easy source of funds for creditors. But that doesn't mean you'll automatically lose your tax refund.
To keep your tax refund in Chapter 7 bankruptcy, you'll need to either:
Keep reading for specific strategies you can use to keep your tax refund in Chapter 7 bankruptcy. Or, learn what happens to tax refunds in Chapter 13 bankruptcy.
The Chapter 7 trustee will want to know whether the IRS owes you a tax refund you haven't yet received. If you already got your tax refund before filing for bankruptcy and you aren't owed anything further, your answer will be "No." But you'll need to protect all of your cash and money in a bank account with a bankruptcy exemption, or you'll lose it (more below).
If you're still waiting on your tax refund, even if you haven't filed your tax refund yet, your answer will be "Yes." You'll have to protect all of the funds you're owed but haven't yet received with a bankruptcy exemption, too.
Any refund that results from income earned after filing for bankruptcy is yours to keep. This chart explains when you might have to turn over tax refund funds in Chapter 7.
Year before bankruptcy
Your tax refund will be part of your bankruptcy estate.
Year of bankruptcy
A tax refund based on the income you earned before filing for bankruptcy goes to the estate. Note: Most trustees are concerned about tax refunds owed to the filer after the tax year ends, not before.
Tax year after bankruptcy
You keep the full refund.
If you forget to protect your tax refund, there's a good chance you'll lose it. But it doesn't have to happen. These three strategies will help you protect your tax refund in Chapter 7 bankruptcy:
Here's how the three strategies work.
Lowering your exemptions and paying only the tax you owe is a good strategy when you have time to plan before filing for Chapter 7 bankruptcy. The other benefit? You'll get more money in each paycheck. Just be sure to withhold enough to cover the taxes you will owe.
If you've received your tax refund and haven't yet filed for bankruptcy, you can spend it on necessary items that you currently need, such as:
You'll want to avoid using your tax refund money to pay for:
If you buy luxury goods, the trustee could seek to deny your discharge because of bad faith. If you pay back one of your creditors and ignore the others, the trustee may find that you have made a preferential payment that favors one creditor over another. The trustee can force the person or company who received the money to return it to the estate.
So it's best to spend your tax refund on things you currently need. You'll also want to keep good records of how you used the money. However, some districts might have different practices. A local bankruptcy lawyer can tell you what you can expect in your area.
You might be able to keep your tax refund by claiming it as exempt property that the trustee can't take. Here's how it works.
When you file for Chapter 7 bankruptcy, your assets become part of the bankruptcy estate administered (controlled) by the Chapter 7 bankruptcy trustee. The trustee can use the assets to pay creditors. You can "exempt" or keep the property that your state decides you'll need to work and live.
Did you know Nolo has been making the law easy for over fifty years? It's true—and we want to make sure you find what you need. Below you'll find more articles explaining how bankruptcy works. And don't forget that our bankruptcy homepage is the best place to start if you have other questions!
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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.