Can a bankruptcy trustee take my tax refund?

You may have heard that your tax refund may be taken if you file a bankruptcy; however, with the right timing, you can utilize your tax refund, and still file a bankruptcy.

Your tax refund is an asset

Your tax refund is considered an asset in your bankruptcy. It is an asset, even if it is not tax time. For example, if you file your bankruptcy in October of a particular year, you already are due 10 out of 12 months of your prospective refund for that tax year.

Your tax refund remains an asset around tax time, regardless of whether you have actually received your refund yet. If you want to keep your refund, you should not file a bankruptcy before you receive it unless we can protect the refund.   (Of course there may be other circumstances that prompt you to file a bankruptcy sooner, such as an imminent garnishment.)

Protection for your tax refund

As with any asset in bankruptcy, we look to exemptions for protection.  Your tax refund can be protected in two ways:

  1. Your federal earned income credit is 100% exempt (protected). Note this does not apply to Oregon State earned income credit, or to the child tax credit.
  2. We can protect up to $400 of the remainder of your refund.

If the bulk of your refund is federal earned income credit, you may decide, with the help of your attorney, to file your bankruptcy before receiving your refund.  If you and your attorney determine that you would lose your refund in your bankruptcy, you may wish to wait to file until after you receive and appropriately spend your refund.

Why do I have to spend my refund before I file bankruptcy? 

We can only protect $400 total in cash when we file a bankruptcy. This exemption applies to all of your money, whether it is in your wallet, your bank, or in un-cashed checks. (This exemption doubles to $800 in a joint bankruptcy.)

If we cannot protect the refund, we advise our clients to wait to file a bankruptcy until after the refund is received and spent to the point of being under the applicable exemption amounts. How you do this, is critical. I strongly recommend anyone undertaking this pre-bankruptcy planning consult with an attorney, as a mistake here can have a significant impact on your bankruptcy.  The following are general tips, and should not be taken as an exhaustive list, or as legal advice.

 

Don’ts

  • Your refund should not be used to repay any friends or family members, or to pay off any one particular creditor
  • It should not be used to purchase luxury items, or take trips
  • It should not be given away
  • It should not be used to purchase assets that cannot be protected in your bankruptcy

Do’s

  • Your refund can be spent to fund your bankruptcy filing
  • Your refund can be used on ordinary life expenses such as:
    • School expenses for your children
    • Deferred medical expenses, such as doctor and dentist appointment, glasses, or prescriptions
    • Needed car repair
    • Groceries

 

Is my federal earned income credit still protected?

It is possible to save your federal earned income credit and protect it in your bankruptcy.  This means that you would only need to spend down your non-earned income credit portion of the refund prior to filing. If you are considering this, you should consult with a bankruptcy attorney to insure that you have taken the necessary steps to protect your earned income credit.

 

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