Your income tax refund is basically an interest-free loan to the government. If you have paid more in taxes than you owe, the government must repay you for your overpayment. Around this time every year, I often get asked the question, “What happens to my tax refund if I file bankruptcy?”
The trustee assigned to your case may be able to seize your income tax refund, depending upon when you file and whether your refund is fully exempted.
In most Chapter 7 cases, your tax refund can likely be fully exempted, which means the Chapter 7 trustee will “abandon” your refund and you will be able to keep it. If you do not correctly exempt your refund, however, the trustee will request that the IRS send the refund directly to the trustee’s office. Even if you are due some portion of your refund post-distribution, the possibility of a long delay makes this an unattractive option.
Chapter 13 cases are a bit more complicated. If you have a confirmed Chapter 13 Plan that requires repayment of only a percentage of your debt, your trustee will likely seize your refund over the course of the Plan and use the proceeds to increase the percentage paid to unsecured creditors. Income tax refunds in Chapter 13 are considered “property of the estate,” so your trustee will want to apply this money toward payment of your Plan.
In 100% repayment cases, however, the trustee has no interest in seizing your tax refund. If your income is demonstrably sufficient to satisfy your confirmed Plan, the trustee will allow you to keep your tax refund. Often adjusting income tax withholdings upon filing a Chapter 13 is appropriate.
Tax refunds are the assets most frequently captured by bankruptcy trustees. An experienced bankruptcy attorney can assist you in finding the maximum exemption or strategy to protect your tax refund.