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Income Taxes and Bankruptcy

It’s getting to be that time of year when we take out our W-2s and start filling out our state and federal tax returns. If you are also considering filing for bankruptcy there are some things to think about when coordinating the two filings. For example, if you are planning to file for Chapter 7 bankruptcy, when you file your taxes can make a big difference in whether you get to keep your refund. Things that may impact the answers to this include: the amount of your refund, your bankruptcy exemptions, and when you file your case. Let’s look a little closer at income taxes and filing for bankruptcy. 

Timing is critical when it comes to income tax refunds and bankruptcy. In the case of a Chapter 7 bankruptcy, the tax year and timing of the filing will determine whether you get to keep the tax return. An individual’s assets become part of the bankruptcy estate and is controlled by the trustee. A tax refund is one of those assets that if not exempted may be used to pay unsecured creditors. It is very likely that the trustee will ask about a tax refund at your meeting of creditors especially if you file around tax time.  

Depending on how far in advance you know you will be filing for bankruptcy, there are several things you can do to keep your tax refund:

  • adjust your withholding to reduce your refund to a minimal amount
  • spend the refund on necessary expenses, or
  • include the refund in your bankruptcy exemptions.

A tax refund can be tricky because it often involves a process that begins before the bankruptcy filing date and continues afterwards. As always talk to your bankruptcy attorney about the timing of your bankruptcy and filing of income taxes to be sure you are making the choice that is in your best interest.