Will I Keep My Tax Refund in a Chapter 7 Bankruptcy Case?

The timing of the filing of your Chapter 7 bankruptcy case can help determine whether you get to keep your tax refund in full or in part.

The Bankruptcy Estate

The date of filing of a Chapter 7 bankruptcy case determines what debtor property – if any – becomes part of the bankruptcy estate.  Any debtor property that is acquired prior to the filing of the Chapter 7 petition and cannot be claimed as exempt goes into what is called the bankruptcy estate.  This estate then liquidates any of these non-exempt assets to pay creditors some of what they are owed.  The upside for the debtor is that any property or income he acquires after the filing date belongs solely to the debtor and cannot be seized and liquidated to pay off any of the debtor’s pre-filing debts.

Section 541 of the Bankruptcy Code defines property as “all legal or equitable interests of the debtor in property as of the commencement of the case.”  This includes proceeds and profits from property that became part of the estate but was not received prior to filing.

Tax Refunds

As an example, assume that a debtor files for Chapter 7 bankruptcy in January 2016.  Further assume that the debtor is entitled to a tax refund for tax year 2015, but has not received it at the time he files for Chapter 7 bankruptcy.  Under Section 541 of the Code the debtor’s tax refund for year 2015 becomes part of the bankruptcy estate because the debtor became legally entitled to it in year 2015 – the year prior to filing.  For that reason, I normally counsel debtors to, if possible, think about the effect of the timing of their bankruptcy on their tax refund.

Florida exemption laws give an individual debtor can exempt up to $1,000 in personal property and an additional $4,000 in exemptions that the debtor can apply toward any property if they do not own a home.  For these debtors the timing of their Chapter 7 bankruptcy filing is immaterial as use of these exemptions can protect some or all of their tax refund.  For debtors that are expecting tax refunds significantly larger than the dollar value of their exemptions, my advice is to delay their filing by a few weeks or months.  Once they received their tax refund, it is entirely permissible for a debtor to use the money from their refund to pay for rent, food, other necessities as well as the costs of their bankruptcy case.  At that point, it is safe for the debtor to file for bankruptcy.  That said, it is important to note that if the debtor spends their tax refund on luxuries or on property that cannot be exempted, those luxury purchases or non-exempt property will have to be turned over to the bankruptcy estate.

Bottom line: If you are expecting to receive a prior-year tax refund after you file for bankruptcy, it is important to talk to you attorney about either exempting the refund or the timing of your bankruptcy filing.  If you have questions about your tax refund and a potential bankruptcy filing feel free to give our office a call. Initial consultations are always free.