Bankruptcy

Tax Refunds and Bankruptcy: ?Tis the Season!

By Russell A. DeMott, Charleston Bankruptcy Lawyer

Tax refunds are property of your bankruptcy estate.  There are two times of the year this can be especially problematic.

During Tax Season

During tax refund season–the first four months or so of the year–you may be entitled to a tax refund.  If you are getting a refund, you want to be able to keep it.  This is called ?exempting? the property.  That is, you want to be able to claim the refund as property you may keep.  Most exemption statutes?either the federal exemptions or your state’s?are fair and allow a certain amount of your refund to be kept.  However, using your exemptions on your tax refund may limit your ability to use the exemptions to protect other property, such as bank accounts, equity in vehicles, and jewelry, just to name a few.

Important: If you are getting a refund, do your best to determine the amount of the refund, both state and federal.  If this causes problems with your exemptions, you may simply decide to wait to file until after you have received the refund and spent it.  For example, you may have mortgage payments due, clothing needs, school expenses, medical expenses, car repairs, or other necessary expenses.  Using the refund for these purposes is allowable.  If you have any doubt about whether a particular expenditure is appropriate, be sure to discuss this with your bankruptcy attorney.

During the Last Quarter of the Previous Year

Refunds can also cause problems during the last quarter of the year (October through December).  If, for example, you have been having large amounts withheld from your paycheck, the refund attributable to the part of the year prior to your bankruptcy filing is an asset of the estate.   For example, if you file bankruptcy on November 15 and have too much withheld in taxes (say an additional $2000 more than you?d owe up to that point), the overpayment?$2,000 in our example?is an asset of the estate.  To avoid this second type of tax refund problem, you need to adjust your tax withholding to a significantly lower amount.  Find out how much you must have withheld to eliminate any refund.

This also makes sense from a financial planning standpoint.  I have never heard a financial planner suggest you should overpay withholding and allow the government to use your money interest-free for a year.

Important: Make sure you are not having excessive amounts withheld from your paychecks.  Seek assistance from a tax professional to determine the appropriate amount you should have withheld to minimize your tax refunds.

Russell A. DeMott is a Charleston, South Carolina Bankruptcy Lawyer who helps people file Chapter 7 and Chapter 13 bankruptcy.

Full post as published by Bankruptcy Law Network on January 24, 2010 (boomark / email).