Bankruptcy

Can the bankruptcy trustee take my tax refund?

By David Leibowitz, Illinois and Wisconsin Bankruptcy

A bankruptcy trustee might be able to take your income tax refund whether you have filed a chapter 7 or chapter 13 bankruptcy case. Some courts say that this procedure is improper – but it happens every day in many places.   How can this be?  Well, income tax refunds in chapter 13 are “property of the estate” so your chapter 13 trustee will want to apply this money toward payment of your plan in many cases.  Different chapter 13 trustees handle income tax returns differently around the country, so discuss this with your bankruptcy trustee before you file your case. You may want to adjust your withholding to avoid this issue.

On the other hand, in chapter 7, only the part of your income tax refund for the time before you file the bankruptcy case is considered.  Make sure your lawyer schedules your income tax refund on lines B-18 or B-21 of your Schedules.  And make sure that your attorney claims the maximum exemption possible for you.

Otherwise, the chapter 7 trustee has the right to ask the Internal Revenue Service to send the tax refund directly to the trustee. And it will!  You may get some back but you may not.  Every case is different.  In any event, if you and your lawyer don’t handle this correctly, you run the risk of a long delay before you see your income tax refund.

Bankruptcy trustees take income tax refunds more frequently than any other asset.  You can protect your income tax refund by claiming it to be exempt.  In most cases, you’ll claim a “wild-card” exemption.  In some cases, you might be able to claim that “earned income credit” or “child-care credits” are welfare benefits, which could be exempt under the law of your state.  So work with your attorney to protect it to the fullest extent of the law.

Full post as published by Bankruptcy Law Network on August 09, 2010 (boomark / email).