Protect a Tax Refund During Bankruptcy
Prevent a Tax Return From Being Seized By the Bankruptcy Court
Nov 10, 2009
For consumers who opt to file for bankruptcy around tax time, the idea of losing a sorely needed tax refund check is a legitimate concern. Luckily, there are ways to prevent all or a portion of a tax return from being seized by a bankruptcy trustee to pay creditors.
Spend the Tax Return
If taxes are filed and received within 60 days of the bankruptcy filing, the court has the right to request that funds from the return be contributed to creditors. If, however, an individual spends the tax refund on household necessities, the bankruptcy court will disregard the full amount of the return. Household necessities include:
- Groceries
- Car repairs
- Household items
- Home maintenance costs
Individuals who use the money to pay creditors or attempt to give the money as a gift to any third party may quickly discover that the bankruptcy court has the right to demand that they be held responsible for recovering the lost funds and delivering the money to the bankruptcy trustee.
File Bankruptcy Independently
If a consumer who is married and regularly files a joint tax return files for bankruptcy independently of his or her spouse, the bankruptcy court is only entitled to half of any tax refund the couple receives. The remaining half can be kept by the non-filing spouse.
If, however, the spouse who is filing for bankruptcy is not currently employed and has not been employed for the duration of the fiscal year, the tax return can be kept in its entirety by the working spouse since the working spouse is the only one who has contributed to the refund. See Case 08-46189-DML.
Take Advantage of Tax Exemptions and the Wildcard Exemption
Any consumer wishing to protect his tax return should check with an attorney to find out which tax exemptions are applicable in his state of residence. Using tax exemptions may allow him to protect all or the majority of his tax refund check. As a rule, the lower the amount of the tax refund, the higher percentage of the check a consumer can expect to keep.
A wildcard exemption is also an option for a consumer wishing to file bankruptcy. Not all states will permit a wildcard exemption, but for those that do, a wildcard exemption can be used to cover any item, up to a given amount, that the consumer wishes to keep. It is permissible to put the wildcard exemption toward homes, cars, or even tax refund checks.
Tax Refunds Cannot Be Seized for Tax Exempt Retirement Income
If an individual currently lives on a tax exempt retirement fund, such as Social Security, any unnecessary withholding that results in a tax refund cannot be seized by the bankruptcy court. This is evidenced in Smith v. Mosier.
In addition, if even a portion of a consumer’s income is considered exempt, any portion of the tax return that is due to the otherwise exempt income must be returned to the filer by the bankruptcy trustee.
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