Can Trustee Take Tax Refund After Discharge? (Can I Keep My Tax Refund in Chapter 7 Bankruptcy)

There’s nothing quite like a tax refund, is there? All of a sudden this money seems to fall from the heavens, directly into your lap, and, depending on your circumstances, it can be a real treat or a total life-saver.

Normally, these refunds are yours to keep, but in certain circumstances, the rules aren’t all that clear, or not as well known, at least. Say, for example, you have or are in the process of filing for Chapter 7 bankruptcy, and a tax refund comes your way.

Can Trustee Take Tax Refund After Discharge

Are you allowed to keep it, or will a trustee claim it as an asset and forward it to the relevant creditors?

The answer to this question depends on a number of variables, including when you receive the refund, when you filed for bankruptcy, and whether you can secure bankruptcy exemption for said refund. So, is that check that arrived in the mail yours or someone else’s? Read on to find out.

Does The Tax Refund Pertain to Money Earned Before or After You Filed for Bankruptcy?

To figure out who that lovely tax refund belongs to, you first need to ask yourself what it is exactly it’s refunding. In other words, is it kickback from your income before you filed for chapter 7 bankruptcy or after?

If it pertains to earnings made before bankruptcy, we’re sorry to say that it belongs to the bankruptcy estate, and the trustee will seize the funds and use it as a partial means of repayment on your behalf. This is the case whether you have been discharged or not.

On the other hand, if the tax refund pertains to income earned after your bankruptcy, it’s all yours!

Sometimes, the situation isn’t as clear-cut, and the tax refund is based on earnings of periods both before and after filing for bankruptcy. If this is the case, you’re eligible to keep any funds based on your post-bankruptcy income. The rest will be collected by a trustee and paid to creditors.

So, to sum up…

  • Tax refund pertaining to income earned prior to chapter 7 bankruptcy — Not yours, regardless of discharge status.
  • Tax refund pertaining to income earned after filing for bankruptcy — All yours!
  • Tax refund pertaining to income earned both before and after bankruptcy — Shared between you and creditors.

How To Protect Your Tax Refund From Trustees

The good news is that there are measures you can take to keep trustee paws off your tax refund, including…

  • Adjusting your withholding — This method is time-sensitive, so you’ll have to act early in the tax year.
  • Spending your refund to cover essential expenses — These could be attorney fees or general living expenses.
  • Securing bankruptcy exemption — A tax refund is considered an asset during bankruptcy, meaning it’s sometimes eligible for protection in the form of exemption.

Adjusting Your Withholding

By regularly adjusting your tax withholding before filing for Chapter 7 bankruptcy, you can fulfill your tax obligations more accurately, leaving more money spare in your paychecks that you can spend on essential living expenses.

Just be sure to withhold enough money to cover your taxes, otherwise, you’ll make your financial situation a lot worse.

The key takeaway here is that you must spend the extra money that would otherwise make up the tax refund before you file for bankruptcy, and you can only spend it on essentials. If you use it to procure assets, the assets will be seized after you file for bankruptcy.

Necessary Expenses

You can also keep your tax refund after filing for bankruptcy if you allocate it to cover necessary expenses. This isn’t considered fraudulent, as it’s understood that assets can be used by bankrupt parties to pay for realistic living expenses.

Now let’s take a look at what is technically classed as “necessary expenses”.

  • Current rent and mortgage payments
  • Housing repairs
  • Medical fees
  • Clothing
  • Food
  • Car maintenance and fees
  • Educational fees
  • Legal fees

Any expenses that fall outside of these areas are classed as unnecessary. Let’s take a look at some specific examples…

  • Advanced rent or mortgage payments
  • Repayment of an individual creditor — This is referred to as preferential payment. In bankruptcy, creditors must be treated as equals in order to keep the situation as fair as possible, so if one creditor benefits more than the others, the trustee will reclaim the money for the estate.
  • Any form of luxury product If your frivolous spending is discovered, the trustee will take measures to deny your eventual discharge, as you have acted in “bad faith”.
  • Paying a friend or family member back

It’s important that you keep detailed records of how every penny is spent, so you can prove to the authorities, the trustee, and your creditors that it was spent in an acceptable and essential manner.

You should also check in with your local bankruptcy attorney to establish what you’re permitted to spend on, as the list can differ ever so slightly from district to district.

Protecting The Tax Refund With An Exemption

When you file for chapter 7 bankruptcy, the trustee will collate your assets and use them to repay your creditors; however, certain assets deemed essential to your work and life are deemed as exempt, and cannot be seized by the trustee.

In the eyes of most states, money in your bank account isn’t eligible for exempt status, but some do grant you something referred to as “Wildcard Exemption” that can be applied to any asset, including your tax refund.

It’s a sure-fire way to secure your newfound funds, but saving your wildcard for a more important asset may be a more strategic move — it all depends on how large your refund is.

Final Thoughts

There you have it — any tax refunds based on income earned before filing for bankruptcy will be seized by the trustee and divided among your creditors, even if you receive the tax refund after your discharge.

Any refunds derived from your income earned after filing for bankruptcy are yours to keep, unless, of course, there’s an overlap, in which case, all parties involved will get their fair share.

Total
0
Shares
Previous Post

How Does Worker’s Comp Affect Tax Return?

Next Post

Can You File Your Taxes Twice? (And What Happens)

Related Posts