Bankruptcy is a difficult process. However, it offers a light at the end of a dark financial tunnel. While you are going through bankruptcy, you may not feel any more optimism about your financial situation than you did before. That is because during bankruptcy, you lose a lot. Much of your money and assets will go toward paying your debt, and you must continue to live in a tight financial spot for months or years. This can make parting with your annual tax refund even harder. It feels like you are losing a yearly bonus on which you relied for a bit of financial freedom.
Tax refunds during bankruptcy often go toward paying your debts instead of giving you a little more leeway in your income. However, there are ways to try and keep all or some of your tax return.
Your Tax Refund During Chapter 7 Bankruptcy
Tax refunds can become complicated during a Chapter 7 bankruptcy. However, the bottom line is that your bankruptcy trustee will likely take a portion or all of your annual tax refund as part of the bankruptcy estate and use it to pay your creditors.
When you file for bankruptcy, the trustee determines everything that is part of your bankruptcy estate, including all of your assets like money in the bank, your home, and your vehicles. However, since the definition of assets for your bankruptcy estate is quite broad, it also includes anything that is due to you from transactions and work prior to filing for bankruptcy. This would include your prior year’s tax refund, even if you did not file your taxes until after you began the bankruptcy proceedings. For example, if you file for bankruptcy in December 2021, then your tax return for the 2021 year would be part of your bankruptcy estate even though you would not get it until 2022, after the bankruptcy filing date. Your 2021 tax refund is based on work you conducted prior to the bankruptcy.
Your next year’s tax return that includes income from the year during which you were going through the bankruptcy may be different. You are entitled to any refund based on income you earned after the filing date. In regard to our previous example, if you filed for bankruptcy in December 2021, then all of the income you earn during 2022, after the bankruptcy filing date, may provide you with a refund that you can keep next tax season.
However, the tax return may be a bit more complicated. If you filed for bankruptcy in June 2021, then half of last year’s wages were prior to filing for bankruptcy and the other half of the wages were earned after the filing date. This means your bankruptcy estate may be entitled to a portion of your refund while you are entitled to the remainder.
Your Tax Refund During Chapter 13 Bankruptcy
Since a Chapter 13 bankruptcy works differently than a Chapter 7, your tax refund may be handled differently as well. It may need to go toward your debt payments or, if your payments are going well, then you may be able to keep it.
During a Chapter 13 bankruptcy, your trustee develops a plan for how you will pay all or a portion of your debt. You will be on a payment plan, requiring you to pay a certain amount toward the debt each month for years. This plan is based on how much you earn, how much of these wages must go to essential costs, and how much disposable income can be paid toward your debts. This plan will need to take into account your tax refund.
In many cases, the plan will call for the refund to be turned over to the trustee and used toward your debt. This is common when you do not have much disposable income going toward paying your debts. In this case, putting your refund toward the plan can be difficult to swallow, yet in your best interests. In other situations, the trustee reviews the tax refund each year and determines whether it should affect your current payment plan. If you have met all of your payments and can continue to do so without the help of the refund, then the trustee may let you keep it.
How your annual tax refund is handled during a Chapter 13 bankruptcy has a great deal to do with your trustee. You should speak with your trustee to determine what they will consider with your refund.
Retaining Your Refund Through Exemptions
There are numerous exemptions that entitle you to keep certain assets out of the bankruptcy estate, which means they cannot be used to pay off your creditors. Basic exemptions include your bedding, clothing, kitchen appliances, and other household goods. Others allow you to keep insurance benefits and pensions.
Some of the federal or Ohio exemptions may apply to all or a part of your tax refund, enabling you to keep a certain amount for yourself. These exemptions can depend on the jurisdiction in which you are filing for bankruptcy, so be sure to speak to an experienced Cleveland bankruptcy lawyer to learn more about exemptions that may impact your tax refund. For example, Ohio allows what is known as a “wild card” exemption for up to $400 of any property.
Do You Have Questions About Your Taxes During Bankruptcy?
Whether you have already filed for bankruptcy or you think it may be the right solution for your financial situation, call Cleveland bankruptcy lawyer’s Matthew Alden and Patrick Miller of Luftman, Heck & Associates as soon as possible at (216) 586-6600. He understands your fears about moving forward with a bankruptcy and can explain your options, as well as how your tax returns during the process might be handled. You can also email us at email@example.com.