The Impact of Bankruptcy on Your AZ and Federal Tax Refunds

What Happens to Your Tax Refund After Filing For Bankruptcy?

You’ve gotten to the point where you’re realizing that bankruptcy is going to be the best way to deal with your overwhelming debt. Yet you know that you have a tax refund coming up, and you’d like to be able to use that money to start getting back on your feet after your debts have taken up all your resources for so long. Will you actually be able to keep your tax refund? Or will the bankruptcy court take your refund to satisfy your creditors?

The answer is: It depends. By working with a Tucson bankruptcy attorney, you can understand how the law applies to your specific situation and what you can do to keep more of your tax refund (if possible). However, here’s a general overview of what bankruptcy law allows:

Woman reviewing documents for her tax return

Tax Refund by Year under Chapter 7 Bankruptcy

A tax refund will be considered disposable income that can be used for paying your creditors. If the tax refund was for the tax year before your bankruptcy filing, the entire refund will be considered part of your estate, which can be ordered to be paid to your creditors. So, if you’re expecting a $5,000 check, all of that will likely go to your creditors before your remaining debts can be discharged.

If you are expecting a tax refund for the current tax year, the court will likely prorate the refund according to the income you made up to your bankruptcy filing. So, only part of that check will likely be earmarked for your creditors. You may be able to keep the other part.
If you get a refund for the tax year following your bankruptcy filing, you will be able to keep all of that refund.

Knowing how tax refunds are handled by the bankruptcy court, you can plan with your Tucson bankruptcy attorney on when to file your bankruptcy. You might wait until you have actually received your tax refund so that you can spend it before you file for bankruptcy. Just be sure you are spending it on allowable things. You cannot spend it on:

Repayment of just one debt
Large, luxury items
Repayment or gifts to family or friends

You can spend your tax refund on housing expenses, car payments and repairs, food and clothing, medical care, and education. Talk with your bankruptcy attorney in Tucson if you are unsure about what’s allowable.

Tax Refunds under Chapter 13 Bankruptcy

A Chapter 13 bankruptcy plan reorganizes your debts and sets up a new payment plan based on your ability to pay. If you receive a tax refund under Chapter 13 bankruptcy, it will be included among your assets, and it will likely be distributed to your creditors. However, a tax refund will not be used to determine your payment plan as it is not consistent income.

Deciding voluntarily to apply your tax refund to your Chapter 13 bankruptcy plan can help you pay off your debts faster, so you may want to consider this. However, if you want to keep the refund, you can talk to your bankruptcy attorney in Tucson about applying for an exemption. You will have to file a plan modification, and you will have to specify how much you want to exempt and what you will be spending it on. Some allowable expenses can include:

House repairs
Car repairs
Appliance repair or replacement
Unexpected medical costs

If the exemption is approved, you will also have to provide receipts for these expenses, as well as other documentation.

Tax refunds can be tricky under bankruptcy law, but your Tucson bankruptcy attorney can guide you through each of the possibilities to help you understand how best to handle them. You may also be encouraged to adjust your withholdings so that you don’t end up with a large refund. That way, you can spend more of your money from each paycheck, rather than having a big payout at the end of the year. Your bankruptcy attorney serving Tucson will help you understand the options and the benefits of each.

Call An Experienced Tucson Bankruptcy Law Firm

Call My AZ Lawyers if you are thinking about filing for bankruptcy because you have become overwhelmed by debt. Our experienced bankruptcy attorneys represent clients in both Chapter 7 bankruptcy and Chapter 13 bankruptcy, and they can help you understand how assets like tax refunds, property, and bank accounts are treated under each so you can make the best plan to meet your goals. Our Tucson bankruptcy lawyers are committed to helping you get the maximum debt relief possible. Call us today to schedule a consultation and learn more.