WILL I LOSE MY TAX REFUND IF I FILE FOR BANKRUPTCY?
The chances are highly unlikely that you will have to forfeit your tax refund if you file for chapter 7 bankruptcy, unless that is….So, what are some of those “unless” scenarios? Bear in mind that the following discussion is limited to Northern Virginia. As in those bankruptcy cases filed in Alexandria, Virginia. Every state does things a little differently.
Scenario 1: You file for bankruptcy on your own
Part of the deal when filing for bankruptcy is that you have to disclose all of the assets that you own. When people typically think of assets they normally think of houses, cars, furniture, stock, and money in the bank. Tax refunds, or the potential of a tax refund however is not something that most people think of as an asset when contemplating bankruptcy. But the fact of the matter is that the US Supreme Court has made it clear: tax refunds are indeed part of the bankruptcy estate. Part of the estate simply means that it is potentially up for grabs.
The other key thing to keep in mind is that in bankruptcy if you want to keep the asset, you have to exempt the asset. And this is where many people who file a chapter 7 bankruptcy without an attorney (pro se if you want to use fancy Latin terminology) trip up. Around this time of the year (January –May) many people are expecting a tax refund. The tax refund needs to be listed on the bankruptcy petition, properly exempted AND you need to file a timely Homestead Deed. Merely exempting it on the bankruptcy petition is not enough. That last part, the Homestead Deed, really trips people up.
Which brings me to my final point: the chapter 7 trustee is not your friend. So, just because he or she seems nice, and just because they smile at you when they meet with you at the meeting of the creditors does not mean that they will not jump at the opportunity to take your money. And if you think that they will feel sorry for you because you have decided to file on your own, you better think again. They are there to represent the interest of the unsecured creditors. And by the way, just because it is the end of the year, say November 2013, and you decide to file for bankruptcy at that point it does not mean that the 2013 tax refund is not up for grabs. It is in indeed. Once again, it must be listed and properly exempted.
Scenario 2: The careless bankruptcy attorney
If your attorney is in a hurry or careless you could lose part or all of your tax refund. This is especially true if you normally get a sizable tax refund around this time of the year (say $4,000 for instance). How? Because Virginia’s Homestead Exemption typically only gives you $5,000 to exempt your assets with. That means that if you have some other assets that need to be exempted and there are no other exemptions other than the Homestead Exemption (say a life insurance policy with some cash value, a couple of thousand worth of stock, a car with some significant equity, etc) then you will now find yourself in a pickle. You will have to give up something and that something may be worth several thousand dollars.
The solution? Instead of filing your bankruptcy case in January or February of the year before you have filed and received your tax refund simply delay the filing of your case by a few months. So, file your tax return as early as possible, collect your sizable tax refunds as quickly as you can and then spend that tax refund money on necessary household items. Get braces for your daughter, fix your car, put some new windows in the house, pay your bankruptcy attorney their legal fees -that’s especially important- and when most/all of that money is gone a few months later than you can safely file your bankruptcy case. Notice that I said spend your money on life’s necessities. I did not say take a trip to Vegas or “donate” that money to your brother.
So barring the above scenarios, or if you simply are not expecting a significant tax refund, then chances are you have nothing to worry about.