Filing Bankruptcy and Tax Refunds

by Kent Anderson, Esq.

April 17, 2012

Tax Refund for Bankruptcy

Tax refunds are soon due and so are people filing bankruptcy.  Expect to see a significant jump in bankruptcy filings as taxpayers get refunds from overpayment of their income taxes. According to a study by the National Bureau of Economic Research, as reported in a USA Today article on tax refunds and bankruptcy, more than 200,000 households will use their tax refunds to cover the costs of filing for debt relief this tax season. Small wonder; the economy remains in the doldrums and the costs of seeking legal help have increased due to additional requirements imposed on courts, lawyers and trustees by Congress.  In extensive 2005 legislation, the requirements for filing bankruptcy were dramatically increased and penalties were created for failure of lawyers to comply.

Philadelphia lawyer and former president of the National Association of Consumer Bankruptcy Attorneys, Henry Sommer, was blunt but clear when he said: “They need the money so they can afford to file for bankruptcy.” It is a sad commentary on the reason many people hurry to a tax preparer when they are expecting a refund. A tax refund that must provide the money necessary for payment of filing fees, useless credit counseling, lawyer fees and debtor education, all of the ingredients required to obtain relief in the bankruptcy court.

While it may not even be possible to file for relief before a family files their tax returns, there is an additional reason to take care of taxes first. In many courts, there is no exemption for tax refunds. This means that a tax return filed after bankruptcy could result in loss of any refund to the trustee. This would be disappointing at best and could even risk the loss of a discharge if the debtors spend that refund without trustee permission.  The failure to give an estate asset to the trustee upon demand can result in denial of or revocation of a discharge.

Photo from IRS.gov

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I was admitted to practice in 1978. I am certified as a Consumer Bankruptcy Specialist by the American Board of Certification. I regularly speak on tax and bankruptcy issues at state, regional and national conferences. Years of experience in practice before the Internal Revenue Service and Oregon Department of Revenue have given me the background to resolve a large variety of consumer tax issues.

Last modified: April 18, 2012