Tax Refunds: If a debtor is currently owed a refund for any year prior to the year of filing bankruptcy, the estate is entitled to 100% of the proceeds to which the debtor would be entitled. If a single person or a married couple files bankruptcy, that typically means 100% of the refund goes to the estate, but if a married person files individually, typically 50% of the refund becomes property of the bankruptcy estate. The non-debtor spouse would be entitled to keep 50% of the refund.
PROBLEM: Jack files a bankruptcy on January 15, 2007, but his wife does not file bankruptcy. They have not yet filed their 2006 federal income tax return, but when they do file on April 15, 2007, they realize they will get a $2,050 refund. Since the wife did not join Jack in filing bankruptcy, only half of the refund ($1,025) becomes bankruptcy estate property. Every rule has exceptions, so you need to discuss your specific tax scenario with a bankruptcy lawyer prior to filing for relief.
STRATEGY: If practical, file bankruptcy AFTER receiving and consuming your income tax refund. A debtor should not spend a refund on the purchase of new assets because those assets will become property of the bankruptcy estate. The funds should be used to pay ordinary and necessary expenses.Bankruptcy clients often flood law firms in the second quarter of the year because they use their tax refund to pay for their bankruptcy fees and costs. This is one of many perfectly acceptable uses of the tax refund.
See also Tax Refunds As Assets and Reduce Your Tax Withholdings to Avoid Paying the Trustee.
Copyright Chip Parker. All rights reserved.
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Last modified: October 21, 2012