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What Happens To Tax Refunds In Chapter 7 Bankruptcy Cases?

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Filing for Chapter 7 bankruptcy is a great solution for becoming debt-free if the majority of your debts are unsecured. When you are approved for a discharge in Chapter 7, all of your unsecured debts will be forgiven, but you may have to surrender some of your assets, including your tax refund. Before you file, you may want to know how the trustee will handle your refunds, and here are three things you should know.

Why the Trustee Takes Refunds

The first thing to understand is that a bankruptcy trustee will be assigned to your case. The role of the trustee is to collect and sell certain assets and to use the money to pay your creditors. If you do not have any assets, your creditors will not receive any payments, and the full balances owed will be wiped away.

You should understand that assets do not only refer to things you currently own, but they can also include cash you expect to receive. This cash could come from an inheritance or lawsuit settlement, but the main source of cash you may be expecting is a tax refund.

The trustee may have the right to intercept your refund, but it will depend on several things, including the timing of your case.

Why Timing Matters

When you file for Chapter 7 bankruptcy, you will have to list all of the income you received within the last six months to one year. If you recently received a tax return, you may also have to include that in these figures. In most cases, people that file Chapter 7 are allowed to keep the tax returns they recently received, as long as the money was spent on necessary things, and this includes:

  • Mortgage payments
  • Home repairs
  • Utilities
  • Medical care
  • Food
  • Clothing

If the refund was spent on some type of luxury item, you may have to surrender the item to the trustee, even though you received the refund and made the purchase prior to filing for bankruptcy. To be safe, you may want to wait for six months after receiving the refund because the trustee will not be as likely to question what you spent the money on if this much time has passed.

On the other hand, if you file your taxes after filing for bankruptcy, the trustee is likely to intercept your refund. If this happens, you may never see the money because the trustee may take it directly from the IRS.

If you believe that this will happen, you could plan ahead by changing your exemptions for your paychecks. If you raise the exemptions, your paychecks will be higher because fewer taxes will be withheld. When this is done, it could actually reduce the amount of tax refund you will receive, and you will not have to surrender as much money to the trustee.

Another way to reduce the amount of your refund is to contribute more money to the retirement plan offered at your job. This will decrease your income amount and could help you reduce your tax refund check.

Finally, you should realize that the trustee will only take one tax return at the most. The trustee does not have access to take the tax refund money you receive for the taxes you file the year after filing for Chapter 7.

It is illegal to lie to the trustee about your income, assets, or tax refund checks, but by timing your filing correctly, you may be able to prevent losing your tax check. You can talk to your personal bankruptcy attorney about this to learn more about Chapter 7 bankruptcy.