Many Americans rely on their Federal Income Tax refunds as a source of savings and a means for paying debts and expenses. Depending on their deductions and dependents, some individuals can receive thousands of dollars. If you are on a tight budget, this is an important source of money.
Fortunately, tax refunds can generally be protected in bankruptcy. Tax refunds (or prospective refunds, if the taxes have not been filed) must be listed in Schedule B of the bankruptcy petition. However, they can then be exempted in Schedule C using the bankruptcy exemptions, which allow you to protect most, if not all, of your personal possessions.
For this reason, at this time of year when taxes are filed and refunds are received, it is important for individuals in the midst of bankruptcy to file their taxes as early as possible. The bankruptcy exemptions are not unlimited, so it may be necessary to determine if the bankruptcy can be filed immediately after receiving the refund, or not. I tell my clients this time of year to file as soon as they get their W2s and 1099s so I can then run the refund past the available exemptions.
When anticipating filing bankruptcy, it is also important to be clear what you can, and cannot, do with your refund. You can pay your attorney, pay for repairs for your home or car, or pay for other necessary household expenses. On the other hand, you should not pay back friends or family members, make frivolous purchases, or pay off someone else’s debts.
A side note… if you regularly receive a large refund, you should consider having your employer withhold less. When you get a large refund, you are essentially giving Uncle Sam a yearlong interest-free loan! It’s better to have that money throughout the year (though some of my clients have told me it works as a way of “forced savings”, so to each his own.)
If you are considering filing for bankruptcy during tax season and you are not sure what you can or cannot do with your refund, contact us to set up a free consultation to discuss your situation!