On Monday, I discussed the impact that tax refunds can have before filing bankruptcy, but what happens to your tax refunds after filing bankruptcy? Without proper planning, the trustee assigned to your case can have the Internal Revenue Service (IRS) send the refund directly to the trustee.
In a Chapter 7 case, it is important to include your tax refund on your schedules as an asset and have your attorney claim the maximum possible exemption for you. An experienced Washington DC or Maryland bankruptcy lawyer can determine the best way to exempt your tax refund, as such refunds can typically become one of the assets most frequently taken by bankruptcy trustees.
While only the part of your income tax refund for the period before you filed Chapter 7 is considered, tax refunds can be considered a form of disposable income under the debt repayment plan in a Chapter 13 bankruptcy. You must pay your tax refunds to the Chapter 13 trustee unless you get them excused. Your attorney can help minimize the amount of your tax refund that you would have to give up through a couple of different options.
One way to avoid giving up a tax refund is to decrease the amount that is withheld from your paychecks. This will give you more money up front throughout the year and reduce the size of the refund at the end of the year, although it is important to keep in mind that decreasing the withholdings too significantly could instead leave you with a tax bill to pay. You will also have a bigger paycheck, which could increase your plan’s payment.
Another option for individuals in Chapter 13 plans is to take advantage of their company’s 401k plan. By having a percentage of pretax earnings placed into such a fund, the bankruptcy trustee cannot seize the funds. A bankruptcy lawyer can help in excusing you from paying your tax refund to the Chapter 13 trustee if you need it for unforeseen expenses that you did not budget for in your original schedules.