Filing for bankruptcy will not absolve an individual from filing his or her tax returns. With few exceptions, individuals must be current on filing their tax returns for the previous four years before they can file a Chapter 13 case with the bankruptcy court. Although there is no such express requirement imposed on an individual in Chapter 7, the trustee will generally require them as evidence of historical income. Further, to assess the estate’s tax liability, the Trustee may also need to file in appropriate cases, an IRS 1041 tax return. Under Chapter 13, individuals must also continue to file taxes over the three to five-year lifespan of their case.
Does it matter when I file my tax return?
There are incentives for having your taxes resolved before entering into bankruptcy. For one, the trustee assigned to your case will compare the income claimed in your bankruptcy filing to that in your tax filing. Unexplained or unresolved discrepancies could cause your case to get dismissed. In the context of Chapter 13, individuals who refile after a dismissal are not offered the same protections from creditors as they are the first time around.
Whether or not the individual can keep their refund depends on when they earned it, when they filed for bankruptcy, and whether or not they can protect it with an exemption. Typically, refunds on income earned before the bankruptcy filing become part of the bankruptcy estate. Refunds on income earned after the filing are yours to keep in a Chapter 7 proceeding. Depending on the amount of money coming in, this could provide incentive to file for bankruptcy protection as soon as possible.
Ways you can keep (or protect) your tax refund.
Tax refunds provide a needed jolt to personal finances. If the nature or your bankruptcy case means you are in danger of losing your tax refund, there are a few things you can do to ensure it isn’t taken from you or soaked up by the bankruptcy estate:
- Adjust your tax withholding. This could be a good strategy if you might file for bankruptcy in the next year. More money from each check goes into your pocket; just be sure you’ve left enough withholding to cover the taxes you will owe.
- Spend the refund on necessary items. These include your rent or mortgage, utilities, food, clothes, car payments, prescriptions, and more. What is NOT allowed is to spend the refund on luxury items, IOUs, or preferential payments among your creditors (like paying off one credit card but not another).
- Use an exemption. The rules for exemptions vary by state. Most states will not let you protect cash and bank balances, but some have wildcard exemptions that can be used on any property of your choice, including tax refund which would otherwise be due to the bankruptcy estate.
The interplay between tax code and bankruptcy court is complex.
The nuances of how an individual’s tax situation can be impacted by their bankruptcy case are too plentiful to list. The information provided by the IRS and states are lengthy, confusing, and overwhelming for most of us. With so much riding on your bankruptcy case, it is important to get it right. The Law Offices of Jeffrey Lohman have decades of experience with bankruptcy courts and are ready to help. Let our expert staff work on solving your problem. Contact us today.
The Law Offices of Jeffrey Lohman, P.C. is considered a debt relief agency pursuant to federal law. We are attorneys who help people file for bankruptcy relief under the Bankruptcy Code.