Your Income Tax Refund & Chapter 7 Bankruptcy

Posted By : admin
Category : Bankruptcy
21 - Jan - 2015

It’s tax time people!  At tax time it is typical that the amount of Chapter 7 bankruptcy petitions filed increases.  This is true because many people who need to file bankruptcy use their income tax refund, or a portion of their income tax refund, to pay an attorney to represent them in bankruptcy and to pay the filing fee required.

However, it is important to know that filing Chapter 7 bankruptcy too early may jeopardize any income tax refund you are expecting.  Specifically, if you file Chapter 7 bankruptcy in the Southern District of Indiana prior to receiving (and possibly even spending) your income tax refund, you may lose it.  Even if you received the income tax refund after you filed bankruptcy and already spent it, the bankruptcy trustee in charge of your case may be entitled to that money.

This time of year bankruptcy trustees are very interested in when you received your income tax refund, when you spent it, and what you spent it on.  Trustees in the Indianapolis division of the Southern District of Indiana are allowed to take a pro-rated portion of your income tax return so long as it is not attributable to the earned income credit.  This means that if you file a Chapter 7 bankruptcy on November 30, 2014, then the bankruptcy trustee would be entitled to ask you to turn over 11/12th of your income tax refund received in 2015 for 2014 minus any portion you received as a result of the earned income credit.

If you file a Chapter 7 bankruptcy in February, 2015, and haven’t yet prepared your tax return you may be setting yourself up to lose your income tax refund completely.  Since we are no longer in 2014 you are now entitled to your entire 2014 income tax refund.  So, if you file prior to receiving/spending it, then you are going to have to hand the whole thing (less the earned income credit) over to the bankruptcy trustee.

Sometimes a debtor opts to file a bankruptcy petition knowing that they will likely lose their entire income tax refund.  This may be the case if the debtor is being garnished.  In Indiana a garnishment means that 25% of your net income can be taken by your creditor.  So, if you are losing $800.00 per month to a garnishment, but believe your income tax refund will only be $300.00 it likely makes more sense to get Chapter 7 bankruptcy filed now to stop your garnishment.

This small mistake that can cost a debtor hundreds or even thousands of dollars .  Every year when sitting in bankruptcy hearings I hear a debtor that didn’t have an attorney tell a trustee that they dont have their income tax refund anymore because they needed it to pay rent, to pay a babysitter, or even just to buy food.  Unfortunately, it just doesn’t matter.  The trustee can still require you to turn over the funds even if you have already spent them and can ask the Court to revoke your bankruptcy discharge if you fail to do so.  This unfortunate result is one of the reasons I think it is a good idea to hire a bankruptcy attorney to represent you.  An attorney can review your case and determine how to best protect your income tax refund and other assets.  The attorney can also answer your questions about the process and will appear with you at the hearing.

Halcomb Singler, LLP, offers one free initial consultation for those who believe they may need to file for bankruptcy.  Contact our office at (317) 575-8222 to schedule your appointment at our Carmel, Indiana location.