Chapter 7 Bankruptcy and Tax Refunds — What You Need to Know

After you file for Chapter 7 bankruptcy, will you be allowed to keep your income tax refund?

You may be able to keep your refund — if you plan ahead. To avoid losing your tax refund check, you’ll need to consider the timing of your bankruptcy filing.

bankruptcy taxes

Tax Refunds Are Considered Assets in Chapter 7 Bankruptcies

As soon as you file for Chapter 7, most of your assets become part of your bankruptcy estate and are eventually distributed among your creditors.

If your bankruptcy case is filed during tax season, your refund will likely be considered an asset, regardless of whether you’ve received the check yet.

Chapter 7 bankruptcies are based on the property you own, minus any exemptions. Tax refunds are considered property, and in most cases, they are not exempt under Utah law. If you aren’t careful in choosing your filing date, you may be required to turn your tax check over to the bankruptcy trustee.

Timing Your Chapter 7 Bankruptcy to Keep Your Tax Refund

If you don’t want your refund allocated to your bankruptcy creditors, you’ll have to delay filing your Chapter 7 case until after you have received and spent the money.

A word of warning: You can’t simply go out and append the money on frivolous purchases. Buying luxury items before filing for bankruptcy can place your discharge at risk, as it has the appearance of fraud.

Instead, use your refund for necessities. Using this money to pay your mortgage, utility bills, medical costs, food, car maintenance or other living expenses isn’t likely to cause a problem for your Chapter 7 claim.

You can also use these funds to pay your bankruptcy attorney as well as any case-related costs and filing fees.

Tax Refund Considerations for Future Chapter 7 Bankruptcy Filers

If you plan to file for Chapter 7 later in the year, you can avoid this issue with next year’s income tax refund by adjusting your tax withholding now.

The number of allowances you claim on your W-4 determines the amount of federal income tax that is withheld from your paychecks. If you have a high allowance count, the IRS holds more of your money throughout the year. Once you file your tax return, they refund the difference between withholding and your tax liability.

If you lower the amount of your withholding, you’ll keep more of your salary as you earn it, rather than getting a tax refund next year. Be careful not to have too little withheld though, or you could incur an IRS penalty for underpayment.

To determine the appropriate withholding amount in your case, consult with a tax professional and your bankruptcy lawyer.

The experienced bankruptcy attorneys at Lewis Adams & Associates, serving the greater Salt Lake City area, can help you determine your best filing option for your bankruptcy case. To schedule a complimentary consultation to discuss Chapter 7 bankruptcy, contact our West Jordan office today.