Tax refunds and bankruptcy

Posted By Tom Hensel || 2-Feb-2012

A popular question this time of year is "what happens to my 2011 tax refund in my bankruptcy case"?

In Chapter 7 cases, we need to determine what your anticipated tax refund is and then use the appropriate exemption to protect this 'anticipated refund'. If the refund ends up being less than what was forecasted, there is little to be concerned with. However, if the refund ends up being more than what was anticipated, an amendment may be appropriate. In cases where the refund far exceeds the anticipated amount, it may be that not all of the refund can be exempted - creating an 'asset' of the estate to be liquidated by the Chapter 7 Trustee.

In Chapter 7 cases where a large refund is expected, there may be some strategy involved with the timing of the filing date. This is why it is important to consult an experienced bankruptcy attorney to assist you with your case.

In Chapter 13 cases, unless the proposed dividend to unsecured creditors is 100% (i.e. a plan where unsecured creditors are to be paid in full), federal tax refunds will need to be accounted for in 1 of 2 ways:

1) they will need to be pledged to the Chapter 13 Trustee. Theoretically, this means that they will go towards increasing the dividend to the unsecured creditors. This is the required method of accounting for federal tax refunds in cases filed in the Detroit Division of the Eastern District of Michigan. However, should the Chapter 13 Debtor have an unforeseen expense - it may be possible to tap into the refund to help pay for it. For example, a Chapter 13 Debtor prepares his 2011 return and finds out he's entitled to a $1500 refund. He also just learned that his car needs a new transmission that is going to cost $900. A Plan Modification may be filed to seek to use $900 of the refund for this unforeseen expense.

2) the anticipated refund amount would need to be pro-rated as income and figured into the monthly household budget. For example a client wishing to keep his $1800 yearly federal income tax refund would need to add an additional $150 per month to his Schedule I. This would then translate into a higher Chapter 13 Plan payment. This is the preferred method of accounting for federal tax refunds in cases filed in the Flint Division of the Eastern District of Michigan. The danger of accounting for tax refunds in this manner is this - what happens if the Debtor ends up only being entitled to a $600 refund? He may have been paying money to fund his Plan that he never had and he may have been living with an unnecessarily tight budget.

When it comes to federal tax refunds in your bankruptcy case, make sure to consult with your attorney.

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