Your Tax Refund and Personal Bankruptcy

It's tax season and a question asked by many people is: "Do I need to report my tax refund?" The short answer is yes, your tax refund is part of the bankruptcy estate. However, you and/or your attorney may be able to use an exemption to allow you to keep all (or at least a potion) of your refund. Here's my little disclaimer before you read the rest of this blog...every case is different and every state is different. What's in this article is a general analysis under the federal code.

I guess it makes sense to explain and define the term "bankruptcy estate." I'll use Chapter 7 personal bankruptcy as an example. Under Chapter 7 all property and assets owned by the person filing bankruptcy (the debtor) are put into a big 'ole pot. This pot is called the bankruptcy estate. The technical definitions and requirements are found in the United States Code at 11 U.S.C. 541. This estate is then administered by a bankruptcy trustee whose job it is to liquidate any assets and administer payments to creditors. The point here is that your tax refunds are considered an asset and must be reported as part of your bankruptcy petition. But, as always, depending on the circumstances of each case you may have the ability to retain part of your refund.

After reporting the tax refund as an asset (along with all other assets) the bankruptcy code allows for certain exemptions (meaning you may keep some equity). When filing for bankruptcy you may choose either the federal exemptions (found at 11 U.S.C. 522(d)) or the state exemption/other federal exemption scheme. Here, I am going to explain how it is possible to use the exemptions found at 11 U.S.C. 522(d) in order to retain all or part of a tax refund. The code enumerates twelve categories of exemptions, unfortunately none of them say "tax refund." However, you may be able to exempt your tax refund under 11 U.S.C 522 (d)(5) which is also known in the biz as the "wild card" exemption.

The wild card exemption allows a debtor to exempt up to $1,075 an any property (the amount of this and all other exemptions changes every three years and is scheduled to change again this coming April). So, you can choose to exempt up to $1,075 of your tax refund under this subsection. Additionally, 11 U.S.C. 522(d)(5) allows the debtor to use up to $10,125 of the unused portion of their homestead exemption (11 U.S.C. (d)(1)). The homestead exemption is just what it sounds like. It lets the debtor exempt up to ($20,200) of equity in the property that the debtor uses as a residence. So, if you have money left over from subsection (d)(1) you can also use that to exempt the tax refund.

Like I've said, exempting a tax refund may not work in every case, but it's something to keep in mind. I guess the moral of the story is this...don't forget to report your tax refund to your attorney (and to the court). Also, remember to plan your exemptions accordingly.