Every time I meet with a new client I always get this question: What happens to may tax refund?

For many of my clients the lump sum cash of a tax refund is a huge deal, this money is usually a way to get caught up on bills or even put something away and be ahead for at least a little while.

First, it is important to realize what your tax refund is.  Your tax refund is YOUR money that is being held by the government to offset your tax obligations.  For those of you getting a refund, this means that you paid too much of YOUR money to the government and they are simply returning it to you.  In some cases you will get more back than was withheld because you are eligible for refundable credits, such as the Earned Income Credit, however for the most part you have overpaid the government and are getting your money back.

This means that your tax refund is income, it is money you have earned, you have just been letting the government hold your money for you to pay towards your future tax obligation.

So here is how we treat a tax refund in a bankruptcy case…

CHAPTER 13 CASES

If you are in a Chapter 13 case, your tax refund has probably already been accounted for so no need to worry.

In New Jersey some trustees will require your bankruptcy attorney to divide your tax refund by 12 and add it back into your monthly income.  Remember, your tax refund is income, it is just income that the government is holding for you.  This can be stressful for clients who have large tax refunds because they don’t have that extra money each month, that only comes once a year.  I generally will advise clients to talk to HR and adjust their exemptions up so that instead of getting a large tax refund, they will instead have more money in their paychecks each pay period and will be able to pay the trustee and save whatever is leftover in their bank account.

I know what you are thinking, but won’t I owe the IRS money if I do that.  Usually not.  Remember, a refund is an over-payment to the government, you have some wiggle room. An adjustment up to exempting 1 or 2 people will generally not result in a huge bill if you are getting back a large refund, your refund will probably just be smaller.  It is important to talk to the HR, payroll department, or accountant at your company and they will assist you with this process.

CHAPTER 7 CASES

In a Chapter 7 case, a large tax refund can be a trickier matter.  Most Chapter 7 trustees consider a large anticipated tax refund an asset of the bankruptcy case.  This means that your bankruptcy attorney is going to have to list this as an asset and exempt it.

Like on a tax return, you have exemptions in a bankruptcy case that can be used to protect your personal property, items like cars, furniture, bank accounts, and in this case your tax refund. It is very important that your bankruptcy attorney reviews your exemptions carefully prior to filing your case and ensures that your tax refund is properly listed and exempted.  In most cases, assuming your refund isn’t over 10 or 11 thousand dollars your bankruptcy attorney should be able to protect all or most of your refund from the trustee.

Bottom line: It is important that you review this issue with your bankruptcy attorney and make sure he or she knows you are anticipating a refund so that your attorney can make sure that your petition discloses this information and properly accounts for your refund in all of the right places.

Looking for more information on how we can protect your tax refund from your creditors.  Call our office at 732-302-9600 or fill out our online consultation and we will call you!