It’s Tax Season and the Taxman and Trustee Want your Taxes
Filing for bankruptcy could result in losing your tax refunds, depending on the time of year. Bankruptcy trustees may claim an interest in your tax return as early as December. So, it’s important to analyze your situation personally to determine when is the best time to file for bankruptcy.
Updated on January 1, 2025.
Key Points:
- Filing for bankruptcy during tax session could result in losing your tax refund.
- Some states protect the Earned Income Tax Credit or the Child and Dependent Care Tax Credit.
- Bankruptcy lawyers don’t always warn their clients about the risks of losing their tax refund to the bankruptcy estate.
The Beatles warned you about the Taxman in 1966, and I’m warning you now. It seems French journalist Alphonse Karr was correct in 1849 when he said: “The more things change, the more they stay the same.”
Ready to File For Bankruptcy During Tax Season? Think Again!
The start of the 2024 tax season is well underway, and if you are considering filing for bankruptcy, now may not be the time.
Most people love tax season because they get their tax refunds. I’ve never met anybody who was receiving a tax refund and didn’t make plans already or know in advance how they were going to spend the money. Accountants also love tax season for obvious reasons. Even bankruptcy lawyers love tax season because clients use their tax refunds to start or pay off their bankruptcy. But do you know who else loves tax season? The bankruptcy trustee!
What Most Bankruptcy Lawyers Won’t Tell You
Tax refunds are important for two different reasons. For one, debtors want to keep it. They need that money. They worked hard for that money, and let’s be honest, it’s your money. That’s the only reason you are getting it back. But the other issue is that lawyers don’t always mention this, so when the client is at the 341 meeting of creditors, they find out the bad news for the first time.
The 341 meeting of creditors, sometimes known as a 341 meeting, is named after the section of the Bankruptcy Code. At the 341 meeting, the bankruptcy trustee asked all debtors the same general questions regarding their bankruptcy case. In a separate post, I will discuss the standard list of questions asked by bankruptcy trustees. But for now, know that this will be the first time you interact directly with the bankruptcy trustee.
Because tax refunds can be substantial and provide a well-timed financial lifeline for most of us, it’s important to figure out if the tax refund is exempt. By exempt, that is another way of saying protected in the world of bankruptcy. If your tax refund is nonexempt, then it belongs to what is known as the bankruptcy estate, and the trustee will take it and use those funds to distribute among your creditors.
Exemptions vary per state. Some states allow a debtor who has filed for bankruptcy to keep a portion of their tax refund, such as the Child Tax Credit or Earned Income Credit. Florida, my home state, is one of the states. Then again, Florida is known as a debtor’s paradise because of its many protections for debtors, such as unlimited homestead exemption. At the same time, other states have such a limited protection of your home’s equity that bankruptcy is not an option.
Other states such as Alabama, Idaho, Kansas, Louisiana, Missouri, Nebraska, Nevada, Ohio, and Oklahoma also protect the Earned Income Tax Credit or the Child and Dependent Care Tax Credit. Mississippi has a federal and state exemption with a maximum amount of $5,000 each.
Always confirm with your bankruptcy attorney if your state exempts tax refunds.
How Do You Protect Your Tax Refund
When it comes to filing for bankruptcy and tax season, even if you are filing as far back as November, the trustee may claim an interest in your tax refund at the 341 meeting. So, how can you protect your tax refund? The strategy is simple enough. Delay. Delay. Delay.
By delaying the filing of the bankruptcy petition for a few months after you receive your tax refund, depending on the amount, might resolve the problem. Of course, this means spending the tax refund slowly and reasonably and not withdrawing it all from your bank account and taking a vacation or going on a shopping spree. What is reasonable varies per debtor based on their financial situation. While I think it’s reasonable that you take some time off and enjoy a five-day cruise in the Bahamas, I guarantee you that the bankruptcy trustee will not.
That cruise looks like fun, doesn’t it? Wouldn’t you love to be there? I know one person that doesn’t want you to enjoy that cruise. The bankruptcy trustee!
Not every debtor has the luxury of time when it comes to filing for bankruptcy. For example, a lawsuit by a credit card company resulted in a court order to garnish wages. Unfortunately, if faced with this situation, there will be no choice but to file for bankruptcy immediately to stop that wage garnishment. Of course, this means you will lose your tax refund, but at least you’re not losing 15 to 25% of your wages every pay period. Sometimes, there is no choice but to choose between the lesser of two evils.
Colleges and universities can purchase my bankruptcy law textbook directly from Routledge Publishing. For paralegals and students buying single copies, you can do so via Amazon books. To access my YouTube channel, click this link.
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Please note the information on this site does not constitute legal advice and should be considered for informational purposes only.
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