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Will I Lose My Tax Return in Chapter 7 Bankruptcy?

Updated: Feb 28

Trying to Keep Your tax return in bankruptcy

One of the most common questions we hear during tax season is, "Will I lose my tax return if I file Chapter 7?" We get it, this is essentially the same concern folks always have when considering bankruptcy. You want to file bankruptcy to get a fresh start and you want to keep your stuff.


In this blog, we discuss whether you can keep your tax return in a chapter 7 and what questions you'll want to consider before filing bankruptcy during tax season. We also briefly review what happens to your tax return in a Chapter 13 bankruptcy in Central Texas.


Tax Returns and Bankruptcy: A Strange Relationship

On the one hand, many folks in debt look forward to getting their tax returns to pay down some of their debt. On the other hand, bankruptcy is a type of debt relief that gets rid of most if not all of your debt. That's why it's strange to see folks take pause when they learn they may lose their tax return if they file bankruptcy.


But here's the deal, they were planning on using their tax return to pay off a small portion of their debt. Now that they're thinking about filing bankruptcy, they stand to have most, if not all of their debt essentially erased. Of course, it would be nice to have all of their debt forgiven and keep their tax return, and that happens sometimes. We discuss in more detail below ways to try planning for this outcome. But, if they file for bankruptcy, have most or all of their debt erased, and lose their tax return in the process, then the only thing that's happened is they've exchanged of a small amount of money to get rid of a large amount of debt.


Almost everyone would agree that's a really fantastic deal. It's certainly a lot better than exchanging a small amount of money (i.e. your tax return) to get rid of a small amount of debt and leave a large amount of debt for you to continue paying on for many years to come.


Are Tax Returns Required for Bankruptcy?

Are tax returns required if I'm filing bankruptcy

The short answer is yes, tax returns are required to file bankruptcy. But, like everything within the law there are exceptions.


Everyone who files a Chapter 7 is required to provide the bankruptcy trustee a copy of the most recent tax return they filed with the Internal Revenue Service. You may read that and think, "you didn't say I had to provide the trustee with last year's tax return."


Sure, I didn't say you had to provide a copy of your individual tax return for last year, but if you had an obligation to file a return last year and you didn't file one, and the time for you to file one has come and gone, then that's a problem for you. Your Chapter 7 trustee will likely take issue with the fact you haven't filed taxes when you were supposed to and the United States Trustee may also take note and decide to take a closer look at your case. Simply put, those are both problems you don't want if you can avoid them. Oh, and if I'm not being clear enough, there's a real chance you won't get a discharge...so file your taxes prior to filing bankruptcy.


If you're filing a Chapter 13, then you're required to have filed taxes for the last four years prior to filing bankruptcy. You have until the day before your meeting of the creditors (aka 341 meeting) to meet this requirement, and if you fail to satisfy this requirement then you can all but guarantee that your case will be dismissed and your debt won't be discharged.


But do I Have to Rush to File Taxes During Tax Season Before Filing Bankruptcy?

No. Right now as I'm writing this blog it's almost March of 2024. There's no requirement for my clients to file taxes for the 2023 tax year before we file their bankruptcy. Instead, for the clients who haven't filed taxes yet for 2023, we'll provide their 2022 returns to the trustee and that will work just fine.


Chapter 7 Bankruptcy and Your Tax Refund

If you've done much research on Chapter 7 bankruptcy you know that it's often called a "liquidation bankruptcy," meaning the trustee will take and sale any property that can't be protected with exemptions. This is why so many folks fret over whether they can keep their tax return if they file Chapter 7.


Can a Bankruptcy Trustee Take Your Tax Refund?

Can the bankruptcy trustee take your tax return

Absolutely, they can. To understand why let's remember why we get tax returns in the first place.


All year long you give the government a portion of your paycheck, a portion that you designate based on the tax withholdings you elect, and at the end of the year we calculate how much you actually owe for the year based on everything you earned and spent. If you gave the government more money than you were supposed to then you get a return. But in reality all you're getting back is your money that you overpaid the government. So bankruptcy law looks at your tax return like it's your money from last year, which means that your tax return is part of your bankruptcy estate. If you can protect your return with a bankruptcy exemption, such as a wildcard exemption, then you have nothing to worry about. But if you can't protect your refund with an state or federal exemption then the trustee may come knocking for it.


Can I Keep My Tax Return in Chapter 7?

The first thing to point out here is that in order to even ask this question, the person asking it must not have received their tax return before filing bankruptcy. You simply have nothing to worry about it you've already received your tax return before filing bankruptcy, as long as you didn't use it to pay off debt or purchase items that can't be protected with exemptions. In fact, a really common strategy a lot of folks take with their tax returns is to use them to pay their bankruptcy attorney. This is a perfectly acceptable thing to do and nobody will question you for doing it.


Now, if you file bankruptcy before receiving your tax return then you're right to be asking this question. And if you're in a situation where you can't protect your return with an exemption then it's fair game for the trustee to take. That said, there are certainly other factors aside from your return that the trustee may consider before deciding whether they want to take your return. This is why it's a good idea to work with our Austin bankruptcy lawyer who can help guide you through the bankruptcy process from start to finish.


Tax Refunds in Chapter 13 Bankruptcy

In the context of a Chapter 13 bankruptcy, your tax return will almost certainly be considered "disposable income" that the bankruptcy code requires you to contribute into your repayment plan.


Local Rules in the Western District of Texas Bankruptcy Court

texas bankruptcy court

Our local rules in Central Texas were modified in 2020 so that all tax returns are presumed to be disposable income and have to be turned over to the trustee.


Notice to Retain Tax Returns

There is a way to keep your tax return in a Chapter 13 here in Central Texas, but you need to have a good reason. If you have a legit need to spend your tax return for the support of you or your dependents, then you can file a Notice to Retain explaining why you need to keep your return. Just filing a notice to retain isn't enough to guarantee that you can keep your return though, so it's essential to make sure that you have a good reason for your request.


Considerations Before Filing Bankruptcy in Tax Season

Instead of filing bankruptcy and then asking whether you're going to lose your return, a little planning may help keep your tax return.  The following are some simple points to consider if you're worried about keeping your tax return while filing bankruptcy during tax season.


Do You Need to File Bankruptcy Quickly?

Is there a reason why you need to file bankruptcy right now or in the next few weeks? If you absolutely have to file right now then you're probably saving your home or car or trying to avoid a judgment. If you haven't received your refund yet and you absolutely need to file right away, then the protection you're getting from filing bankruptcy is probably much more valuable than keeping your tax return.


If there's not an urgent reason why you need to file right away, then you may be able to time your bankruptcy filing so that you receive your tax return before filing.


Are You Expecting to Receive a Tax Return?

This one is obvious but there's another layer to it. Of course, if you don't expect to get a return then you don't need to worry about strategizing the time of filing taxes and bankruptcy.


The other thing to consider here is whether you owe a tax debt to the IRS. If you owe the IRS money then they're likely going to take whatever money you may be owed for your return, so you likely don't need to worry about strategizing when you file bankruptcy because there won't be anything for the trustee to take after the IRS takes your refund.


How are You Planning on Spending Your Tax Refund?

If your plan is to spend your refund money to pay off some debt, then maybe it doesn't matter when you file bankruptcy.


But if you're planning on spending your return on things you need like living expenses, medical or dental work, car repairs, home furniture, or clothes then waiting to file bankruptcy until after you receive your return and have time to spend it is a good idea. If you've been neglecting this sort of spending and you don't have an urgent need to file bankruptcy, then waiting and using your refund in this manner can make a lot of sense for you and your family.


Similarly, if you've been wanting to file bankruptcy but you're not sure how you're going to be able to afford a bankruptcy lawyer, using your tax refund to hire an Austin bankruptcy law firm may also make a lot of sense.


Can I File Taxes in Bankruptcy?

Yes, there's nothing keeping you from filing your taxes after you file bankruptcy but before you receive your discharge.


What if I File Bankruptcy before filing Taxes?

If you file bankruptcy during tax season and you haven't filed taxes yet, then there's a chance the trustee may choose to keep your bankruptcy open until you file your taxes and they may want your refund. So if you're thinking you want to file bankruptcy and then file your taxes after your bankruptcy is over, that may not be the safest way to go about protecting your tax return.


Conclusion

The safest way to assure you can keep your refund is to file your taxes first, wait until you get your refund and spend it, and then file bankruptcy. That's not to say that you're definitely going to lose your return if you file bankruptcy before you receive your refund, but there are many factors to consider here and speaking with an Austin bankruptcy attorney can help you in deciding what's the right move for you. Finally, if the only thing you lose in your bankruptcy is your tax return and you get rid of significantly more debt in the process, then it's hard to argue with the position that you got a really good deal and maybe it was ultimately worth it. But again, working with a bankruptcy lawyer is the best way increase your chances of keeping your return in bankruptcy.

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