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Can You Keep Your Tax Refund After Filing Chapter 7 or 13?

tax refunds

If you file a Chapter 7 in Indiana your exemptions may not completely cover your tax refund. Debtors can lose tax refunds in Chapter 7 if the tax refund is so large that it exceeds any wild card exemption amount. You are allowed to keep property that does not exceed the exemptions. The trustee sells or distributes any property over the amount of equity and exemptions you are allowed to keep. In a Chapter 7 bankruptcy, keeping your income tax refund is all about what you own when you file the case and the allowed exemptions.  If you have spent the tax refund before you file there is no asset for the Trustee.  bankruptcy 7 or 13Technically, the tax refund is a property just like any other property you own. It is an unpaid debt to you that the government uses interest-free for a year.

Chapter 13 Tax Problems

But in Chapter 13, your annual refund is disposable income that should be paid to a Chapter 13 trustee to repay creditors. In Chapter 7 or 13, you want to plan the timing and your exemptions so you never get a tax refund which can be lost. Debtors in the Western District of Kentucky, lose their tax refunds if your plan pays less than 100%.  In Chapter 13, retaining your tax refund is about planning your budget and decreasing your tax withholdings. You must turn in a copy of your prior two years of tax returns whenever you file bankruptcy for Chapter 7 or Chapter 13. In Chapter 7, the bankruptcy trustee looks through this tax return to find property or transfers of property.

If you are getting a tax refund, you may want to spend it before filing any Chapter 7 bankruptcy. The government owes you a refund if you pay more than the required withholding. You don’t collect it until after you file the income tax return. That is why in Indiana, in Chapter 7, the Chapter 7 trustee pro-rates the tax refund and asks for a portion of the refund. It is an asset the Chapter 7 Trustee often recovers because the exemption in Indiana is so tiny. The Debtor is always due some part of that refund.  

How to Keep Tax Refunds in Chapter 7 or 13 Bankruptcy

An Indiana Example

In Indiana, the exemption for a refund was only 350 dollars in 2021. With tax refunds of 5,000 dollars, a Chapter 7 bankruptcy filing in December must turn over 4,650 dollars to the trustee, who gets over $1,100 for paying creditors the remaining $3,487. For example: $5,000 tax refund – $350 exemption – $1162.50 trustee 25% fee = $3,487.50 for creditors.

Instead, if you file bankruptcy in February after you receive and spend the refund. Then, you keep $5,000 instead of $350. The $350 exemption is for all your money in a bank account or a tax refund. So, if you have money in the bank, you might have nothing left to exempt the refund. Since it is common to get a 5,000-dollar refund, the trustee often profits from bankruptcy cases in Indiana.  But she will also look for the dividends you are paid from any stock you have and for other property which is not fully exempted.

Kentucky uses the Federal exemptions

Spending the tax refund to repay relatives or purchase a property that is not exempt creates problems. In Kentucky, you can usually safely spend a refund on food, clothes, and furniture because Kentucky uses the federal exemptions for household goods.  The federal exemptions are so large that most people rarely use exceed them. Car or home maintenance is often another safe way to spend the refund because maintenance does not create an asset or increase your equity in the property.

Next, if you have any money in your bank account, you might need to draw it out or spend it before filing. Kentucky and many other states use the federal exemptions. In2022 the federal exemptions allow you to keep about $28,900 in real property. Half of what you don’t use to keep your home residence can be used to keep any other kind of property as a wild card exemption.

In 2022 the federal exemptions have a specific $1,325 wildcard exemption. Kentucky has a much larger wildcard exemption than Indiana. This makes it possible to keep over $14,450 + $1,325 if you don’t use the $28,900 real estate exemption to keep a home. Please note that the full amount of the $28,900 exemption is meant to keep your home. However, the remainder of what you don’t use for your home is reduced to half if you use it to keep other property.

Your Income Tax Takes Your Income Tax Refund

You might lose a tax refund in Chapter 13 because of the requirement to pay to the trustee funds that exceed your monthly budget. In other words, it is a requirement that all your disposable income is paid into the plan.

In the western district of Kentucky, you must turn in a copy of your yearly income tax return by May 15th. Western Kentucky allows you to keep the income tax deduction in the first year of your plan. Also, a tax refund is an asset you exempt during the first year.

In the later years, a tax refund is a disposable income you must use to repay your creditors. You lose the tax refund in the second through fifth year of the plan. You may keep the earned income credit portion of the refund, but you must surrender the child credit.

Filing a Motion to Keep the Refund

In some circumstances, you can petition the bankruptcy court to keep the refund for payment of necessary medical expenses or other unusual events and severe needs for the refund. The attorneys evaluate the tax on the total monthly income and collect the required sensitive or confidential information to prepare your petition. Reasonable and necessary expenses are allowable. But you must anticipate them in your budget and Chapter 13 plan. But, it is not always possible to anticipate nor plan for every expense.

Generally, you want to increase your deductions, so you don’t get a refund in Chapter 13 because you can’t lose what you never get.  Plan to file bankruptcy with a bankruptcy attorney with experience because timing is everything in discharging the maximum debt relief and keeping your property.   Planning your taxes and tax deductions are just part of proper bankruptcy planning.

Modifying Chapter 13 Plans to Keep the Refund

100% plans do not lose their bankruptcy estate tax refunds. Interestingly, a plan modification might allow you to keep the refund. If you do have a refund, there might be possible maintenance expenses that you cover by filing a motion with the court to use it for a furnace, air conditioner, or other expenses.

A good Chapter 13 bankruptcy attorney or experienced law firm plans for such maintenance expenses. You might use the refund to pay for an emergency expense but increase your plan payments to make up for the immediate use of the funds. This requires filing a motion for approval of using the refund.

In the plan submitted by your law firm, it is also possible to propose that the furnace will go out in year two and need replacement. There are also steps to cover an expense by a tax refund, tax withholding, or get gradually increasing or decreasing plan payments which adjust to changing incomes and expenses.

However, sudden expenses might also require conversion to Chapter 7 bankruptcy. You can modify the plan payments, request a step plan that allows larger payments later, change how much creditors get, and you might even earmark tax refunds for emergency repairs.

What Do You Need to Do to Keep Your Refund After You File a Chapter 7 or 13 Bankruptcy?

You can only keep Chapter 7 income tax refunds if you use an exemption. But, if you transfer property out of your name, you can’t use the exemption. For instance, the exemption is not usable if you pay back $750 to your mom for a loan before filing Chapter 7. This is because it is a preferential or fraudulent transfer. You can only exempt property you own and need to start over on.   Either way, the trustee sues your mom to recover the money. Instead, by using an exemption in Chapter 7, or an expense using it for an expense in Chapter 13, you might be able to keep the money and repay her after filing. However, by transferring assets, you lose the ability to keep assets.

It is easy to keep a tax refund in Chapter 7 by spending a refund before you file for a Chapter 7 bankruptcy. Then, after you spend the tax refund, it is no longer an asset. In Indiana, the trustee looks at next year’s tax season refund as an asset if you file bankruptcy after September in Chapter 7. In Indiana, the exemption is minimal, and the trustee will pro-rate any refund check.

Exemptions in Indiana and Kentucky

The exemption is only $350 in Indiana. But, in Kentucky, you have a $1350 wild card exemption plus one-half of the unused real estate exemption. If you rent or have no home, this is about an additional $14,450 in 2022. Up to $15,800 might be available to keep a tax refund or tax withholding in a Kentucky Chapter 7. Also, these exemptions increase every year.

⎆ Instances When Losing the Tax Refund are Better

In some plans, losing the tax refund might mean finishing the bankruptcy sooner than expected. A Chapter 13 bankruptcy case must pay back both priority and secured debts in full. Chapter 13 also must pay back the same amount as Chapter 7. Losing the tax refund may help you repay the required priority expenses back quicker, making a plan more feasible or affordable with lower payments.

It is Important to Get an Assistance from an Experienced Bankruptcy Attorney!

Suppose you are planning to file bankruptcy for Chapter 7 or Chapter 13 and want to know the options to get the tax refund. In that case, you must contact a professional and experienced bankruptcy attorney. Call Nick Thomson to prepare your petition and get maximum debt relief and tax refunds. I believe in maintaining a healthy attorney-client relationship to make sure I help you with my best expertise.

Resources for Bankruptcy

Louisville, Kentucky Bankruptcy Forms

Filing Chapter 7 & Chapter 13 Bankruptcy • Video

Annual Budgets and Tax Refunds in Bankruptcy

Chapter 13 and IRS Tax Returns and Refunds in Bankruptcy

Your Fresh Start on a New Budget with Bankruptcy

How to Qualify for Chapter 7

If you are considering filing bankruptcy, don’t delay because timing is crucial. I am here to help you. So, contact my office immediately to start the conversation—Nick C. Thompson, Bankruptcy Lawyer: 502-625-0905.

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