The purpose of this article is to help you legally protect any tax refund you may be entitled to at the time you file bankruptcy. Bankruptcy law controls any tax returns (this includes both federal and state tax returns) from previous years that you were required to file, but have not yet filed, at the time you file your bankruptcy. Federal law requires that, regardless of whether you are filing a Chapter 7 or Chapter 13 bankruptcy, ALL tax returns must be filed from ALL prior years before your bankruptcy can be filed (Please note – if you are not required to file tax returns for any reason, this law does not apply to you). There is a small exception to this law: If you are filing a Chapter 7 bankruptcy you have a grace period of about 21 days after you file your bankruptcy to file all required tax returns from all prior years.
Bankruptcy law also controls future tax returns. In Chapter 13 you are required to file all tax returns that come due during the bankruptcy (3-5 years). In Chapter 7 the ONLY future tax return that matters is the one that will be due at the end of the year in which you file your bankruptcy.
Tax refunds are classified in two ways in bankruptcy, either exempt or non-exempt. Exempt simply means the trustee cannot take the refund, non-exempt means they can. The classification of your tax refund depends on two factors – when you receive the refund, and the type of refund you will receive.
Refund For Past Tax Returns
If you file bankruptcy BEFORE you file tax returns for any past years, any refunds you are entitled to once you do file those past returns are likely non-exempt. If there is any chance you are owed refunds from any prior unfiled tax returns, it’s usually best to make sure you file those returns before you file bankruptcy. When you do finally get these refunds, all of these tax refunds must be received and fully spent (appropriately, which I will address later in this article), BEFORE your bankruptcy is filed. If you have not received and spent all refunds prior to filing bankruptcy, it is likely that you will be required to turn over these refunds to the trustee when you receive them.
Refund For Future Tax Returns
A future tax return is simply one that you’ll be required to file for future years.
If you file a Chapter 7, the ONLY future tax return that matters will be the tax return you are required to file next year. If, when you file your tax return next year, you are entitled to a refund, it is likely that part of that refund is exempt (KEEP) and part of it is non-exempt (LOSE). Determining what portion is exempt, and what portion is non-exempt is really pretty simple – it all depends on what day of the year you file your bankruptcy, divided by 365. This calculation will give you the percentage of the refund that is non-exempt (LOSE) and then the rest will be exempt (KEEP). For example, if you file bankruptcy on April 30th that is the 130th day of the year. 130 divided by 365 equals .36, so 36% of your refund is non-exempt (LOSE) and 64% of your refund is exempt (KEEP).
Please note that if you file your bankruptcy in the early months of the year you are likely to lose less of your future tax refund than if you file your bankruptcy in the later months of the year.
If you file a Chapter 13, your future tax returns will be those that you will be required to file for the next 3-5 years while you are in bankruptcy. It’s possible that if you are entitled to a tax refund for any of those years, you could lose some, or all, of those refunds.
The Earned Income Credit (EIC) Portion Of Your Tax Refund
The Earned Income Credit (EIC) portion of your tax refund has special treatment in Kansas. Kansas law considers the EIC portion of your refund exempt (KEEP) in bankruptcy, but only if it meets the following two requirements:
- The refund must not have been received at the time your bankruptcy is filed.
- You are only allowed to claim one year of EIC refund as exempt.
This means that you get to claim as exempt the EIC portion of one tax refund that you have not yet received. For most people this would mean they would claim the EIC portion of the next tax refund they receive as exempt. For example, if you filed your bankruptcy on 9/1/2020, your 2020 tax refund would be received sometime in the year 2021, and you would be able to claim the EIC portion of that 2020 tax refund as exempt. The portion of the refund that is not EIC would be considered non-exempt, and is subject to turnover, as indicated in the Refund For Future Tax Returns section above).
How to Spend a Tax Refund Before Bankruptcy
Before I address the many ways you can spend a tax refund before you file bankruptcy, I need to stress what you can’t do with a tax refund:
- NEVER give any portion of your tax refund to any friend or family member for any reason.
- NEVER purchase something for a friend or family member.
- NEVER pay a debt, bill, or any other type of expense for a friend or family member.
- NEVER pay any unsecured creditor (these can include but are not limited to Medical Bills, Credit Cards, Payday Loans, Personal Loans, Signature Loans, Past Due Utility Bills, Past Due Rent, Civil Judgments, etc.) more than $600 TOTAL per creditor, in the 90 days before you file bankruptcy
Here are some appropriate ways (these are just some of the examples, and in no way include all possible options) of spending a tax refund prior to filing bankruptcy, and there are generally no limits on how much you can spend:
- Car: Catch up on back car payments, pay your car loan off, buy yourself a new car, pay for repairs to your car, pay for insurance on your car
- House: Catch up on back house payments, pay your house loan off, pay for house repairs and/or remodeling, pay for insurance on your house
- Household Goods: You can buy necessary items for the house, such as appliances, furniture, beds, etc.
- Clothing: You can buy clothes, coats, shoes, etc. for you, your spouse, and all of your dependents
- Food: You can buy up to one year’s worth of food for your family (for example stock up on groceries, or buy a side of beef)
- Vacation: Believe it or not, you can take the family on vacation
Here are the Top 10 things you need to know about bankruptcy and tax returns in a very simplified list:
- Any past tax returns that are due at the time you file your bankruptcy, but have not been filed yet, are controlled by bankruptcy law.
- If you file bankruptcy in the early months of the year it’s less likely that you will have to turn over any of your tax refunds than if you file in the later months of the year.
- Any tax refunds you receive for wages you earned the year after you filed bankruptcy, and all subsequent years, are not subject to bankruptcy law and those future refunds are safe.
- File your tax returns, get your refund, spend it, and then file bankruptcy if you are concerned about keeping any non-EIC portion of your refund.
- If you want to keep the EIC portion of your next refund, file bankruptcy before you get that next refund (you will probably lose the non-EIC portion of that refund).
- Do NOT give your friends or family members any of your tax refunds for any reason.
- Don’t pay any unsecured creditors with your tax refund, but if you must pay attention to the $600 90 day limit rule noted above (if you do pay more than $600 in 90 you may have to wait to file bankruptcy until 91 days from when you made the last payment to that creditor).
- Keep receipts for anything you spend your tax refund on.
- If you receive ANY tax refund after you file bankruptcy do not spend ANY of it until you get confirmation from us that it permissible.
- Read this article thoroughly so that you don’t end up losing the money you could have kept.