Bankruptcy & Tax Refunds

The unpalatable act of paying federal income taxes is tempered when the result is a tax refund.  Annually, tax refunds are a predictable source of funds for many Americans.  The majority of filed tax returns result in the IRS/Department of the Treasury issuing a refund check to a taxpayer. In 2018, the average federal tax refund was $1,865. How does filing bankruptcy affect a debtor who receives a tax refund?

Filing a bankruptcy case creates a bankruptcy estate that becomes a legal titleholder of all the debtor’s assets and property rights. Any monies paid to creditors come from the liquidation of assets in this estate. Simply put, the fewer non-exempt assets, the less that creditors receive. The only property absorbed into this bankruptcy estate is that which is considered non-exempt under state and federal law. Assets classified as exempt do not become the property of a debtor’s bankruptcy estate. Thus, the relevant question is whether a tax refund is exempt and therefore not the property of the estate.

The answer is that if all or part of a tax refund was earned before filing the bankruptcy case, this portion of their tax refund is part of the bankruptcy estate and subject to being distributed to creditors pro-rata. The tax refund belongs to the estate unless it is protected by an exemption. Some states have wildcard exemptions that may be applied to safeguard any type of property that is not exempted by other provisions of their exemption schemes. Utah does not offer a wildcard exemption.

The Solution:

For those individuals who need to file bankruptcy and obtain a fresh start but are about to receive a well-deserved and useful tax refund, there is a solution. If possible, delaying the bankruptcy filing as long as possible will allow a tax refund to be retained with the funds used to provide some financial relief before the bankruptcy filing.

The optimal way to avoid losing a tax refund in bankruptcy is to spend the refund before filing bankruptcy. However, keep in mind that spending the tax refund on non-essential, luxury items may cause problems in the bankruptcy case since this newly-acquired property may itself be non-exempt and part of a debtor’s bankruptcy estate.

Using the refund on ordinary expenses, including mortgage payments, rent, home maintenance, food, clothing, utilities, educational expenses, car repairs, insurance, and medical expenses does not increase the amount of a debtor’s non-exempt assets. A spent tax refund that does not result in the acquisition of non-exempt property means there is no tax refund or other non-exempt assets to protect in a bankruptcy case. The bottom line is that the person filing for bankruptcy has nonetheless been able to use the tax refund.

The Morrison Law Group strives for complete client satisfaction with the services that we provide throughout a bankruptcy case, as well as the ongoing services that we provide post-bankruptcy. Not all Utah Bankruptcy attorneys can make this statement, but the Morrison Law Group is not like other Utah bankruptcy law firms. Call 801.456.9933 today to schedule a FREE consultation. We have locations in Ogden, Logan, Sandy, Orem, and St. George to serve the residents of the counties of Weber, Cache, Salt Lake, Utah, Morgan, Davis, Washington, and surrounding areas.

Theron Morrison

Theron Morrison

Utah’s top bankruptcy and consumer protection attorney.