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Tax Refunds and Bankruptcy: Can You Keep Your Money?

Tax Refunds and Bankruptcy: Asset vs. Income in Chapter 7 or Chapter 13 Bankruptcy in Michigan

Tax Refunds and Bankruptcy

The issues involved in Federal or Michigan tax refunds and bankruptcy are several. One one hand, an expected tax refund is an asset that must be listed and exempted in either a Chapter 7 or a Chapter 13 bankruptcy. In a Chapter 7 bankruptcy, in which assets are potentially liquidated by the Chapter 7 Trustee, if the expected refund cannot be fully exempted (i.e., protected), the Trustee may require it to be turned over to be dispersed amoung your creditors.

On the other hand, in a Chapter 13 bankruptcy, an expected tax refund is, here in the Eastern District of Michigan, Detroit Division, generally considered to be a form of income that must be devoted to your Chapter 13 payment plan. (In other parts of Michigan, including Flint, this is not necessarily the case.)

Tax refunds and bankruptcy: Chapter 7 Issues

Tax refunds pop up as an issue in Chapter 7 bankruptcies in two forms, primarily: refunds that you’ve already received and refunds that you expect to receive.

Expected tax refunds and bankruptcy:

As mentioned above, tax refunds, or the right to receive a tax refund, are assets that must be disclosed and valued in bankruptcy, right along with your couch, your wardrobe, your car, your comic book collection, and everything else that you own. Even if you only expect to receive a refund, and even if the actual date on which you will receive the refund is still several months away.

Thus, if you file a Chapter 7 bankruptcy in Michigan on December 1st, and you are fairly sure that you will receive a Federal tax refund of $1,200 in the coming year, your bankruptcy petition should list the expected tax refund prorated as of the date of filing. You would not list the whole $1,200 because you still have 1 month of the current year to go before the year ends, and, thus, income taxes are not paid and not owed for the month that has not yet occurred. In other words, the part of the year that falls after the date you file your petition in which your employment results in further taxes paid above what you owe and thus generate a right to a refund is not part of the legal bankruptcy estate that is automatically created upon the filing of a bankruptcy petition. The Chapter 7 Trustee only has the right to liquidate property that is part of the bankruptcy estate.

So, in this example, you would list $1,100 only as an asset “possessed” as of the date of the December 1st filing.

Further, if you are married and your spouse is not part of your bankruptcy, you further need only list as your owned percentage of the expected refund either 50% of the total, or your proportion of the refund that derives from the percentage of your income contributing to the household taxable income the refund is based upon relative to your non-filing spouse’s. (For instance, if you earn all of the household’s income and your spouse is a stay-at-home dad or mom, it is debatable that the spouse actualy has a right to 50% of the fund since the spouse contributed no income.) This is a local issue that will greatly depend upon your jurisdiction, your Trustee, and your judge.

Whatever the net amount listed as an asset on your bankruptcy petition schedules, however, it must then be protected from possible liquidation by the Trustee. Assets in Chapter 7 bankruptcy are protected through the application of so-called “exemptions” in your schedules by your bankruptcy attorney as the schedules are prepared. Exemptions are bits of either the Federal Bankruptcy Code statute or Michigan state statute that allow certain types of property up to certain dollar-value limits to be exempted, or removed, from the legal bankruptcy estate. If an asset is not in the bankruptcy estate, it is not subject to the administration, or liquidation power, of the Chapter 7 Trustee.

In Michigan, we may elect to utilize a set of Federal bankruptcy exemptions or a set of exemptions under Michigan law. Neither set provides a specific exemption for an expected tax refund. Thus, the Federal exemptions are generally used as they provide a “wild card” exemption which may be used for any type of property. However, this “wild card” exemption can run thin quickly depending upon what other assets you may have.

Michigan bankruptcy attorney John M. Hilla is experienced and skilled at applying exemptions and protecting assets and providing the clients of The Hilla Law Firm, PLLC the maximum protection available for their assets.

Already-received tax refunds and bankruptcy:

The issue of tax refunds you’ve already received and Chapter 7 bankruptcy arise generally in the first quarter or two of the year when you may have only recently received your tax refund. The question the Chapter 7 Trustee is going to have generally in this part of the year is, “What did you do with the money?”

The reason for this question is, again, related to the Trustee’s power to liquidate assets of the bankrutpcy estate for the benefit of your creditors, whose debts are otherwise to be totally discharged by the Chapter 7. The Trustee has the power to recover what are called “preferences,” as well as fraudulent transfers of property from your estate to other people.

Preferences are payments on debts you’ve made in either the 90 days prior to filing the bankruptcy to as long as 12 months prior to filing, depending upon whether the creditor you’ve paid is an “ordinary” commercial creditor or an “insider” creditor (family member, corporation you have an interest in, and others with influence over you on a personal or business level). If you have made a payment of $600 or more to a creditor meeting one of the above definitions in the appropriate timeframe, that is a “preference.” Which is to say, you’ve preferred to pay that creditor back rather than all of the other creditors whose debts are to be discharged in the bankruptcy.

The Bankruptcy Code doesn’t like preferences. It says that all unsecured creditors must be treated similarly. That is, they all have to get an even-Steven split of whatever your bankruptcy estate has to offer. The Chapter 7 Trustee will sue the preferred creditor for the funds, whether it is American Express or your great-great-grandmother.

The Chapter 7 Trustee can also avoid (or un-do) fraudulent transfers of bankruptcy estate property. Thus, if you got your tax refund and gave half of it as a gift to your great-great-grandmother, this is bad news for your grandmother. The Trustee will sue your grandmother for the funds and potentially raise issues of bad faith in your own bankruptcy filing, endangering your discharge and raising the possibility, even, of criminal penalties depending upon the intent with which you made the transfer.

If you have made such a transfer and are considering filing for bankrutpcy, it is imperative that you consult an experienced Michigan bankruptcy attorney such as John M. Hilla before proceeding.

Tax Refunds and Bankruptcy: Chapter 13 Issues

Although Chapter 13 bankruptcy is a more complicated process than Chapter 7 bankruptcy, the issue of tax refunds and bankruptcy are actually a little more straightforward. In a Chapter 13 bankruptcy, none of your assets are liquidated. Although an expected tax refund must still be listed and exempted as there is always the possibility of converting to a Chapter 7 later on, bringing the Chapter 7 Trustee back into the picture, and non-exempt assets may have an impact on the size of your monthly Chapter 13 plan payment, no one will take your assets in a Chapter 13.

Instead, depending upon where you file your Chapter 13 bankruptcy case and the policies of the Chapter 13 Trustees in your area of Michigan or elsewhere, you may or may  not be required to turn your tax refunds as they come in over the life of a 3-5-year Chapter 13 payment plan over to the Chapter 13 Trustee as a form of your income along with your monthly payments. In particular, this varies greatly on the east side of Michigan, where the Detroit Division Trustees will always want your refunds committed unless you are repaying 100% of your unsecured debts in your Chapter 13 payment plan, while the Flint and Bay City Trustees may not.

Thus, depending on where you live and how much you are repaying to your unsecured creditors in your plan, you may or may not need to plan on turning over your tax refunds for the life of your Chapter 13 bankruptcy to the Trustee. Again, if there is a non-filing spouse involved, the exact amount required to turn over to the Trustee will be proportional.

For more information on the Chapter 13 bankruptcy payment plan, click here.

If you are a Michigan resident considering filing for bankruptcy, contact the Michigan bankruptcy attorneys of The Hilla Law Firm, PLLC to schedule a free initial consultation by calling (866) 674-2317 or clicking the button below.

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One Comment on “Tax Refunds and Bankruptcy: Can You Keep Your Money?”
  1. What Happens to My Tax-Return if I File Bankruptcy? | Michigan Bankruptcy Lawyer Says:

    […] To read more, read our full blog on the topic of tax refunds and bankruptcy in Michigan here on the … […]