Can I keep my tax refund upon the filing of bankruptcy?

Some people file for bankruptcy during tax season. The thought is to use their tax fund to help pay for the bankruptcy filing. However, it is important to know just how tax refunds are handled in bankruptcy. The Bankruptcy Code basically views tax refunds twofold:

1) the right to receive a tax refund, which is for a year prior to the filing of the bankruptcy is undoubtedly property of the Bankruptcy Estate and must be exempted to fully protect it; ; or

2) the debtor may have a excessive withholding from his or her wages by their employer for the current tax year. If a refund does result from this withholding, then oftentimes the refund is prorated over the entire year with the prebankruptcy portion being considered property of the Bankruptcy Estate. It would then be necessary to exempt this portion to fully protect it from the reach of creditors.

Most of the time the exemptions are generous enough that the tax refund can be fully exempted. However, in those situations where the debtor is not able to fully exempt it, then it will most likely be expected to be turned over to the Bankruptcy Trustee. 

 

THE FILING OF BANKRUPTCY CREATES AN AUTOMATIC STAY

The filing of a bankruptcy petition brings about the creation of an automatic stay. This stay basically prevents any further action against you by creditors.  It prohibits:

1) any act to collect, assess or recover a claim against the debtor that arose prior to the filing of the bankruptcy petition;

2) the setoff of any debt owing to the debtor that arose prior to the filing of the case against any claim against the debtor; and

3) the commencement or continuation of a proceeding in the United States Tax Court concerning any tax liability by the debtor for a tax year prior to the filing of the bankruptcy petition. 

 

INTERNAL REVENUE SERVICE PROVIDED WITH EXCEPTIONS TO THE AUTOMATIC STAY

Even though the automatic stay prevents most actions, the Bankruptcy Code provides numerous exceptions where the stay does not apply. An exception is granted to the Internal Revenue Service. This exception allows the Internal Revenue Service or other taxing authority to set off a tax refund that existed prior to the bankruptcy filing against a tax debt that also existed prior to the bankruptcy filing. If there is a pending action to determine any tax liability for a period prior to the bankruptcy filing, then the taxing authority may hold the refund until a final determination is made. Clearly any tax refunds for tax years after the bankruptcy filing do not fall within the exception and may not be intercepted or setoff against tax years after the bankruptcy filing. 

It is important to note that this exception to the stay only applies to income tax liability and not with respect to any other non-tax liability owed to any other government entity. For instance, any setoff or interception of a tax refund to pay student loans or other debts owed to a government agency is stayed.

 

DEBTOR MAY UTILIZE AVOIDANCE POWERS GRANTED BY THE BANKRUPTCY CODE

The Bankruptcy Code provides the debtor with certain avoidance powers. Any levies or executions by unsecured creditors that take place within 90 days prior to the filing of the bankruptcy may be avoided. Therefore, any tax refund intercepts made by the Internal Revenue Service for such things as student loans or other government owed debts can be set aside if made within 90 days of filing the bankruptcy petition.

 

EXPERIENCE COUNTS WHEN SELECTING A BANKRUPTCY ATTORNEY

If you are interested in filing for bankruptcy or simply have any questions, then contact Pittsburgh Bankruptcy Attorney Rodney Shepherd. We may be contacted through our contact information form on our website or by telephone at 412 471-9670. A free consultation will be scheduled to better analyze your situation to put you on the road to financial freedom.