With all of the details you must keep track of when you file for bankruptcy, your tax refund is probably the last thing you are worried about. But if you knew you might lose most of next year’s refund without the proper planning, you might make it a priority. So how exactly does bankruptcy affect your tax refund?
Your Current Refund
When you file for bankruptcy you are only allowed to have a certain amount of cash, including what is in your checking and savings accounts. This includes your tax refund for the current year.
If you haven’t filed last year’s taxes, received your refund, and spent the money before your bankruptcy is filed, the court can take your refund once you receive it. If you are in this situation, you should discuss delaying your bankruptcy with your attorney until you receive your refund and spend the money. With the proper planning and your attorney’s guidance, you should be able to wait to file your bankruptcy and not lose your refund.
Your Refund Next Year
When your bankruptcy is filed, you obviously will not have tax refund money from the current year’s taxes since you cannot file until the year is over. However, this is not exactly the way the bankruptcy court views it.
When you file your case, a certain portion of the tax year is already over. Even though you can’t get your refund until next year, the bankruptcy law views you as being eligible for a portion of your tax refund when you file. This portion is based on how much of the year has already passed.
For example, if you filed for bankruptcy at the end of April, a third of the year is over for tax purposes. Even though you can’t technically get your refund until the following year, bankruptcy law acts as though you were due a third of the year’s tax refund when you filed for bankruptcy. Consequently, when you file your income taxes the following year, the court can take a third of your refund.
How not to Lose Next Year’s Refund
There are two ways to prevent losing your refund.
If you file very early in the year, then only a small percentage of the year will have passed when your bankruptcy is filed. If the percentage is small enough, the bankruptcy trustee isn’t going to bother to try and take that portion of the refund because the dollar amount will be too small.
The other way to prevent losing your refund is to make sure you either don’t get a refund at all, or the refund you do get is very small when you file. If no refund exists, there is nothing for the court to collect. If your refund is small, it won’t be worth the trustee’s time to collect it.
But how can you be sure your refund is small or non-existent?
If you strategize properly with your accountant and your bankruptcy attorney, you can drastically lower what your refund will be at the end of the year. You can reduce your refund by changing what is withheld from each paycheck. An accountant or other tax professional can help you know exactly what to change in order to accomplish this. With his or her help, you will receive only a small tax refund, or none at all.