This Week's Topic

Given the number of questions people ask about tax refunds, there seems to be a lot of confusion on the subject. Many people like to use tax withholding (or over-withholding) as a means of forced savings.

As a result, a lot of people depend on receiving a big refund to either pay off bills, fund big purchases, or pay legal fees to so they can file bankruptcy.

The first thing you need to know is that an anticipated tax refund is an asset of your bankruptcy estate, just like a savings account. Well, not just like, but close. The portion of an anticipated tax refund that may become property of the estate depends on when you file your bankruptcy petition.

For example, if you file bankruptcy now, and you haven’t filed your 2023 tax return and received your refund, 100% of your 2023 refund is property of the bankruptcy estate, and the trustee is entitled to use it to pay your creditors unless it is exempt under your state law.

If, however, you wait to file your bankruptcy case until after you receive your 2023 tax refund, you can spend the refund for your living expenses and/or deposit it in your checking or savings account. If it’s in an account, you will need an exemption to cover it in order to keep it once you file.

If you continue to have more money withheld from your paycheck than is needed to cover your 2024 taxes, the portion of the accrued funds that is an asset of the estate is equal to the amount of time since the first of 2024. In other words, if you file for bankruptcy on May 1, 1/3 of your excess withholding for the year is property of the estate (at least theoretically). In this example, your future refund is somewhat speculative and therefore a bit more questionable from the trustee’s standpoint.

So how do you prevent an anticipated tax refund from becoming property of the bankruptcy estate? For refunds that you are already entitled to, they must be covered by an exemption. As for future refunds, the better practice is to adjust your withholding so that it closely approximates what you will owe for next year’s taxes. Adjusting your withholding will also help you manage your money once you’ve filed bankruptcy and have to start living without credit cards.

If you are filing a chapter 13, adjusting your withholding will also enable you to propose a more realistic repayment plan and (hopefully) make it easier for you make your plan payments. And be aware that, if you file a chapter 13, the trustee will likely require you to use any future refund to pay your creditors (so you might as well adjust your withholding to minimize future refunds).

Tip for the Week: If you are thinking about filing bankruptcy in the next few months, file your 2023 tax return as soon as possible so that you will receive any refunds before you file.

Next week’s topic: tips on filing bankruptcy without an attorney.