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Will you lose your tax refund if you file bankruptcy?

On Behalf of | Mar 13, 2023 | Bankruptcy

If you have substantial debt, bankruptcy may be your only means of getting out of it and of obtaining a fresh start. If you have a large tax refund coming, you may plan to use it to celebrate your new, debt-free status.

Unfortunately, tax refunds are bankruptcy trustees’ favorite assets to recover, as they require little effort and overhead to recoup. The National Bankruptcy Forum explains the rule regarding bankruptcy and tax refunds along with the one exception to the rule.

Tax refunds and bankruptcy

Beginning on the day you file bankruptcy, any assets that you own become part of what the law considers the “bankruptcy estate.” If you have a tax return coming, or if you already received a tax return, the money instantly becomes one of those assets. The bankruptcy trustee — who is responsible for collecting and liquidating assets for the purposes of repaying your creditors — may decide to use your tax return first and foremost to carry out his or her duties.

When tax returns are exempt

In most cases, a large tax return is an easy target, as it is cold, hard cash. However, certain exemptions may protect your refund from your trustee. For instance, your trustee cannot use any part of your refund that comes from a Child Tax Credit or Earned Income Credit for repayment purposes.

How to keep your return

The best way to keep your tax return is to simply spend it. The less money you have left over from your return, the less appealing it looks to your trustee. To make your refund go further, pay bills ahead of time. Some such bills on which you should make advanced payments include rent, utilities, cellphone bills, car payments and insurance. You may also want to invest in medical and dental care, new clothes, home and vehicle maintenance and educational expenses.

Unfortunately, you can lose your tax refund to your bankruptcy trustee. However, with a little planning, you can make the most of the money you get back from the IRS.