The average employee has a predictable income. Unless they fall ill or lose their job, they know roughly what they should make with every paycheck. There are very few times when the average adult suddenly receives a windfall or a large amount of money at once.
The tax refund possible after someone’s annual tax return is one of the rare circumstances in which someone may receive a lump sum of money without any strings attached. People often wait for tax return season to complete major projects at their homes or replace a failing vehicle.
Those struggling financially may look forward to tax return season as a chance to catch up on their debts. Some people even file for bankruptcy before they file their tax returns in the hopes of preserving their refunds for personal use. That strategy may not work as well as they might hope. How can a bankruptcy filing affect someone’s income tax refund?
Tax returns are part of the bankruptcy estate
If someone filed for bankruptcy while waiting for their tax refund, they would need to report the amount. It might factor into the repayment plan in a Chapter 13 bankruptcy or be subject to distribution to creditors in a Chapter 7 bankruptcy.
Simply waiting to file a tax return until after filing for bankruptcy doesn’t eliminate the threat to someone’s tax return funds. They typically need to estimate what they received and report that. In a Chapter 7 bankruptcy, they may need to use those funds to repay creditors before their discharge. In a Chapter 13 filing, the amount of the refund could influence their payment obligations to creditors.
The only real way to avoid the loss of someone’s tax refund is to eliminate the need for a refund entirely. Workers struggling financially want to go over the tax withholding paperwork they filed with their employers. More accurate withholding practices mean that there will be less sent to the federal government and therefore less due to the taxpayer as a refund. People can then both maximize their household income and minimize how much of their property is vulnerable in their bankruptcy filing.
Bankruptcy can affect many different aspects of someone’s finances. Learning about unique bankruptcy rules, including what may happen with someone’s tax refund, could help them maximize the benefits that a filer derives while minimizing their challenges and losses.