Chapter 7 Bankruptcy and Your Tax Return and Refund

bio_burnsWhen filing Chapter 7 bankruptcy, it’s important to understand several things about your tax return and any possible tax refund you may have coming. Bankruptcy law is very specific about how tax return information and tax refunds are to be applied in bankruptcy proceedings, especially if filing under Chapter 7.

As a Maryland bankruptcy attorney, I find that clients often have many misconceptions about tax returns and tax refunds as they pertain to their bankruptcy case. First of all, let me say that if you are trying to time your bankruptcy filing and tax return filing so that you have a nice cash windfall from your tax refund after all your debt is wiped out, forget it. Bankruptcy law requires you to file your most recently due tax return and all prior returns before filing Chapter 7 bankruptcy. Failure to do so will result in rejection of your bankruptcy petition. Similarly, once you file for bankruptcy, the trustee assigned to your case will notify the IRS of your case and any refund due to you for the year in which you file bankruptcy will be sent directly to the trustee for inclusion in your bankruptcy estate.

Why Chapter 7 Bankruptcy Requires Tax Returns to Be Current

Bankruptcy law requires that anyone filing for Chapter 7 bankruptcy be current on their tax returns. This means that if you file for bankruptcy between now and April 2013, you must have your 2011 tax return and all earlier tax returns filed with the IRS. If you file after April 15, 2013, you must also have your 2012 return filed.

Many clients come to my Maryland bankruptcy attorney’s office hoping to file their most recent tax return AFTER they file for bankruptcy. Of course, if you know that you’re going to get a big refund and will either spend it on bills or hand it all over in the bankruptcy, it makes sense that you’d want to put off receiving that refund until the bankruptcy is over in hopes that you get to keep it all. However, bankruptcy law doesn’t work that way.

There are four primary reasons why bankruptcy law requires people to get all their tax returns up to date before filing bankruptcy:

  1. If you owe any back taxes, the IRS wants their share before any unsecured creditors, like credit cards and medical bill collectors, get any of your money.
  2. Bankruptcy court uses your most recent tax returns to determine what your financial situation is and how much you were earning compared to your current earnings.
  3. Creditors are entitled to receive copies of your tax return prior to responding to your petition for bankruptcy.
  4. If you are entitled to a tax refund, Chapter 7 bankruptcy law requires that any portion due to you for a time prior to filing bankruptcy must be included as part of your bankruptcy estate from which the trustee will pay your creditors.

icon_01A note about tax refunds received prior to bankruptcy: If you receive a tax refund prior to filing for bankruptcy and spend it all on a vacation, expensive gifts or other extravagancies rather than using it to pay bills and other living expenses, your bankruptcy trustee may decide that you are abusing the bankruptcy system and could reject your petition. Don’t try to cheat the system.

Chapter 7 Bankruptcy and Your Future Tax Refunds

Some clients who come to my Maryland bankruptcy attorney’s office have the mistaken impression that filing Chapter 7 bankruptcy will mean they forfeit their tax refunds or a portion of them for many years to come. That is not the case. Only refunds relating to income you earned prior to filing for bankruptcy can be applied to your bankruptcy case.

Here’s how this plays out. If you filed for bankruptcy in 2012, your trustee will prorate your refund and keep only the portion due to you for the months preceding your bankruptcy filing date. If you filed on July 1, 2012, which is half way through the year, then 50% of your refund will be applied to your bankruptcy estate and the rest goes to you. If you file in late December of 2012, then all of your tax refund will be included in the bankruptcy.

Tax refunds due to you for years after your bankruptcy filing will not be affected. If you file Chapter 7 bankruptcy in 2012, no portion of your refunds for 2013 or subsequent years will be affected.

Get help understanding how Chapter 7 bankruptcy will affect your tax refund

In Maryland, bankruptcy attorney John Burns can help you understand how Chapter 7 bankruptcy will affect any tax refund you are owed and ensure that all your paperwork and tax returns are in order before filing for bankruptcy. Call our office at 301-441-8780 to schedule an appointment.