A tax refund can be a big deal when money is already tight. You may be counting on it for rent, car repairs, groceries, or unpaid bills. If you are also considering bankruptcy, though, the refund may become part of the case.
What happens to the money depends on when you earned the refund, when you file, which chapter you use, and whether an exemption protects it.
How a Tax Refund Becomes Part of a Bankruptcy Case
When you file bankruptcy, most property in which you have a legal or financial interest becomes part of the bankruptcy estate. That can include a tax refund tied to income you earned before filing, even if the IRS or Minnesota Department of Revenue has not sent it yet.
Timing can get tricky if you file midyear. Part of a future refund may come from income earned before the bankruptcy and part from income earned afterward. Courts may divide the refund to determine how much belongs to the estate.
So waiting for the check to arrive does not necessarily keep it out of the bankruptcy.
What Happens to a Refund in Chapter 7
In Chapter 7, the trustee looks for nonexempt property that can be used to pay creditors. A tax refund can be part of that review.
You do not automatically lose every refund, though. Available exemptions may protect some or all of it. Minnesota residents may also choose between Minnesota and federal exemption systems, depending on the facts of the case.
How Chapter 13 May Treat Your Tax Refund
Chapter 13 handles property differently because you keep your assets and make payments through a repayment plan.
Tax refunds received during the case may still affect that plan. Depending on the terms of your case, you may be required to turn over some or all of a refund to the Chapter 13 trustee for distribution to creditors.
This is one of those situations where spending the money first can create a problem later. If a refund arrives while you are in Chapter 13, check with your attorney before using it. Your plan may already say what needs to happen with the funds.
When You May Be Able to Keep Some or All of the Money
The source of the refund can matter. Minnesota law protects certain tax credits tied to public assistance and low-income taxpayers, including some refundable federal and state credits. Other exemptions may also protect a portion of the money.
A refund caused mostly by excess withholding is not necessarily treated the same way as one made up largely of protected tax credits. The total amount matters too.
That is why knowing the size of the refund isn’t enough. Your attorney needs to know where the money came from and which exemption system applies to your case.
Why the Timing of Your Filing Can Change the Outcome
People sometimes assume they can solve the problem by filing before the refund arrives. It is not that simple.
If you already earned the right to the refund, all or part of it may still become property of the bankruptcy estate. Filing after you receive the money can create different issues, especially if you spend it quickly or use it to repay certain people before filing.
Payments to relatives or friends can draw extra attention. Large purchases or transfers may also require explanation.
Before changing your filing date or spending a refund because you are worried about losing it, have a bankruptcy attorney look at the situation first.
Talk to a St. Cloud Bankruptcy Attorney About Your Tax Refund
If you are expecting a refund or still have refund money in your account, bring it up before filing. At Kain + Henehan, we can look at when the money was earned, what makes up the refund, and which exemptions may protect it. Contact Kain + Henehan by calling (612) 438-8006 or filling out the online form to speak with a bankruptcy attorney about how your tax refund could be treated in your case.