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What Will Happen to My Tax Refund if I File Bankruptcy?

With the deadline for filing taxes fast approaching[1] this is a concern for many individuals contemplating filing bankruptcy. Whether your tax refund can be protected and thus exempted from being taken by the bankruptcy trustee and distributed to your unsecured creditors depends on the specific facts of your case – primarily 1) whether there is significant equity in your home, and 2) the total fair market value of other personal property or equity in other real property you own.

As a general rule, however, you can keep your tax refund only to the extent that it can be exempted in your bankruptcy petition. California has a generous “Wild Card" exemption that can be used to protect your tax refund if you do not have significant equity in your home.

Tax refunds can be taken by the bankruptcy trustee if they are not disclosed on Schedule B of your bankruptcy petition and properly exempted on Schedule C. You can also be forced to turnover the amount of your refund to the trustee if it is unwisely spent prior to filing, i.e., paying for a vacation, purchasing a large screen television, or purchasing other items that are not regarded as a living necessity. Using the refund to repay a family member, friend, or business partner is also a big no-no that can cause a problem with your bankruptcy. Even if your tax return is not yet filed, you must list and exempt any anticipated refund or you run the risk of losing the entire amount. As such, it is best to file your tax returns prior to filing bankruptcy.

If you are getting a large refund then you can hold off filing until you have spent the refund on living necessities. You can spend the money on rent, mortgage payment, food, clothing, medical services, car payment, car repairs, or other reasonable living necessities. You can also use that money to hire a bankruptcy attorney. Make sure you keep a record or receipts of how the refund was spent.

In short, the best ways to protect your refund in bankruptcy are to file your taxes prior to filing bankruptcy, and to consult an experienced bankruptcy attorney to help you navigate some of these complicated tax refund and bankruptcy issues.

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