Will You Lose Your Tax Refund In Bankruptcy?
Tax season has come and gone, and for many of us, it’s time to wait for that tax refund. But you may also need bankruptcy. Can your tax refund be taken in bankruptcy? What’s the best way to protect a tax refund?
No Specific Exemptions for Refunds
There is no express exemption for a tax refund. Exemptions are treated like money or property, the way any other money or property would be treated.
The good news is that Florida provides a $1,000 exemption that you can use on anything you want (which includes a tax refund), and that amount increases to $4,000 if you don’t have a homestead or you don’t claim a homestead exemption in your case.
You may be wondering how to fit both a tax refund, and the value of your other property, inside of the $1,000-$4,000 range. The best strategy is to use the exemption on the money, and not actual property. That’s because property usually has a limited value, and costs money for the trustee to take, store and sell.
That means the trustee is more likely to leave your property alone, even if it’s not protected. The trustee is more likely to want to take hard cash in the bank. So using the exemption on the cash and “exposing” physical property is often a good strategy.
Not Every Refund Can Be Taken
But not every tax refund you earn can be taken by the bankruptcy court. The only tax refunds that can be taken are refunds that are earned during the year prior to your bankruptcy filing. The question is when was the refund earned. If it’s before the bankruptcy, it can be taken.
Often, a refund may represent money earned before a bankruptcy and money earned after the bankruptcy. For example, let’s say that you file for bankruptcy on June 1, 2021. In March 2022, you get a tax refund. Some of that refund may be from earnings that happened after June 1, 2021. So, only a part of the refund would even be part of your bankruptcy estate. You wouldn’t have to protect that part of the refund because it couldn’t be taken.
Spending the Refund
One strategy that many people use is simply spending the refund before you file. Obviously, it makes no sense to buy things with the money—those things have value, which then need to be exempted anyway.
However, you could spend the refund on car repairs, home repairs, vet expenses, a necessary medical procedure or doctor’s visit, food, or any normal, routine expense that you would normally incur.
Remember that there is a fine line between proper expenditures of a refund, and bankruptcy fraud. That means that if you do want to spend a refund before filing bankruptcy, you should consult with an attorney first, to make sure you don’t have a problem with your bankruptcy later on.