What Happens to Your Tax Refund in Bankruptcy?

If you’ve filed or are preparing to file bankruptcy, you may wonder if you’ll still receive an income tax refund and, if so, whether or not you’ll get to keep it. This article covers how bankruptcy can affect your tax refund and what you can do to keep as much of your refund as possible.

How Does Bankruptcy Affect Your Tax Refund?

Many Chapter 7 filers are able to keep their full tax refunds thanks to exemptions or by using the refund for necessary expenses like groceries, rent, or utility bills before filing.

That said, refunds for taxes on income you earned before you file bankruptcy are always part of your bankruptcy estate. Whether or not you get to keep the refund depends on whether it’s covered by a bankruptcy exemption and which type of bankruptcy you file.

Chapter 7 and Chapter 13 treat your tax refund differently. For most of this article, we focus on how tax refunds work in Chapter 7 since it’s the most common type of personal bankruptcy. But we also include a section later in the article on how refunds work in Chapter 13 bankruptcy. Regardless of which chapter you file, if you have concerns about losing your tax refund in bankruptcy, you can get legal advice specific to your case by setting up a free consultation with a bankruptcy attorney.

To better understand how your tax refund is affected during a bankruptcy filing, it’s important to first know what a bankruptcy estate is.

Your Tax Refund and the Bankruptcy Estate

When you file for bankruptcy, a legal entity called a bankruptcy estate is created. This includes everything you own or are entitled to when you file your case. Even if you haven’t received your tax refund money yet, refunds for income earned before your filing date are part of your bankruptcy estate.

Why Is Your Tax Return Part of the Bankruptcy Estate?

You might wonder why a refund you haven’t received yet is considered part of your bankruptcy estate. Bankruptcy law treats tax refunds for income earned before your filing date as money you were entitled to at the time you filed your case — even if the IRS hasn’t issued the refund yet.

Here’s a simple way to think about it: If you overpaid your taxes, that extra money belongs to you. Bankruptcy law sees overpaid taxes like money sitting in a bank account — except the "bank" in this case is the IRS. Because this was essentially your money before filing, it’s included in your bankruptcy estate.

Can the Trustee Take My Refund After My Case Is Closed?

If you’re expecting a refund for income earned before your filing date, it’s important to know that the trustee can’t take your refund after your bankruptcy case has been closed. However, the trustee can choose to keep your case open until you receive the refund if they expect the amount to be large enough to justify the effort. This is another reason why many filers choose to spend their refunds on necessary expenses before filing or rely on exemptions to protect it. We’ll explain more on these options below.

Is Your Tax Refund Protected by Exemptions?

Exemptions are laws that help people filing for bankruptcy protect certain property, including potentially all or part of a tax refund. Each state has its own exemption laws, and there’s also a set of federal bankruptcy exemptions. Some states let you choose between federal and state exemptions, while others require you to use the state system.

Whether your refund is protected depends on the rules in your state. Some states allow you to choose between federal and state exemptions, while others require you to use the state system. Whether your refund is protected depends on which exemptions apply in your case.

State Exemptions for Tax Refunds

Some states have specific exemptions that protect tax refunds or refundable tax credits, like the Earned Income Tax Credit (EITC) or the Child Tax Credit. 

If your state doesn’t have a specific exemption for tax refunds, you may still be able to protect it using a wildcard exemption. Some states offer wildcard exemptions as part of their exemption system, allowing you to protect property — like a tax refund — that doesn’t fall under any specific category, up to a certain dollar amount.

Federal Exemptions for Tax Refunds

The federal bankruptcy exemptions don’t specifically protect tax refunds, but they do offer a wildcard exemption. This allows you to protect property of your choice, including tax refunds, up to a certain dollar amount. The wildcard exemption is often used to protect cash assets like refunds, which are easier for trustees to access and use to pay creditors. Currently, the federal wildcard exemption is $1,475 plus any unused portion of your homestead exemption, up to $13,950 total.

Many filers who claim the wildcard exemption choose to apply it to their tax refund first. This is because trustees are more likely to take a tax refund than a piece of property, as refunds are easier to convert into money to pay creditors.

How To Protect Your Tax Refund Before Filing Bankruptcy

If you receive your tax refund before filing for bankruptcy, only the portion that’s still in your possession on the filing date becomes part of your bankruptcy estate. 

Many bankruptcy filers take steps to protect their refund before they file, such as:

• Spending the refund on necessary expenses (if the refund is received before filing bankruptcy)

• Adjusting their tax withholding to avoid overpaying if they haven’t yet received a refund or filed their bankruptcy case

Spend Your Refund on Necessary Expenses

One option some filers consider is spending their tax refund on necessary expenses before filing for bankruptcy. This ensures the money is no longer part of your bankruptcy estate when you file.

Examples of acceptable expenses include:

• Rent or mortgage payments

• Utilities

• Groceries

• Necessary home or car repairs

• Medical or dental bills

• Insurance payments

• Clothing or shoes you truly need

It’s important to avoid spending your refund on luxuries, like vacations, expensive jewelry, or gifts, as these kinds of purchases could raise red flags in your bankruptcy case. Trustees closely review how refunds are spent, so focus on reasonable and necessary costs. It’s also a good idea to keep proof of your purchases.

Adjust Your Tax Withholding to Avoid Overpaying

Another option many filers consider is reducing the likelihood of receiving a refund in the first place. If you’re planning to file for bankruptcy within the next year, you can adjust your income tax withholding so that you only pay the amount of taxes you owe throughout the year.

This increases your take-home pay throughout the year, which you can use to cover living expenses without building up a large tax refund. However, keep in mind that if you underpay your taxes, you may owe money when you file your tax return. It's a good idea to review your tax withholding carefully to avoid owing money when you file your return.

What Happens If Your Refund Isn’t Fully Protected?

If you receive a tax refund after filing for bankruptcy and it isn’t fully covered by exemptions, the trustee may require you to turn over the non-exempt portion. Here’s how to handle the situation to avoid complications:

• Don’t spend the refund. If your refund isn’t exempt and you spend it anyway, the bankruptcy court could deny your discharge or even revoke a discharge that’s already been granted.

• Notify your trustee. Let the trustee know you’ve received (or are expecting to receive) a refund, and ask how to turn over the non-exempt portion.

Failing to disclose or turn over a non-exempt refund can cause serious legal problems, so it’s important to be up front with the trustee.

The Trustee’s Role in Managing Tax Refunds

The bankruptcy trustee (the person overseeing your case) will likely ask about expected tax refunds during your 341 meeting of creditors. You’ll need to include any expected refunds as an asset on your bankruptcy forms. This allows the trustee to determine whether the refund is exempt or if it should be used to pay creditors.

If you’re not sure whether your refund is exempt or how exemptions work in your state, consider consulting a bankruptcy lawyer. A free consultation can help you understand your options and avoid mistakes.

Can You Get Rid of Tax Debt in Bankruptcy?

Bankruptcy is a powerful debt relief tool that can help you get a fresh start by getting rid of credit card debt, medical bills, and other other unsecured debts. 

It can help eliminate certain tax debts, but the specifics depend on the type of bankruptcy and the nature of the tax debt.

If you’re filing Chapter 7, you can only discharge tax debt that’s more than three years old, provided the tax return was filed on time and the IRS assessed the debt at least 240 days before filing. You’ll also need to be up to date on all your income tax filings and cannot have committed fraud or tax evasion.

In Chapter 13, tax debts are treated as priority debts, meaning they must be paid in full through your 3–5-year repayment plan. While these debts aren’t dischargeable, Chapter 13 allows you to manage payments without additional interest or penalties.

Can You Keep Your Tax Refund if You File Chapter 13 Bankruptcy?

In most Chapter 13 cases, you won’t be able to keep your tax refunds during the required 3–5-year repayment plan. That’s because both tax refunds based on income you earned before filing bankruptcy and refunds based on income earned during your repayment plan are considered part of your bankruptcy estate.

This means your bankruptcy trustee can take these refunds and use them to pay creditors as part of your payment plan.

How Trustees Handle Tax Refunds in Chapter 13

Each Chapter 13 trustee has their own policies for handling tax refunds. For example, some trustees may:

• Automatically take all refunds you receive during your case,

• Allow you to keep the refund if you file a statement showing the money is needed for necessary expenses, or

• Only take refunds that exceed a certain dollar amount.

If you’re filing Chapter 13, it’s a good idea to contact your trustee’s office to learn about their specific policy for handling tax refunds.

Let’s Summarize…

Tax refunds for income earned before you file for bankruptcy are usually part of your bankruptcy estate. In Chapter 7, you may be able to protect your refund with exemptions or by spending it on necessary expenses before filing. In Chapter 13, most tax refunds received during your repayment plan will likely go toward paying creditors.

To keep as much of your refund as possible, consider using exemptions, spending the refund on essentials before filing, or adjusting your tax withholding to avoid overpaying in the first place. If you’re unsure about how exemptions apply in your case, consider setting up a free consultation with a bankruptcy attorney for personalized advice.

FAQs About Tax Refunds in Bankruptcy

I Don't Know How Much My Tax Refund for This Year Will Be. What Should I Do?

• If your refund has been consistent for the last few years and you haven't had any major life changes, such as getting married, having a child, buying or selling a house, or getting a new job, estimate this year's refund based on that amount.

• If your refund is different every year or you don't know how much you might receive, you can use a free tax refund calculator online to estimate this year's refund.

Why Do I Have To List My Tax Refund if I Won't Get It Until Next Year?

You must list all your property (also called assets) on Schedule A/B. This includes anything you own or have a right to when you file, such as your tax refund even if you haven’t received it yet.

While you're not getting your refund until you file your tax return the following year, as of the filing date, you're already entitled to a portion of the refund you'll be getting. After all, you've been paying taxes all year long.

Are All Tax Refunds Protected in Bankruptcy?

No, there's no general rule that all tax refunds are protected. You can only protect your tax refund if the exemption law you're using has a specific tax refund exemption you can claim, or if there is a wildcard exemption you can use.

Federal bankruptcy exemptions have a pretty generous wildcard, so folks using the federal exemptions can typically protect their tax refund in full. Some states provide exemptions that protect tax refunds that are the result of a specific tax credit, like the Earned Income Tax Credit or the Child and Dependent Care Tax Credit. Some states, like Arizona, don't have any protection for tax refunds or a wildcard exemption.

What Happens if I Don't List My Tax Refund?

If you don't list your estimated tax refund as an asset on your Schedule A/B, you can't protect your refund by claiming an exemption for it on your Schedule C.

If you don't claim an asset, including a tax refund, as exempt on Schedule C, the trustee handling the case can take a portion of the refund and use the money to pay unsecured creditors.

The Trustee Says I Have To Amend My Forms To List My Refund. What Should I Do?

Since you can only protect your refund with an exemption if you list it, you should amend (update) your Schedule A/B to list your tax refund as an asset, and amend your Schedule C to claim all available exemptions. If no exemptions are available to protect your refund, you only have to amend your Schedule A/B.

👉 If you’re an Upsolve user and need instructions on how to use our free web app to prepare your amendment, please visit help.upsolve.org and use the "Submit a Request" feature in the top right corner to send us a message. 

Will the Bankruptcy Trustee Take My Whole Refund?

It depends. The trustee may take all or part of your refund, depending on when you file and what portion of the refund is tied to income earned before your filing date. In some cases, the trustee can claim 100% of your refund.

Can I Just Wait Until the New Year To File My Bankruptcy To Protect My Refund?

No. If you file bankruptcy at the beginning of January, or any time before you receive your refund in the new year, then the trustee may be able to take 100% of your tax refund. That's because you were entitled to the full refund when your bankruptcy case was filed.

How Will the Trustee Know How Much My Refund Was? 

As part of your duties as a debtor in bankruptcy you have to provide your trustee with a copy of your tax return once it's been filed. The trustee will use the refund information on your tax return to calculate the pre-filing portion of your refund.

While there is nothing that says you have to file your taxes before Tax Day, the trustee can't close your case until they get a copy of your return. The sooner you get your taxes filed and a copy of the return sent to your trustee, the better.