Tax Refunds and Chapter 7 Bankruptcy

In only a few weeks, taxes are due. Which begs the question: if you are going through Chapter 7 bankruptcy or are considering filing for bankruptcy, what tax rules apply to you? Can you spend your tax refund if you are in the midst of bankruptcy? If you haven't filed for bankruptcy yet, should you use your tax refund to pay back some of your debts?

The first thing to note is that a tax refund is included as an asset for bankruptcy estate purposes. In other words, if your tax refund is not exempt, the bankruptcy trustee will collect your refund as part of your bankruptcy estate, which is used to pay back creditors.

Wildcard Exemption

If you have already filed for bankruptcy, you may be able to keep your tax refund through the wildcard exemption.

During your Texas Chapter 7 bankruptcy, debtors have the option to choose between state or federal bankruptcy exemptions. If you choose federal exemptions, you may exempt your tax refund under the wildcard exemption, Section 522(d). The wildcard exemption allows a debtor to exempt up to $1,150 of any personal property, and up to $10,825 more of any unused amount of the federal homestead exemption.

Should You File Bankruptcy Before or After Tax Time?

Now may be the perfect time for you to file bankruptcy. Since you are about to receive your refund, you may be able to use those monies to pay for any costs associated with the bankruptcy, including attorney's fees.

While it may be tempting to pay back a family member or friend who lent you money, or to pay off your credit card debt, doing so can lead to trouble later on in the process. The bankruptcy trustee may consider this "improper preference" of one creditor over another and may even ask you to pay back the money to the bankruptcy estate (even if you have already spent it).

The Interaction of Complicated Laws

The U.S. Bankruptcy Code, Texas bankruptcy laws and federal tax laws — as well as the ways these laws work together — are complicated. Therefore, it is in your best interest to speak with a bankruptcy lawyer.