One of the questions I frequently hear from people considering filing Chapter 7 bankruptcy is: What happens to my income tax refund if I file bankruptcy?

This is an important question, and one that should be addressed before filing a bankruptcy petition.

In fact, an income tax refund is one of the most commonly overlooked assets in bankruptcy. Debtors sometimes forget to disclose an anticipated tax refund, and surprisingly, even attorneys occasionally overlook it when preparing bankruptcy petitions.

In Michigan, this can be particularly important because federal income tax refunds can be substantial, especially for families with minor children who qualify for certain child-related tax credits. Depending on the family’s income and circumstances, these credits can result in a sizable federal income tax refund.

The good news is that in many cases, I can protect my clients’ federal and Michigan income tax refunds when filing Chapter 7 bankruptcy. However, the key is properly disclosing the refund and addressing it before the bankruptcy case is filed.

Let’s take a closer look.

1. Is My Income Tax Refund an Asset in Bankruptcy?

Yes. An anticipated income tax refund is generally considered an asset of your bankruptcy estate.

When you file Chapter 7 bankruptcy, the bankruptcy trustee has the right to examine your assets to determine whether there is any property that can be liquidated for the benefit of your creditors.

This includes both federal and Michigan income tax refunds.

Many people mistakenly believe that because they haven’t received their tax refund yet, it doesn’t need to be listed in their bankruptcy petition. That is incorrect.

If you file bankruptcy during the year, you may already have earned a portion of the income that will generate your next tax refund. Even though you haven’t filed your tax return or received the money, the portion attributable to the pre-bankruptcy period is generally considered property of the bankruptcy estate.

For example, if you file Chapter 7 bankruptcy in July, you have already earned income during the first six months of the year. Any anticipated income tax refund attributable to that pre-bankruptcy period must be considered when preparing your bankruptcy schedules.

2. How Do We Calculate the Tax Refund in a Chapter 7 Bankruptcy?

When I prepare a Chapter 7 bankruptcy petition, I carefully examine whether my client is entitled to a federal or Michigan income tax refund.

Generally, we prorate the anticipated refund based on the portion of the tax year that has elapsed before the bankruptcy filing.

For example, assume you anticipate receiving a $6,000 federal income tax refund for the current tax year and file Chapter 7 bankruptcy on July 1.

Approximately one-half of that anticipated refund may be attributable to the portion of the year before bankruptcy.

That means approximately $3,000 could be considered an asset of the bankruptcy estate, subject to applicable exemptions.

The actual calculation can depend on the circumstances, including when income was earned, when tax credits arose, and other factors affecting the refund. It is not always as simple as dividing the refund by twelve and multiplying by the number of months elapsed.

This is why it is important to have an experienced bankruptcy attorney properly calculate and disclose the anticipated refund.

3. Can I Protect My Tax Refund With a Bankruptcy Exemption?

In many cases, yes.

One of the most important things I do when preparing a Chapter 7 bankruptcy petition is determine whether my client has an available wildcard exemption that can be used to protect an anticipated income tax refund.

Depending on which exemption system applies and the debtor’s other assets, an available wildcard exemption may protect some or all of the portion of the refund that belongs to the bankruptcy estate.

Michigan residents generally have a choice between using Michigan bankruptcy exemptions and the federal bankruptcy exemptions. The available exemptions differ, and determining which system provides the best protection requires examining the debtor’s entire financial situation.

For some clients, there may be sufficient available exemption to protect the entire anticipated refund. For others, the available exemptions may be more limited.

The important point is that an income tax refund should never be overlooked when determining which exemptions to claim.

4. Chapter 7 Trustees in Michigan Are Looking for Your Tax Refund

Chapter 7 trustees in the Eastern District of Michigan are very familiar with income tax refunds.

In fact, trustees routinely examine bankruptcy petitions to determine whether debtors are entitled to federal or Michigan income tax refunds.

If a refund is anticipated, the trustee will want to know how much of it is attributable to the pre-bankruptcy period and whether the debtor has properly claimed an exemption.

If the refund is not properly disclosed, that can create unnecessary problems in an otherwise straightforward bankruptcy case.

I have seen situations where debtors simply forget about an anticipated refund when completing their bankruptcy paperwork. Unfortunately, that does not make the refund disappear as an asset of the bankruptcy estate.

This is one of the reasons I pay particular attention to tax refunds when preparing bankruptcy petitions.

5. What If I Already Received My Tax Refund Before Filing Bankruptcy?

This is another important issue.

Suppose you receive a $6,000 income tax refund in February and then decide to file Chapter 7 bankruptcy in March.

A Chapter 7 trustee may want to know what happened to that $6,000.

Did you use the money to pay your rent or mortgage? Did you purchase groceries, pay utility bills, repair your vehicle, or pay other ordinary living expenses?

Or did you transfer a substantial portion of the refund to a family member, repay a loan from your parents, or give the money to a close friend?

These are important distinctions.

An experienced Chapter 7 trustee will examine significant expenditures made shortly before bankruptcy, particularly when a debtor received a substantial tax refund.

If you used the refund for legitimate living expenses, that is very different from transferring money to a family member or friend shortly before filing bankruptcy.

Transfers to relatives and other insiders can raise additional bankruptcy issues, including potential preference or fraudulent transfer concerns, depending on the circumstances.

My advice is simple: Be prepared to explain what happened to any substantial tax refund you received before filing bankruptcy. Do not assume that because the money is already gone, the trustee will not ask about it.

6. Can Creditors Intercept My Federal or Michigan Income Tax Refund?

Yes. And this is another reason why the timing of a bankruptcy filing can be important.

Outside of bankruptcy, certain creditors and government agencies can intercept or offset your income tax refund.

For example, the federal government can offset your federal income tax refund if you owe certain qualifying debts. These may include:

• Past-due federal income taxes.
• Certain defaulted federal student loans.
• Past-due child support.
• Certain other qualifying federal or state government debts.

Michigan can also intercept state income tax refunds for certain outstanding obligations, including qualifying state debts and past-due child support.

This can be particularly frustrating for someone who is already struggling financially and is counting on their tax refund to catch up on household expenses.

In some situations, filing bankruptcy before a creditor or government agency intercepts the refund may help preserve money that would otherwise be taken.

However, bankruptcy does not automatically prevent every type of tax refund offset. Certain government offsets, particularly those involving child support and other nondischargeable obligations, require special consideration.

The timing of the filing and the nature of the debt are important.

7. Should I Wait Until After I Receive My Tax Refund to File Bankruptcy?

Not necessarily.

This is a question I frequently discuss with prospective bankruptcy clients.

Some people believe they should always wait until they receive their tax refund before filing bankruptcy. Others believe they should file immediately to prevent creditors from intercepting the refund.

There is no universal answer.

If you are facing wage garnishments, bank account levies, lawsuits, or other collection activity, waiting may create additional problems.

On the other hand, if you are expecting a substantial tax refund, we need to determine how that refund will be treated in bankruptcy and whether it can be protected through available exemptions.

In many situations, filing bankruptcy before a creditor intercepts your tax refund can make a significant difference.

The important thing is to coordinate the timing of the bankruptcy filing with the anticipated refund and the client’s overall financial circumstances.

8. My Experience Protecting Tax Refunds in Chapter 7 Bankruptcy

In the vast majority of the Chapter 7 bankruptcy cases I file, I am able to protect my clients’ anticipated federal and Michigan income tax refunds.

That doesn’t happen by accident.

It requires properly identifying the anticipated refund, calculating the portion attributable to the pre-bankruptcy period, and determining which exemptions are available to protect it.

It also requires asking the right questions before filing.

I have practiced bankruptcy law exclusively for more than 35 years and have represented more than 25,000 people facing financial difficulties. Over the years, I have learned that some of the most important issues in a bankruptcy case are the ones that can easily be overlooked.

An income tax refund is a perfect example.

The worst thing you can do is fail to disclose an anticipated tax refund because you assume it doesn’t count as an asset.

A properly prepared bankruptcy petition should account for your anticipated refund and include any available exemptions necessary to protect it.

Conclusion: Don’t Lose Your Tax Refund Because of a Bankruptcy Filing

If you are considering Chapter 7 bankruptcy in Michigan and expect to receive a federal or Michigan income tax refund, you should discuss that refund with your bankruptcy attorney before filing.

In many cases, there are ways to protect the refund and preserve that money for your family’s needs.

Additionally, if creditors are attempting to intercept your federal or Michigan income tax refund, filing bankruptcy at the right time may prevent the loss of money that you otherwise desperately need.

I have helped thousands of Michigan residents navigate these issues, and I understand how important it is to protect every dollar possible when someone is struggling financially.

If you are considering filing Chapter 7 bankruptcy and are concerned about losing your income tax refund, contact my office before filing. I can review your circumstances, determine what exemptions are available, and help you understand how bankruptcy will affect your anticipated tax refund.

Law Offices of Walter Metzen
Detroit Bankruptcy Lawyer
313-962-4656
www.detroitbankruptcylawyer.com