Tax refunds and bankruptcy

While many people are busy preparing their tax returns, in this post we will focus on the treatment of tax refunds in bankruptcy.

In a Chapter 7 personal bankruptcy, a debtor filing in New York State may exempt up to $5,000 of cash or cash equivalents ($10,000, if the debtor is a married couple filing jointly), if the homestead exemption isn't taken. Accordingly, for a single debtor, if his or her New York State or federal tax refund exceeds $5,000, then the bankruptcy trustee can require the debtor to turnover to the bankruptcy trustee the difference between the tax refund(s) and $5,000.

However, if a debtor files for bankruptcy in June of a given tax year, then the amount of the tax refund would be prorated between the pre–bankruptcy period (the beginning of the tax year through the day before the filing date, which monies would be paid to the bankruptcy trustee for distribution to creditors) and the post–bankruptcy period (the filing date through the end of the tax year, which monies would be retained by the debtor).

If a debtor expects a large tax refund post–bankruptcy filing, he or she could raise the number of withholding allowances or amount withheld to reduce his or her tax refund, or delay the bankruptcy filing until after receipt of the tax refund.

For questions about the complex interplay between taxes and bankruptcy, please contact Jim Shenwick.