How Will Bankruptcy Affect My Taxes?

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How Will Bankruptcy Affect My Taxes?

This time of year, every client who is considering filing for bankruptcy wants to know how it will affect their taxes. What forms will you need to file with the IRS? Will you be able to keep your tax refund during bankruptcy?

Tax season can be challenging enough on its own, and adding bankruptcy into the mix definitely complicates matters. Always consult with an experienced bankruptcy attorney if you have tax questions related to the specifics of your bankruptcy. For a general understanding of how filing for bankruptcy affects your taxes, read on.

Filing Taxes During Bankruptcy

If you petition for certain types of bankruptcy, the IRS may require that you file additional tax forms beyond the 1040 that you are used to preparing. This is because in bankruptcy, your assets and debts become part of the bankruptcy estate. All estate administrators, including those of bankruptcy estates, must file form 1041 to the IRS in addition to their personal tax filing.

In Chapter 11 or Chapter 13 bankruptcy, the bankruptcy trustee will file taxes for the estate. However, in Chapter 11, the debtor generally remains in control of his or her assets, so will file both the 1040 and 1041 themselves.

Will You Keep Your Refund?

You’ve probably been looking forward to your refund check all year, but the hard truth is that bankruptcy trustees will jump to seize a tax refund if it’s available. This is because unlike selling assets, seizing cash is an immediate and relatively effortless way for the creditor to get paid back.

A tax refund that’s received after filing for bankruptcy is considered part of the bankruptcy estate, and the court will require you to turn it over. With careful planning, however, you may be able to keep your tax refund in bankruptcy. When you file for bankruptcy with Benson Law Firms, we’ll help you come up with a plan to protect as much of your tax refund as possible.

What You Can (and Can’t) Spend Your Refund on

If you’ve received a large tax refund, your best bet is to spend it prior to filing for bankruptcy. Before you run to the mall, however, understand that you won’t get away with buying a new Xbox or other luxury goods. You also cannot use it to pay credit cards or repay a loan from a family member or friend.

So, what can you spend your refund on? Regular household expenses are fair game, including your car payment, rent or mortgage payments, food, utilities, clothing, medical expenses, and educational expenses. Keep careful records of how you spend your refund, because the bankruptcy court will require proof that it was used to pay basic living costs.

Minimizing (Yes, Minimizing) Your Refund

Because your tax refund could be seized to repay your creditors, the best course of action is to avoid getting a tax refund in the first place. If you are thinking of filing bankruptcy in the next year and received a large refund last year, the first thing we will do is look at your tax withholdings. We’ll then adjust your withholdings so only the necessary taxes are withheld from your paycheck. This way, you’ll have extra money in your pocket each payday, and only a small refund, if any at all.

Excusing Your Refund

In Chapter 13 bankruptcy, you may be able to “excuse” your tax refund if you can prove that the money is required to make your plan work. For example, if you make just barely enough to cover your living expenses and plan payment, but then have an unexpected and necessary expense that you can’t afford, you may ask the court to excuse your refund so you can pay that bill.

Some expenses that might warrant an excused refund include unexpected major medical expenses, funeral expenses, and car or appliance repairs. You may not excuse a tax refund to pay for food, rent, clothing, or other routine living expenses.

Work with a Bankruptcy Lawyer and Certified Public Accountant

As a licensed bankruptcy attorney and CPA, Michael J. Benson of Benson Law Firms is uniquely qualified to help you navigate tax season while filing for bankruptcy. We will work with you to get the fresh start you need and help you rebuild your finances after bankruptcy. Please contact our offices today to schedule your free initial bankruptcy consultation.


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