A common question I get this time of year is whether the trustee will take the debtor’s tax refund if he files for bankruptcy. The answer depends upon many factors.
The Trustee has a duty to administer non exempt assets if those assets are worthy of administration. For a tax refund to be worthy of administration the refund must be large enough to justify the time and effort to take and distribute the money to unsecured creditors
If the debtor can wait to file his bankruptcy, then often the simplest solution to the problem is to have him file the return and then receive and use the refund.
However, this is not always possible.
If the debtor is having his wages garnished or a garnishment is scheduled to begin, it may be necessary to file before a refund can be received. Timing issues will also occur if a house is in foreclosure, or a car is about to repossessed.
If the debtor cannot wait for whatever reason, the following factors will determine whether the refund will be taken:
- As previously discussed, is the amount of the refund worthy of administration? This is an issue of local practice and will often vary from court to court.
- Is any portion of the refund for Earned Income Credit. It is necessary to check state law on this issue. In Louisiana, Earned Income Credit is specifically exempt, so a debtor with Earned Income Credit keeps it.
- Does your State have a “Wild Card” or “Cash” exemption? Some states allow a certain amount of cash to be treated as exempt from creditors, other states have what is refereed to as a wild card exemption that will allow a debtor to exempt an item that is otherwise not exempt. Louisiana has no such exemptions.
As can be seen the timing of a bankruptcy when a tax refund is expected depends on many factors. Local practice and State law being the major considerations.