Filing for bankruptcy results in different outcomes and affects several areas of your life both positively and negatively. One of the questions people usually ask is “how does filing for bankruptcy affect your tax refund?” This is a valid question because the answer will help you understand your situation better in order to plan accordingly.
When an individual files for bankruptcy, their assets are affected. Here’s how; the court assigns a bankruptcy trustee to their account. The job of the trustee is to liquidate their assets and use the funds to pay off their outstanding debts.
As you may know, income tax refunds are also considered assets, and since income tax refunds are also considered assets, you may thus be wondering how filing for bankruptcy affects your income taxes. First, there are a few things that you must understand.
How filing for bankruptcy may affect your tax refund
If you earned your tax refund before filing for bankruptcy, that portion of the tax refund is at the disposal of your bankruptcy trustee. The exception is if the refund is protected by an exemption. For instance, if you file for chapter 7 bankruptcy and shortly after, you file your tax return for the previous year and receive a tax refund because you earned your tax refund before filing for the bankruptcy, your bankruptcy trustee is entitled to your entire refund.
Basically, your tax refund will be taken away if you earned it before you filed for bankruptcy unless you are protected by an exemption. An exemption helps you protect your tax refund. It is advisable to find out if you are entitled to claim the federal bankruptcy exemptions. This will protect your assets.
An alternative is to exhaust the tax refund by spending it before filing for bankruptcy. If your tax refund will not be exempt and you do not want it to be claimed when you file for bankruptcy, you should spend it.
Spending it also requires knowledge. You should spend it on simple expenses like food, repairs, mortgage, medical bills and so on. Spending it on assets like jewelry and real estate will not help your bankruptcy case.
Finally, If you have already filed for bankruptcy and your tax refund is not exempt, do not attempt to spend it, as this could lead to a lot of trouble for you in the long run.
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