Can I Keep My Tax Refund if I File for Chapter 13 Bankruptcy?

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Tax day is once again approaching, and, if you have filed for bankruptcy, you undoubtedly have some new questions this year about filing your taxes and whether or not you can receive federal tax refunds.

Here, we will focus on Chapter 13 bankruptcy and the effect it will have on your federal taxes and refund(s). Firstly, let’s go over the definition of this type of bankruptcy. In order to be able to file for a Chapter 13 bankruptcy, you must be either: gainfully employed, self-employed or a sole proprietor. The reason for this requirement is that a Chapter 13 is actually a reorganization of your debts rather than a forgiveness of your debts. In addition, all of your tax returns within the past four years must have been filed correctly and on time.

A Chapter 13 bankruptcy filing will allow you to keep possession of all of your assets/property. The purpose of a chapter 13 proceeding is to create a plan that will allow you to pay back all or most of your debts over the next 3 to 5 years. Other types of bankruptcies can result in you losing assets that you cannot pay for.

In order to file for a Chapter 13, your total debt burden must not be so high so that creating a reasonable repayment plan would be impossible. Your repayment plan will be based on your income, your reasonable living expenses, and the specific debts that you have incurred. As you will be required to pay a specific amount of money each month to a number of different creditors, you will be living on a very strict budget until these debts are sufficiently paid down or paid off completely, depending on what is specifically set out in your repayment agreement.

Around tax time, the appeal of receiving a substantial lump some of money in the form of a tax refund can be very tempting when you are living on such a strict budget every month as you repay your debts.

That being said, it is important to know that, for many people involved in a bankruptcy case, tax refunds are often delayed or are required to be used as payment toward your Chapter 13 debts. This is especially true if any or all of the reason you filed for bankruptcy is overdue federal tax debts.

When you file for a Chapter 13 bankruptcy, you will be required to put all of your disposable income toward repayment of your debts. Disposable income is defined as any income that is not used to pay for your reasonable monthly living expenses. Under this definition, your tax refund will be considered disposable income because you will not have listed any potential tax refund money when you filed for Chapter 13 bankruptcy.

However, it is possible for you to excuse your tax refund from being considered part of your disposable income on a year-by-year basis. This is only possible if you have encountered a necessary living expense that can legitimately be considered unexpected.

In order to be able to keep your tax refund during a Chapter 13 bankruptcy, a separate plan modification will need to be filed each year. In your Chapter 13 plan modification, you’ll need to specify exactly how much money you will be receiving as a tax refund.  You will also need to provide details that will prove your need to keep the money.

Anything that is considered part of your regular monthly living expenses will not be reason enough for the court to allow you to keep your tax refund during a Chapter 13 reorganization. The reason for this is that you agreed to certain expenditures when you originally filed your bankruptcy petition, and you will be held responsible for making ends meet with the income that you are currently generating.

To learn more about specific situations that may allow you to keep your tax refund if you have filed for a Chapter 13 bankruptcy, contact our office today. Feel free to use this contact form, and please use the information provided on our law blog to learn more about the ins and outs of bankruptcy.

Image credit: Gotcredit
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