Tax Returns and Filing for Bankruptcy

Protect your Tax Return in Bankruptcy through Careful Planning

Worrying about what will happen to your tax refund is a valid concern for people who are in bankruptcy or who are contemplating bankruptcy. The vast majority of people in Michigan who file for bankruptcy are entitled to a tax return, which may be hundreds if not thousands of dollars. For an individual or family who is struggling to gain control of their financial situation, this money is critical.

What happens to my tax refund if I file for bankruptcy?

Whether or not and the extent to which your tax refund will be affected by a bankruptcy proceeding depends on many factors. First of all, it is important to note that each state, and even different districts within a state, have their own rules and may apply the same rules in a slightly different manner. Most importantly, however, whether or not you will get to keep your tax return depends on the chapter that you file under.

Chapter 7

In a Chapter 7 bankruptcy, tax refunds are considered an asset and are property of the debtor’s estate. This is true even if you have not yet received the refund. Chapter 7 provides that any amount received 90 days before filing or within 180 days after discharge is properly considered part of the estate. The law goes further, stating that even if the return is not received in this period, a prorated amount of the tax return must be included. The prorated amount applies to any part of the tax return that is accrued before filing for bankruptcy, and it must be included when listing assets and property rights in a Chapter 7 bankruptcy. For example, if you file for bankruptcy on June 30th and you are expecting a $4,000 tax return when you file your taxes the next year, you would have to include a prorated $2,000 in anticipated tax refunds as a future asset on your bankruptcy schedules and petitions.


The good news for most debtors is that while you must include the tax return as income, there are provisions that allow you to exempt it. Bankruptcy law in Michigan enables you to choose between federal and state exemptions. Most people use the federal exemptions, which include a “wildcard” exemption allowing the debtor to protect a certain amount of miscellaneous property. If you have little home equity and few other assets to exempt, you will likely be able to exempt the entire amount of the refund. Therefore, the $2,000 anticipated tax refund from the example above could be included as a wildcard exemption, allowing the debtor to keep all or a substantial portion of the return once it is paid out.

In the event that you fail to tell your attorney or your attorney fails to list your tax return as a future asset, you will lose the sum and the trustee will take the amount and put it towards paying the sum owed to creditors. The law is unforgiving in this regard, and the IRS will likely seize the amount before it ever reaches your hands. As such, it is vital to ensure that you include the amount of the tax return and claim it as an exemption to avoid losing it.

Chapter 13

In Michigan, tax returns are treated differently under a Chapter 13 filing. In a Chapter 13 bankruptcy, the debtor is allowed to keep any tax refund that is issued by the state. Federal tax returns, on the other hand, must be turned over to the bankruptcy trustee. Federal returns are treated as property of the estate and will be used for payment to creditors throughout the duration of your repayment plan.

In the past, the bankruptcy trustee required the IRS to turn the tax refund directly over to the bankruptcy trustee. In a recent court opinion, a district judge ruled that the bankruptcy trustee could not obligate the IRS to issue the return directly to the trustee. As such, debtors in Chapter 13 bankruptcy proceedings must now sign a form authorizing the IRS to forward the refund to the trustee. The end result is the same, and the debtor is forced to forfeit any amount of federal tax return.

Showing of Need

A debtor in a Chapter 13 bankruptcy may still be eligible to keep all or a part of the federal tax return if he or she can show need. Need can be anything from buying new appliances to making necessary home repairs or car payments. The debtor must file a motion, which must be served on the bankruptcy trustee and all creditors, who are then allowed to raise objections.

To avoid the hassle and headache that goes along with proving need, and yet still be able to qualify to keep your tax return, a possible solution may be delaying the bankruptcy filing until you have received the refund and utilized the money in an appropriate manner, such as paying rent, making vehicle payments, buying groceries, or making housing repairs. There are limits on what you can spend the refund on in order to keep it from being included as property of the estate. As such, it is important to consult a qualified bankruptcy attorney.

Qualified Legal Representation

Every bankruptcy case is unique and requires a careful analysis and in depth understanding of the issues involved. The attorneys at Johnson & McLoyd, PLC have over 20 years of relevant consumer advocacy experience. If you want to protect your tax return in a Michigan bankruptcy proceeding, the qualified attorneys at Johnson & McLoyd, PLC can examine your case and suggest your best course of action. Call us today for a FREE consultation - (734) – 669 – 9080

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