The answer to this question is that it depends. It will depend on several factors, including what chapter of bankruptcy you file, how large your refund is, and the timing of your bankruptcy filing.
For those who are filing a Chapter 7 bankruptcy it can actually be a little easier for you to keep your tax refund than in Chapter 13. The reason being is that you can exempt, or protect that refund just like any other asset. The refund is considered an asset just like your house, your furniture, or money in the bank. And because when you file Chapter 7 bankruptcy you are saying to the Bankruptcy Court that you cannot repay your creditors back, anything which is not exempted becomes property of the estate and distributed to creditors. The bad news is that in Alabama you are only allowed to exempt $3,000 of personal property. The good news is that most people are able to exempt all of their personal property under the law. A tax refund however, especially a large one which you are still owed, is going to be very difficult to protect entirely from the Trustee.
For those who are instead looking to file a Chapter 13, things work a little bit differently. Instead of the Trustee who oversees your case looking to directly take your tax refund if he can do so, he is looking to make sure that you pay that refund each year into your case to your creditors. So while you will receive your refund from the IRS, this amount is already going to be factored into your income and forms the basis as to what you monthly payment is going to be. An altogether separate issue is whether your tax refund may be intercepted by a governmental creditor such as for taxes owed to the IRS or for student loans or child support owed.
There are several ways that you can act to protect the most you possibly can of your tax refund. First, if you are looking to file a Chapter 7 bankruptcy make sure that you are wise in the timing of filing your case (especially around tax season). If it is the end of the year through the beginning of the year, make sure that your attorney exempts as much of that refund as possible. If you can wait until after tax season, you can spend the refund that you have already received on living expenses. That way there is no refund for the trustee to take. You must be very careful in how you spend your refund however, and can create a large amount of trouble for yourself if done improperly. Please speak with a competent bankruptcy attorney before doing so.
Second, you can adjust your withholdings out of your paycheck each month so that the government doesn’t take so much to begin with. This way you will not receive as large of a refund and you can better protect what you do receive. This is particularly useful to do if contemplating filing a Chapter 13 bankruptcy.
This entry is the second in my 2014 tax season series on all things taxes. Check back soon for part three.