What Happens To Tax Refunds In Chapter 7 Bankruptcy?

The really good news: Tax refunds are not income for purposes of a Colorado Bankruptcy. In determining whether you qualify for a chapter 7 bankruptcy, a tax refund is not calculated as part of your income. Also, in chapter 7 bankruptcy, generally only one year worth of a tax refund is ever exposed to the bankruptcy.

The not-so good news: Colorado has no asset exemption to cover non-retirement cash assets. An asset exemption allows you to protect equity in things that you own; for example, Colorado’s homestead exemption is $60,000 ($90,000 for elderly and disabled) (CRS 38-41-201). What that means is neither the bankruptcy trustee nor unsecured creditors can force you to sell your home to get at that home equity so long as the equity is less than $60,000. A tax refund is a non-exempt cash asset. Thus, if you are due a tax refund and file chapter 7 bankruptcy, the chapter 7 trustee will demand that you turnover the tax refund, or intercept it.

Frequently asked question: What if I wait to file my tax return until after I file my chapter 7 bankruptcy, can I get my refund then? Answer: It won’t matter; you incrementally earn your refund over the course of the previous year; on December 31, the U.S. government owes you money. Your claim for the refund exists even if you haven’t filed your tax return. That tax refund claim becomes part of your chapter 7 bankruptcy.

The good news: You can protect your tax refund! If you can wait to file bankruptcy until after you receive the refund, that opens up some options for you to spend it and receive the benefit of the refund. However, there are acceptable and unacceptable ways to spend a tax refund prior to filing bankruptcy; you should hire an experienced bankruptcy attorney to help you navigate the shores of dealing with non-exempt assets. If you spend your tax refund in an unacceptble manner, the trustee can require you to pay him that amount; if you are unable to pay the trustee or otherwise resolve the dispute, your chapter 7 case can be dismissed.