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How Does Bankruptcy Affect Tax Return

File Bankruptcy Tax Free

How filing bankruptcy could affect your tax return and refund. Attorney Robert Geller.

For the average individual consumer, filing bankruptcy and discharging debts has no tax consequences.

In contrast, if your debts are forgiven or settled outside of bankruptcy, the forgiven amount may be added to your income and subject to tax.

Thats called cancellation of debt income.

Debt forgiven in bankruptcy, however, doesnt trigger cancellation of debt income.

The tax free feature of bankruptcy is one very compelling reason why bankruptcy may be a better choice than debt settlement.

It is also a reason to file bankruptcy when facing a foreclosure even if you intend to let the house go. A foreclosure may generate taxable income measured by the difference between the value of the property and the amount owed on the mortgage.

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Turnover Of Tax Refund

Finally, if youâve already filed for bankruptcy and your tax refund is not exempt, make sure not to spend the refund check. That will get you into trouble. Instead, you must contact your trustee asking how to turn over the funds from your non-exempt refund. If you fail to turn over your non-exempt tax refund, your bankruptcy discharge can be denied or even revoked.

Let’s Summarize…

When youâre filing for bankruptcy, itâs important to pay attention to your tax refund so you donât lose it. Hopefully, your refund can be protected by an exemption. But if not,the best solution is to spend your refund on essential expenses before filing so it doesnât need to be protected in your bankruptcy.

Year That Bankruptcy Is Filed

Any refunds for the year in which bankruptcy is filed are sent to your trustee from CRA.

There are two tax returns for this time period: a PRE-bankruptcy and a POST-bankruptcy tax return.

  • The pre-bankruptcy tax return dates from January 1st to the date that you file bankruptcy. If there is a tax debt for this period it becomes part of your bankruptcy. If there is a refund, it is sent to the trustee.
  • The post-bankruptcy tax return begins from the date of bankruptcy to December 31st of that year. If there is an amount owing for this post period, it will need to be paid by you because it is a new debt after bankruptcy was filed. If there is a refund, it will be sent to the trustee.
  • Pre and post returns are filed by your bankruptcy trustee.

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Chapter 13 Bankruptcy Will Allow You To Retain Your Tax Return

Much like a chapter 7 bankruptcy a chapter 13 may also allow most filers to keep tax returns. If the tax return is due to be paid, the filing of a chapter 13 will protect those funds from being garnished. The protection is provided by 11 U.S.C. § 362. The automatic stay continues during the term of the bankruptcy, typically 3 to 5 years depending of factors.

Also much like a chapter 7 if a creditor has taken the tax return it can be recovered and returned to you so long as it was taken within 90 days and the amount more than $600. The key much like a chapter 7 is to ensure that the funds are not taken. The best thing to do is to seriously consider bankruptcy when debt repayment is not possible or if creditors have taken judgment.

Once in a chapter 13 plan you are allowed to keep tax returns so long as the combined federal and Minnesota refunds are less than $2000.00 for a married filer and $1200.00 for a non-married filer. After filing for chapter 13 protection the filer must ensure that wage withholding is correct and that not too much and not too little refund is received. Essentially we want to ensure that the trustee is not owed a portion of the refund and that the IRS is also not owed.

Bankruptcy is a powerful tool to ensure assets are protected, including tax refunds. Contact Bolinske Law today to discuss your situation for free.


Possible Ways To Keep A Tax Refund In Chapter 13

How Does Bankruptcy Affect Taxes Owed

Determining what to do with your tax refund is mainly discretionary, so your trustee might allow you to keep the tax refund. An unforeseen event or need that has affected your ability to pay living expenses might sway the trustee. For instance, it’s common for a debtor to need car repairs or a new vehicle at some point during the plan.

Even so, in most cases, the trustee will require you to contribute your tax refund as part of your Chapter 13 plan. As a practical matter, one of the only available preventive options in Chapter 13 is to adjust your employment tax withholding to decrease your tax refund. The smaller your refund, the less the trustee can take. But it’s best to do this before filing for Chapter 13. You wouldn’t want it to later appear as an attempt to hide bankruptcy income owed to your creditors.

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Can I Keep My Tax Refund

It depends on your circumstances. You must inform your trustee when you receive your tax refund. You also need to provide a copy of your ATO Notice of Assessment. Its important to not spend your tax refund until your trustee makes an assessment and informs you if they have a claim in the refund. Your trustee calculates the following and notifies you of the outcome:

  • Refunds for income you earn before you enter bankruptcy are assets your trustee can claim.
  • Refunds for income you earn after you enter bankruptcy form part of your assessable income for compulsory payments. If your assessable income exceeds a set amount you may need to make compulsory payments. For more information about compulsory payments during bankruptcy see Income and employment.

You still need to lodge your tax returns as your obligations to the ATO remain during bankruptcy.

You Can Wipe Out Or Discharge Tax Debt By Filing Chapter 7 Bankruptcy Only If All Of The Following Conditions Are Met:

  • The debt is federal or state income tax debt. Other taxes, such as fraud penalties or payroll taxes, cannot be eliminated through bankruptcy. In other words, the debt needs to be a regular tax payment that you owed either the State of Wisconsin or the federal government.
  • You did not willfully evade paying your taxes or file a fraudulent return. Bankruptcy will not help in these circumstances. Your actions need to have been lawful.
  • Your tax debt is at least three years old. The original tax return must have been due at least three years prior in order to effectively file for bankruptcy. So if you were to file for bankruptcy in April 2020, for instance, this would apply to your 2017 taxes that were due April 15, 2018.
  • You filed a tax return at least two years before filing for bankruptcy. To eliminate a tax debt, a return for that debt must have been filed. Generally, if your extensions expired and you filed late, you have not filed a true return and will not be able to eliminate the tax debt.
  • The tax debt must have been assessed by the IRS 240 or more days before you file for bankruptcy, or must not have been assessed yet. This is called the 240 day rule. If the IRS suspended collection efforts due to a compromise or previous filing, this deadline may be extended.

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File Irs Form 982 After Bankruptcy Discharge

The correct way to ensure that you do not have to pay taxes on any debt forgiven in bankruptcy, and properly allocate any tax attributes, is to file IRS Form 982 for the tax year in which you received your bankruptcy discharge. See IRS Publication 4681 for detailed information explaining all the above. Many people and even accountants are unaware of this form and the importance of filing it. Be proactive and mention it to your accountant before filing your returns .

Are The Bankruptcy Tax Rules The Same For Chapter 7

Will Bankruptcy Affect a Tax Refund?

Under Chapter 7 bankruptcy, individuals liquidate and sell off all of their assets. Because they have no foreseeable means of paying off their debt, they use Chapter 7 bankruptcy to get themselves as debt-free as possible. Yet they still have to file taxes, too.

If someone under Chapter 7 receives income tax refunds, he or she may be able to keep the full refund. As with Chapter 13, the key is to work with a trustworthy, knowledgeable bankruptcy attorney and bankruptcy trustee to discuss all tax-related issues before filing under Chapter 13 or 7.

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How Your Creditors Are Paid

The official receiver will take control of your assets unless an insolvency practitioner is appointed. An insolvency practitioner is usually an accountant or solicitor.

The person who takes control of your assets is known as the trustee. The law says you must cooperate fully with them.

The trustee will sell your assets and tell the creditors how the money will be shared. Creditors must then make a formal claim. You cannot make payments directly.

If you have assets, money from the sale of these will be used to pay the costs of the bankruptcy process before creditors are paid. If your case is administered by the official receiver the following fees will all be deducted from the money realised:

  • an administration fee of £1,990 if you applied for your own bankruptcy or £2,775 if someone else applied
  • a general fee of £6,000
  • 15% of the total value of assets realised
  • a fee charged at an hourly rate where money is paid to creditors

If there are insufficient assets in your case the official receiver will still process your bankruptcy.

Next, money will be used for:

  • certain debts in relation to employees, if you had any
  • your other creditors
  • interest on all debts

Any money left over will be returned to you. If everyone is paid in full you can apply to have your bankruptcy cancelled .

When The Bankruptcy Order Is Made

The early stages of a bankruptcy are normally handled by an official receiver. An official receiver works for the Insolvency Service and is attached to the court. They will also be your trustee unless an insolvency practitioner is appointed to take over that role. The trustee will realise any assets .

The official receiver will write to you within 2 weeks of the bankruptcy order being made, explaining what you need to know and what you must do.

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Middle Tennessees Top Bankruptcy Attorneys

Its critical that you speak with an attorney before spending or transferring any portion of your bankruptcy tax return. Oftentimes, the simplest solution is to hang onto it until after you file for bankruptcy. A trusted attorney can help you understand all of your options and help you avoid any pitfalls in the process.

Flexer Law has been serving the legal needs of Middle Tennessee residents since 1981. Our experienced bankruptcy attorneys will work diligently on your behalf to provide the best financial outcome for you.

We have three office locations throughout Middle Tennessee to accommodate your legal needs. Contact us to schedule a consultation, and well find the best solution to get your financial life back on track.

Can My Creditors Still Repossess My Assets

How does bankruptcy affect your tax return?

Secured creditors retain their rights under their contract, even after Bankruptcy or Proposal completion. If you fail to meet the contractual obligations, the creditor can repossess the collateral . In some provinces, the secured creditors can still collect from you for the deficiency, even after repossession. Ask your Trustee if this applies to you.

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I Intend To File For Bankruptcy Sometime Later This Year

As in the first example, any refund amount would be deemed as part of your estate under this scenario. However, you can avoid losing the money by, instead, adjusting the amount of money deducted from your paycheck for income taxes so that youll only be covering the actual tax youll eventually owe. This way youll increase the amount of money you have to spend each paycheck.

Chapter 7 Bankruptcy And Your Tax Refundwhen A Person Files For Chapter 7 Bankruptcy Generally A Tax Refund Becomes Part Of The Persons Bankruptcy Estate Along With All The Persons Assets It Is Highly Likely You Will Be Questioned About Your Tax Refund By The Trustee During Your Creditors Meeting The Tax Refund Can Be Used To Pay Unsecured Creditors

Because you can keep any assets you receive after filing bankruptcy, a tax refund can be complicated. Often times, people apply for a tax refund before filing for bankruptcy but do not receive it until after they have filed the bankruptcy petition. The trustee will determine how to treat the tax return depending on when the income was earned that determined the tax refund.

Tax YearTax Refund

IF the tax refund was or should have been received the year before bankruptcyIf the tax refund was not spent, it will be considered part of the bankruptcy estate, like other cash held by the debtor. The trustee typically will consider this tax refund the debtors money, because it is normally viewed as money unnecessarily paid to the federal or state government. This means it is treated just like other cash or money kept in the debtors bank account and used to pay unsecured creditors.

IF the tax refund was or should have been received the year of bankruptcyThe tax refund is prorated based on money earned before and after filing for bankruptcy. This means that the part of the refund attributed to income earned before the bankruptcy filing date will be considered as part of the bankruptcy estate. In other words, it will be considered as funds the trustee can use to pay unsecured creditors, just like cash or money in a bank account. However, the part of the refund attributed to income earned after the bankruptcy filing date can be kept by the debtor .

Approved expenses include:

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Some Good News About Bankruptcy

The IRS considers many types of canceled debt to be taxable income. For example, if you get a credit card issuer to agree to cancel $5,000 of your credit card debt, you might have to count that amount as taxable income when you file your federal income tax return.

However, debt canceled in Chapter 11 bankruptcy is not considered taxable income.

That means if you owed taxes and got them canceled as part of a bankruptcy proceeding, you will not have to report that amount or any of your other debt forgiven by the bankruptcy as taxable income on a future tax return. But you may have to file a form with the IRS to verify that the debt was discharged through bankruptcy and therefore isnt taxable income.

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Planning For Chapter 7

How Does Bankruptcy Affect My Liability to the IRS?

Here are some ways to increase your chances of keeping your tax refund in Chapter 7 bankruptcy.

If you file during tax season. Individuals who file bankruptcy during tax season often have to figure out what to do with the tax refund they have just received. You can use any available tax refund or wildcard exemption to protect it. But if your state doesn’t offer these exemptions, or you want to save your wildcard for other assets, consider these strategies:

  • If possible, file for bankruptcy after receiving and spending your tax refund. If you choose to do this, be sure to use your refund on necessities and not to purchase new assets.
  • Use your tax refund to pay your bankruptcy attorney for the fees and costs of your case.

These strategies have been found to pass muster in most bankruptcy cases because you’re allowed to use your assets to pay expected living expenses. Neither option involves an attempt to avoid paying a creditor, which is considered fraudulent in bankruptcy.

Adjust withholdings. If you expect a significant return because of amounts deducted from your paycheck, the fix is to adjust your tax withholding early in the year. Keep in mind that this tip won’t be as helpful if you change your withholding later in the year such as from October through December.

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How Does Filing For Chapter 7 Bankruptcy Affect My Tax Return

Aside from the questionIf I file for Chapter 7 bankruptcy, and then win a lottery, can I keep the money?the second most asked question is: Can I keep my tax refund under the same circumstance? Its a good and valid, question and one that depends upon certain conditions pertaining to the timing of the actual filing of bankruptcy.

Surprisingly, it is both permissible and legal to factor the question of the status of your tax refund into consideration when filing for bankruptcy. Well go over the various conditions related to timing, however, it might be a good idea to first gain an understanding of how the Chapter 7 bankruptcy process works.

Your Responsibilities When A Bankruptcy Order Is Made

You must:

  • give the official receiver information on your finances
  • give the official receiver a full list of your assets
  • tell your trustee about any rise in income during your bankruptcy
  • tell anyone who offers to loan you over £500 that youre bankrupt
  • go to court to explain why you owe money if asked to do so

There are also things you cannot do while bankrupt. These are called restrictions.

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Closing Of Your Bankruptcy


When you receive a discharge from the court or your bankruptcy case is closed:

  • Youll receive post-bankruptcy letter with your remaining tax debt. Pay in full or contact us to set up a payment plan.
  • Well start collection action
  • You are still required to continue to file and pay your taxes


When youre closing your bankruptcy:


The court appointed third party must:

  • File a final tax return
  • Pay the minimum tax for the following tax year, if applicable
  • Close the bankruptcy within that same year
Reorganization plan

Once the plan is confirmed, you must follow the terms of the plan and continue to file and pay your taxes.

Liquidation plan

Once the plan is confirmed, you must follow the terms of the plan. Continue to file and pay your taxes. File a final tax return and close the bankruptcy within the same year.


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