Tax Refunds and Bankruptcy
This time of year
prompts a fair amount of questions concerning how a tax refund
will be treated by the Bankruptcy Court upon the filing of a
Chapter 7 bankruptcy Petition. Upon the filing of a bankruptcy
case an “estate” is created. The estate encompasses the
Petitioner’s liabilities and assets. In Arizona a tax refund is
treated as a non-exempt asset of the estate. Non-exempt means the
asset, in this case a tax refund, may be attached by the Court and
used to pay creditors.
Filing for bankruptcy
does not mean that from that point on any tax refund you were to
receive will be taken by the Bankruptcy Court. The Court is
entitled to prorate a portion of the tax refund based on the date
the bankruptcy petition is filed. Furthermore, any tax refund,
either within the Petitioner’s possession or “in the mail” when
the case is filed is the property of the bankruptcy estate and
must be surrendered to the Court. An example may be helpful in
explaining the tax refund issue.
Assume the following
facts: Mr. & Mrs. John Smith files for bankruptcy protection on
January 31, 2005. The day before, January 30, 2005, Mr. & Mrs.
John Smith filled out their 2004 tax forms and were delighted to
find out they were going to get a $2,000.00 refund. Their
accountant e-filed the returns that day and the Smiths left
his/her office cheerfully making plans for the refund money. How
will this fact pattern play out as to the $2,000.00 tax refund,
and the date the Smiths filed their bankruptcy case?
The Smiths filed
their bankruptcy Petition on January 31, 2005 thus the bankruptcy
estate has a claim against 1/12th of any refund the
Smiths would be entitled to for the 2005 tax year. As to the
$2,000.00 refund for 2004 taxes, this money asset, although not
yet received, is a non-exempt estate asset that must be
surrendered to the bankruptcy Court. In other words, the Smiths
will lose the refund.
significant tax refunds would be well served to speak to their
bankruptcy attorney before filing their bankruptcy
Petition. He or she will be able to advise you on how best to
proceed so as to protect your interests. Legal expertise in this
area is money well spent and is another reason to seek
professional assistance in this very complex area of the law.