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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. 

     Persons expecting 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.







            The Law Office of DAVID W. REICHEL                    

            86 W. University Drive, Suite 101C                     

           Mesa, AZ  85201-5855                     



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