The prospect of a tax refund makes most of us light up even when we haven’t even calculated what the refund might be.
But if you’re thinking of filing bankruptcy before you actually see Uncle Sam’s check, take a minute to plan.
Your right to that refund is property of your bankruptcy estate even if you haven’t filed the return.
The right to a refund exists as of the end of the tax year.
And unless you have an exemption available to protect the refund, you could end up having to sign the check over to a Chapter 7 trustee.
California’s bankruptcy exemptions can protect $28,000 in any kind of property.
I’m seldom an advocate for spending, but here I go: collect the refund and spend it before you file.
Tax refund is just money
Once you receive your refund and deposit it, it no longer has any special character in bankruptcy. It’s just cash.
Cash that you can use for living expenses, cash to pay for the bankruptcy case, or best yet, cash to contribute to an IRA for your old age.
Here’s a longer list of ways to repurpose cash that can’t be exempted.
Offset
A tax refund in the offing isn’t a problem if you owe money to the taxing authority. The law of offset allows the IRS to apply any money that it owes to you (your refund) to the amount that you owe the IRS.
When you get a discharge of taxes that you owe the IRS, the IRS will be barred from taking your future refunds on account of the prebankruptcy taxes discharged in your case.
Revisit your withholding
While a check from Uncle Sam is always welcome, remember that the refund is just the return of an interest free loan you’ve made the government for the last year.
You’ve paid in more than you owed.
Make that money work for you by reducing your withholding and diverting that money monthly to a savings account for emergencies or a nest egg for your old age.
Let Uncle Sam borrow money elsewhere.
