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Am I Required to Turn over My Tax Refund in a Chapter 13 Bankruptcy Case?

This is a complicated question and the answer depends on your specific Chapter 13 Bankruptcy plan.  In general, if your Chapter 13 plan provides for 100% payment to all creditors, you will be able to keep your tax refund. However, if the plan does not provide for 100% payment to all creditors, including general unsecured creditors (such as credit cards), then you must remit any tax refunds received during the life of your plan to the Chapter 13 trustee, in addition to your regular monthly plan payment to be included in the distribution to creditors. Here’s why:

When filing a Chapter 13 case, a debtor is agreeing to pay all projected disposable income into the Chapter 13 payment plan. Tax refunds are considered additional disposable income that the debtor has over-withheld. Therefore, it is required to be paid into the Chapter 13 plan. If you find yourself in this situation, there will be clear and explicit language in your plan about this, which will also indicate that you are also responsible to provide a copy of your tax return to the trustee at the same time that you file your taxes.

If you expect a large tax refund next year and are considering filing Chapter 13 Bankruptcy in 2011, you may want to delay the filing of your petition until you receive the refund and spend it down in an appropriate manner. Generally, using your refund to pay any reasonable and necessary expenses is acceptable. The types of payments that are consistent with filing for bankruptcy in good faith are paying your rent or mortgage, buying food, making a car payment, or even paying your attorney fees for the Bankruptcy. You cannot use it to pay existing debts to friends or relatives, give the money away, or buy unnecessary luxury goods.

TAX TIP: When filling out your IRS W-9 tax form for your employer, the higher the number of exemptions that you provide, the less the withholding will be, and the smaller the tax refund. In sub-100% Chapter 13 plans, you will want to have as small a refund as possible, because any refund that you do end up receiving just goes to your creditors, and will not benefit you in any way.

Please note that this posting concerns the treatment of tax refunds received after the filing of a Chapter 13 petition.  The receipt of a tax refund prior to your filing may still have an impact on your Chapter 13 means test calculation. Also, the treatment of tax refunds differs in a Chapter 7 Bankruptcy case. Both of these topics will be discussed in future posts.

If you are considering filing Chapter 13 Bankruptcy and have further questions about the effect (if any) on your tax refund, contact me!  I offer a free consultation for all new clients to discuss your individual financial situation. The value of the consultation could be priceless. You have nothing to lose.