If you have started receiving calls from debt collectors, or letters from addresses like PO Box 1120 Charlotte NC, it may be time to start considering debt relief options. If you aren’t sure if bankruptcy is the right option for you, consider taking something like a “Should I File Bankruptcy Quiz” to help you understand if it’s the right option for your situation. If you decide that bankruptcy is right for you, there are some important tax considerations that you should keep in mind.
Although the tax season is stressful, it presents the light at the end of the tunnel for most taxpayers in the form of tax refunds. Most people depend on their annual tax refund. But suppose you are struggling with debts. Do you first file your returns or file for bankruptcy? Here is everything you should know about filing your taxes before bankruptcy relief.
Three Things to Know About Filing Taxes before Filing Bankruptcy
Chapter 7 offers you a chance to start fresh by discharging some debts. However, there are several things you need to consider before filing your case. First, you should consider your tax refund.
A tax refund is a common asset that gets seized under Chapter 7. After filing your Chapter 7 bankruptcy case, a trustee will be appointed to your case. The role of the trustee is to collect all your assets, liquidate them and ensure the assets are distributed to your creditors. The trustee acts on the internet of your unsecured creditors. Common examples of unsecured debts are;
- Credit Cards
- Personal loans without collateral
- Medical debts
- Overdue domestic support payments
- Student loans
- Past rent and lease payments
- Most taxes owed to the government
Since an unsecured creditor does not have collateral to provide security for their loans, you will need to offset these debts through bankruptcy. However, Chapter 7 does not discharge all unsecured loans. For example, student loans, child support, alimony, and taxes cannot be discharged. So, despite filing bankruptcy, you are legally obliged to pay these debts.
When the Chapter 7 trustee assigned to your case seizes your assets, he will use the amount to pay off your unsecured creditors. But before filing Chapter 7 bankruptcy, here is what you need to know about tax refunds.
Before we get started, it’s important to keep in mind that bankruptcy regulations vary from state to state. This means that filing for bankruptcy in Pennsylvania may look different than filing for bankruptcy in North Carolina.
The Court Considers Your Tax Refund Part of the Bankruptcy Estate
When you file Chapter 7 bankruptcy, the assets and property you have interests in will become part of your bankruptcy estate. Bankruptcy estate refers to all assets and interests of a debtor who files bankruptcy. It includes all property you have an interest in, even if they are under someone else’s ownership. Thus, intangible assets like stock also fall under bankruptcy estate.
Chapter 7 focuses on liquidation. So, your trustee can liquidate assets in your bankruptcy estate to generate money to pay unsecured creditors. Fortunately, there is a way you can protect some amounts of equity in some of your assets.
In most cases, bankruptcy exemptions protect tax refunds or at least a part of them. However, the exemptions depend on your state. For example, under South Carolina State, you need to adhere to the South Carolina bankruptcy exemptions, which exempt $5,900 cash per debtor. Or an exemption of $6,100 for wildcard exemptions.
These exemptions help protect your tax refunds. Therefore, even if your account balances and assets are less than the debts you owe, your tax refunds remain protected. Thus, the trustee cannot use our tax refunds to pay off creditors.
NOTE: Bankruptcy exemptions vary according to state. Therefore, you need to check for the exemptions in your state. You can compare between federal and state bankruptcy exemptions if you can use either to determine which will help you best.
You Can Keep the Money by Spending Your Tax Refund
Another way you can protect your tax refunds from being used to repay your debt is by spending the refunds before filing for bankruptcy. However, you will need to wait to file your taxes, get your refund and spend the money before filing bankruptcy relief.
While you can spend your tax refund on anything, you need to be more careful about how you spend it. It is better if you spend it catering for household expenses like;
- Rent or mortgage payments
- Food and basic clothing
- Utilities and car payments
- Medical and dental expense
- Repairs and maintenance for cars or homes
- Education expenses and Insurance payments
NOTE: We recommend spending the money on household expenses since if you use your tax refund to repay your friends or relatives, they could get sued to return the money after filing bankruptcy. So, avoid using your tax refund to make repayments if you intend to file for bankruptcy. The aim is to maximize the tax refund money before filing your Chapter 7 bankruptcy petition.
What If I Have Not Filed My Tax Returns for Years?
Before filing a bankruptcy relief, you need to file all your returns. The court will ask you to submit a copy of your recently filed return before your first meeting of creditors. Failing to file your tax returns could lead to the court dismissing your case.
While some states don’t make it mandatory to file reruns, a Chapter 7 trustee might take a keen interest in your lack of filing returns. So, even if you are not working with a bankruptcy lawyer, it is essential to seek legal advice about filing your taxes.
How Are Tax Refunds Handled Under Chapter 13 Bankruptcy Case?
The main difference between Chapter 7 and Chapter 13 bankruptcy is Chapter 7 focuses on liquidation while Chapter 13 focuses on a workable repayment plan. Tax refunds under Chapter 13 are more difficult to file, and thus, it is always best to consult a Chapter 13 bankruptcy lawyer.
Usually, large tax refunds increase your payment. But in some cases, you might need to submit your tax refunds every year to keep your monthly payments from increasing. A Chapter 13 attorney can analyze your situation and take you through the best option depending on your financial situation.
Take Away: You Might Need to Wait to File Chapter 7 if You Expect a Large Tax Refund
If you expect a large tax refund, it might be prudent to wait to receive it before filing Chapter 7. But if your creditors are taking extreme measures to collect their money and you cannot wait to get your tax refund, consult a chapter 7 bankruptcy lawyer. Call us today to schedule your consultation with one of our bankruptcy lawyers to determine the best way forward.