Tax Refunds After Filing Chapter 13 Bankruptcy

A Chapter 13 bankruptcy case lasts between three to five years. That is three to five New Years, three to five Fourth of July fireworks, and three to five Superbowls. It is also three to five Tax Days (usually April 15th). Tax Day is an important concern for anyone in Chapter 13 bankruptcy and is one of the biggest issues I must address with my clients.

During a Chapter 13 bankruptcy the debtor is required to commit all disposable monthly income to repay creditors. Basically, the bankruptcy debtor pays what he or she can afford to pay over the repayment plan period. However, the bankruptcy courts consider tax refunds to be disposable income. A debtor who receives a large tax refund is essentially telling the bankruptcy court that this money was not needed each month, since the debtor elected to allow the U.S. government to hold onto it during the tax year. Therefore, during your Chapter 13 case, your tax refunds will likely have to be turned over to the Chapter 13 Trustee.

In theory, avoiding this problem is a simple matter of adjusting your tax withholding. Instead of getting a huge income tax refund in April, you receive a small net increase in income each paycheck.

However, you must be careful. If you withhold too little, you could create a tax deficit and owe the IRS. Under the current version of the Bankruptcy Code, adding new tax debt could also create a situation where your bankruptcy case may be dismissed. At any rate, a sizeable tax debt you are unable to pay will cause serious complications for your case.

Tax refunds are another of the many reasons why retaining an experienced bankruptcy attorney is essential. If you are consulting with an attorney about filing Chapter 13 and he does not bring this issue up, leave. An experienced attorney will instruct you whether it is important to adjust your withholding, or to consult with a tax professional to project your tax liability. Ideally, your income tax return will show little or no return, or little or no tax debt.

Contact the experienced Chicago bankruptcy attorneys at Glanzer & Associates, P.C. at 1-312-644-2227 to discuss your specific situation, and to schedule your free, in-person consultation.