2010/2011 Tax Return Refund - Law

I recently filed my 2010 tax return, and thought that a lot of people that are considering filing for bankruptcy may have questions about a potential refund on their own 2010 taxes. For many, this refund is a huge part of the beginning of the year. For some, it can be the difference between being able to survive the year (even after bankruptcy) and having to make even more drastic changes.

Lets look at one scenario. It is late January and an individual is considering bankruptcy. In the past three years the individuals tax refunds has averaged approximately $4,000 (for both state and federal). The individuals income level and family situation has remained consistent throughout the past three years (and the tax year in question). The individual estimates that a tax refund will equal the $4,000 level of the past three years. What happens if the individual files for Chapter 7 bankruptcy before filing a 2010 tax refund? Will that refund be confiscated by the trustee and distributed to creditors? Does the individual have to claim anything on the bankruptcy petition?

The first question we have to look at is whether a tax refund can be considered property of the estate. Only property of the estate is subject to turnover (delivery) to a bankruptcy trustee, and distribution to creditors.

Property of the estate is defined in the Bankruptcy Code as all legal and equitable interests of the debtor in property as of the commencement of the case. The courts have held that this definition is broad and consists of virtually all of a debtors property. The courts have also determined that a refund should be prorated to the percentage of the taxable year. For example, if a debtor filed a bankruptcy petition on October 1, then only nine months (3/4) of a refund would qualify as property of the estate.

The second question is what can be done to protect the refund should an individual file for bankruptcy. Once the debtors interests or assets become property of the estate, the debtor may claim certain exemptions protecting that property. One specific exemption that may apply in California is the wild card should a bankruptcy debtor choose the California (bankruptcy only) exemption statute. In this case, a debtor can exempt any property in the amount of $1,100 plus any portion or a residence or burial plot (around $20,000).

Thus, while in our situation (person filing for taxes in January 2011), the entire tax return for 2010 becomes property of the estate and subject to turnover to the trustee, it is possible, and potentially likely, that the property will remain with the individual through the use of statutory bankruptcy exemptions. Bankruptcy planning comes into play again and the use of exemptions determines what someone can keep and what they cannot.

There is one more piece of tax information that should be briefly touched on. Should an individual owe taxes from a previous period, it is possible that an individual may not be able to exempt a refund owed. This would be a topic of another discussion

OK, one more thing. Always file a return, even if you owe money. It starts the statute of limitations, and in many cases, your bankruptcy case will be dismissed if you have failed to file for the previous year.

For more questions, contact the Henshaw Law Office.

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