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When Should I File My Tax Return if I Plan to File Bankruptcy and Anticipate a Tax Refund?

Debtors often ask their bankruptcy counsel about tax returns and whether they can keep refunds. It is not a far stretch to envision that a family or individual who has been fighting financial battles may be behind on filing tax returns. This could be the case whether a debtor receives a refund or has to make a payment to the Internal Revenue Service (IRS).

Bankruptcy Filing Eligibility Requires All Prior Taxes to Be Filed

Bankruptcy is a reality check to tax evaders, avoiders, and/or procrastinators. During or as a result of initial consultation with bankruptcy counsel, prospective debtor candidates learn all past tax returns must be filed to be eligible to file bankruptcy. No filed tax returns means no eligibility to file bankruptcy. It's that simple. Debtors must be current in meeting all filing obligations to federal and state taxing authorities, even if they are not caught up in making all of their payments for tax debts. This rule applies for income taxes, personal property taxes, real property taxes, and all forms of taxes.

How Should a Prospective Bankruptcy Debtor Time Filing Tax Returns With Bankruptcy?

The question becomes one of timing. When should debtors file tax returns for the most advantageous outcome if they are on the eve of filing bankruptcy and anticipate a refund? It goes without saying that debtors would like to keep refunds for themselves, particularly if refunds may be sizeable and outside the reach of creditors, the trustee, and bankruptcy court.

The prudent course of practice for a bankruptcy debtor is, if possible, to file taxes as far in advance of the bankruptcy filing as possible. The goal is to obtain any tax refund well in advance of bankruptcy petition filing. If debtor receives the tax refund and spends it on household expenses, car repairs, clothes for children, medical expenses, or the like, the debtor will obviously retain the spent refund. You cannot forfeit what is spent. This is true regardless of the amount.

What Are the Options for a Debtor if a Refund is Due After Bankruptcy Is Filed?

What happens if a debtor receives a tax refund after filing bankruptcy? The refund is subject to state or federal exemption limits. Depending on whether the debtor elects to use federal exemption amounts or the state's exemption schedules, the tax refund may be totally retained by the debtor and completely outside the scope and grasp of the bankruptcy and creditors, or it could be within partial or total reach of creditors if exemptions are otherwise exhausted by the debtor's other claimed property.

The more realistic scenario is that part of the tax refund would be exempted, and part would be lost to creditors because the exemption amount is exceeded by the size of the refund. In such a case, the more prudent thing to do is to file a tax return quickly to obtain the fastest possible refund. The debtor can apply part or all of the refund to the next year's tax liability to avoid forfeiture to creditors. If a prospective debtor candidate is contemplating filing bankruptcy at the end of the year, it is prudent to file taxes prior to December because of intervening holidays, office closures, and the large amount of filers who begin income tax filing then. If a debtor intends to file bankruptcy in January and files income taxes then, he or she may have to wait a considerable time before obtaining the refund.