Tax refunds and Chapter 7.
On the day that you file, all of your property, including unpaid tax refunds, will fall under the control of the Chapter 7 trustee. The trustee has temporary control of this property and will look for any nonexempt property that he or she can take for the benefit of creditors.
Assets like cash, balances in bank accounts, stocks and of course tax refunds, are nonexempt assets under Utah law and can be taken by the trustee. There are certain exceptions to this rule, but generally, you should plan to work closely with your attorney to learn how to protect these assets before you file.
As you work throughout the year, you become the owner of your pending tax refund. For example, on July 1, 2012, you are the owner of 1/2 of the tax refund you plan to receive in early 2013. Therefore, if you file your Chapter 7 bankruptcy on July 1, the trustee will have the right to demand that you pay to him or her 1/2 of your refund when you receive it the following year.
Timing is everything.
Our experience shows that during the latter part of the year, trustees become interested in the following year’s tax refunds. For example, if your hearing (which takes place approximately 5 weeks after you file) is set after August 1, you can expect the trustee to ask you to plan on turning over next year’s tax refund when you get it the following year.
However, you are only expected to turn over the prorated share of the refund that you had earned up the date that you file. Again, to illustrate this point, if you file on October 1, you will have worked 3/4 of the year. At your hearing in early November the trustee will ask you to turn over 3/4 of your tax refund when you receive it. Some trustees will lead you to believe they are entitled to the entire refund, which is not accurate.
If you file after the new year begins and before you get the refund, the trustee will ask for the entire refund. For many clients who file in January or February, they must file to stop a foreclosure, garnishment or repossession that will take place before they get the refund. These clients will plan to forfeit their refund.
Ideally, you will be able to postpone your filing until after you receive the refund and spend it appropriately. Generally, if the money is spent to fund your bankruptcy case, purchase exempt property, pay your rent or mortgage or used for living expenses, the trustee will not ask for the money. You will need specific guidance from your attorney before you spend cash that you have in your possession before you file a bankruptcy case. If you file your case in late Winter or the Spring, the trustee will routinely ask you how you spent any refund that you had received and you may be required to produce receipts to prove it was spent appropriately.
Finally, it is important to remember the purpose of a Chapter 7 is to make any nonexempt assets available to the trustee so he can give something to your creditors. Often, clients will plan to let go of certain assets or some cash knowing it is a small price to pay for a complete discharge of their debt.