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Protecting tax returns during bankruptcy

On Behalf of | May 25, 2023 | Bankruptcy

Most California residents eagerly anticipate receiving a tax refund. Nonetheless, issues may arise when an individual is required to file for Chapter 7 or Chapter 13 bankruptcy. The outcome primarily hinges on the measures taken before bankruptcy to safeguard their refunds.

Tax refunds during bankruptcy

In both Chapter 7 and Chapter 13 bankruptcies, the courts consider tax refunds as assets, regardless of whether they have already been received or are anticipated later in the year. During the bankruptcy proceedings, the trustee will inquire about the anticipation of receiving a tax refund.

Similar to other assets, the protection of a tax refund during bankruptcy depends on whether it qualifies for a bankruptcy exemption. Generally, safeguarding a tax refund is not always straightforward. However, if you meet the criteria for the wildcard exemption, you may be able to protect specific property. The wildcard exemption in California is a combination of several sections of the California Civil Code, namely 703.140(b)(1) and (b)(5). Currently, the wildcard exemption amount is $30,825, but this figure is adjusted annually.

Protect your tax return

Some individuals file for bankruptcy after receiving and utilizing their tax refund. They may use the refund for essential expenses such as mortgage payments, living costs and food. Others use the tax refund to cover bankruptcy fees and hire a bankruptcy attorney. Some individuals defer a portion of their salary into an employer 401(k) or IRA. However, it’s important to note that if a person waits until their tax refund is deposited into their bank account, making a retirement contribution won’t have the same impact, as the money deposited by the IRS is considered an asset.

Going through the bankruptcy process poses several financial challenges. Fortunately, with careful planning and consideration, there are steps that individuals can take to retain some of their assets.