The topic of income tax refunds in bankruptcy has popped up on this blog in the past in the context of whether such a refund would put debtors over the median family income limit for the means test. With the New Year, though, as Americans calculate their incomes before the April 15th income tax deadline, some might be wondering whether a bankruptcy trustee would take their refunds and distribute them to their creditors. The answer depends on a few factors.
One, if the refund is trivial, then the trustee might not bother seizing it for the creditors.
Two, income tax refunds can be exempted in bankruptcy through a cash exemption. This is very important because while a yet unpaid refund won’t affect the debtor’s means test income, it is an asset that the trustee can expect the debtor to receive in the future. New Yorkers can choose between the state’s exemptions and those offered by the federal government.
When it comes to cash like an income tax refund, the state’s exemptions can be generous depending on the circumstances. New York debtors who do not take the homestead exemption can claim the lesser of $5,000 or $10,000 minus the aggregate of personal property exemptions (clothing, furniture, etc.) and a $1,000 wild-card exemption. New Yorkers who take the homestead exemption cannot claim a cash exemption.
The federal exemptions, which New Yorkers have only recently become eligible to use, are much more accommodating for income tax refunds. Debtors can exempt at least $1,225 in any property with the wild card exemption. What’s more, up to half of the $22,975 homestead exemption ($11,500 to be exact) can be applied to any property, even if debtors don’t have any home equity to exempt. With up to $12,725 available, most income tax refunds can be shielded from bankruptcy.
Three, as for over-withholding, a refund from payroll taxes are prorated over the course of the year until the bankruptcy filing, so a May filing will result in the over-withheld portion from January through April reverting to the bankruptcy estate.
Debtors are allowed to obtain their tax refunds early and spend them on necessary items and legal fees associated with their bankruptcies.
How to deal with an income tax refund is a small part of a bankruptcy that can go unnoticed by people who try to handle their own filings or hire an inexperienced New York bankruptcy lawyer.
For answers to more questions about tax refunds in bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced Brooklyn bankruptcy attorney Bruce Weiner for a free initial consultation.
