Tax Refunds at Risk in Bankruptcy Case!


This time of year we meet with many people who are exploring bankruptcy options but have questions about how the bankruptcy laws may affect their right to income tax refunds owed to them but not yet received. These laws vary by state and since we practice exclusively in Oregon these comments pertain to the laws that apply to residents of Oregon who are considering a bankruptcy filing in this state. Like anything, the devil is in the details and exceptions exist but for the vast majority of people these general guidelines that follow can apply.

First off, if you receive your tax refunds and spend them on ordinary and necessary living expenses, then you have nothing to worry about in bankruptcy. When a bankruptcy is filed a Trustee is appointed to administer the case and the Trustee’s power differs based on what type of bankruptcy is filed.

In a Chapter 13 case (which is a 3 to 5 year repayment bankruptcy), the Trustee cannot take away your tax refunds. The amount of those refunds may impact your case and oftentimes we will strategize to limit that impact. But at least you can consider Chapter 13 as a solution and be confident that any refunds owed to you can be retained and used to meet your living expenses.

By far the majority of bankruptcy cases filed are Chapter 7 cases. Chapter 7 is a process that takes about 3 months in which the Trustee legally steps into your shoes and owns the right to receive tax refunds owed to you — the Trustee controls the purse strings not you. However, tax refunds, like many other assets, can be shielded from the control of the Trustee using exemption laws. In Oregon, residents can elect to use either the state exemption laws or the federal exemption laws.

The state exemption laws allow you to shield 100% of any federal earned income tax credit received but only allow you to shield $400 of any other tax refund. If you, like many people, rely upon a tax refund to pay occasional bills or annual costs like property taxes, then the state exemption laws may not give much protection.

Curiously, there is no federal exemption law that specifically allows you to shield the federal earned income tax credit. But there is a federal “wildcard” exemption that can be used to shield up to $12,725 of ANY property including tax refunds. However, if you own a home or condo which has equity then this large wildcard exemption may be much more limited in scope.

If you have more questions, give either of us below at 503-786-3800 or send me an email and we can discuss further.

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