Like many other things in life, the timing of when you pull the trigger to file a bankruptcy case can make a huge impact in the outcome. Below I discuss the issue of a pre-petition asset vs. a post-petition asset as it relates to your income tax refund. The conclusion here is that you should generally file a case early in the year if you get a large income tax refund.
The Income Tax Refund
When you file a bankruptcy case you are required to report all your assets in your bankruptcy schedules. One asset that most people don’t think about is their income tax refund. When you file the case determines what portion of an income tax refund is an asset of the debtor. You simply take how many days you are in through the year (when filing the case) and divide by the total number of days. The percentage is what is considered pre-petition of the debtor and therefore an asset of the debtor. The remainder is considered post-petition and is not an asset of the debtor. This is best illustrated by an example. Let’s say a debtor typically gets a $5,000 tax refund. The debtor knows he is going to file a case. Let’s look at what happens if he files November 14th, 2020 vs. March 14th, 2020.
March 14th, 2020 — is the 73rd day of the year. Therefore, on March 14th we are 20% through the year. At that time, $1,000 would be an asset of the debtor ($5000 times 20%) and $4000 would be post-petition.
Nov 14th, 2020 — is the 318th day of the year. Therefore, on Nov 14th we are 87% through the year. At that time, $4350 would be an asset of the debtor ($5,000 times 87%) and $650 would be post-petition.
This issue above closely relates to exemptions which you can read more about here and here. If the debtor in the above example owned his own home, then he would be forced to take the Texas exemptions. Because of that, the tax refund would be non-exempt property. Here is how the Chapter 7 trustee would have treated both of these scenarios.
March 14th, 2020 — $1000 is non exempt property but it is not enough on it’s own to open up an bankruptcy estate and administer money to creditors. He would simply abandon the $1000 back to you an issue a report of no distribution to the Court.
Nov 14th, 20202— the $4350 is enough money to open up a bankruptcy estate. The trustee would ask for a copy of your return when yo do your tax return the next year. He would intercept the refund money to distribute to your creditors and then give you a check for your portion of the refund.
Filing the case to soon
The above example illustrates another point. You can also file the case to soon. The above example illustrates the point for the 2020 tax refund. However, what about the 2019 refund? The IRS generally doesn’t allow you to start filing your taxes until late January. In addition, employers aren’t required to send out their income forms (W2s and 1099s) until January 31. Thus, the debtor needs to also make sure they get their refund for the 2019 year and spend the money. They also need to make sure they spend it correctly (not paying back family members, friends, other creditors, etc). This is where working with an experienced Bankruptcy attorney really becomes helpful.
What about not getting a tax refund
Future wages are considered exempt property vs. the tax refund. Another option is adjust your with holdings with your employer to make sure that you do not get a tax refund (or at least a very large one).
We look at two years of tax returns for every case that our firm files. We ask that you bring those into your consultation if possible. Your Initial Consultation 2019 We can check your income tax refund and see if it will be in an issue in your case. From there, we can properly advise you on the timing of your bankruptcy filing to make sure you get the benefit of your income tax refund.
The Bottom Line: If you get a tax refund every year then it is better to file the case earlier in the year so you get the benefit of that money.
Written by William Collins Attorney at Law Partner, Collins & Arnove