A common question I get this time of year is whether the trustee will take the debtor’s tax refund if he files for bankruptcy.  The answer depends upon many factors.  Talk to your bankruptcy lawyer.  Don’t spend your tax refund until you know for sure your bankruptcy trustee does not claim it.  Spending a tax refund instead of paying it to the bankruptcy trustee can get you arrested.

The Trustee has a duty to administer non exempt assets if those assets are worthy of administration.  For a tax refund to be worthy of administration the refund must be large enough to justify the time and effort to take and distribute the money to unsecured creditors.

If you can wait to file bankruptcy, then often the simplest solution to the problem is to your return,  then receive and use the refund.  We do need to help you spend the refund in ways that will not jeopardize your bankruptcy case.  One huge no-no is paying back relatives with your refund.  You will get your relatives sued by the bankruptcy trustee, which is worse than not paying them back at all. You may use your refunds to pay for your bankruptcy and will be expected to do so.

However, waiting to file bankruptcy is not always possible.  If you are having your wages garnished or a garnishment is scheduled to begin, it may be necessary to file before a refund can be received.   Timing issues will also occur if a house is in foreclosure, or a car is about to be repossessed.

If you cannot wait for whatever reason, the following factors will determine whether the refund will be taken:

• As previously discussed, is the amount of the refund worthy of administration?   This is an issue of local practice and will often vary from court to court and trustee to trustee.
• Is any portion of the refund for Earned Income Credit?  Some states have specifically exempted Earned Income Credit.  It is necessary to check state law on this issue.  In Kansas, there is no exemption for Earned Income Credit so you lose it along with your tax refunds.
• Does your State have a “Wild Card” or “Cash” exemption?  Some states allow a certain amount of cash to be treated as exempt from creditors, other states have what is refereed to as a wild card exemption that will allow a debtor to exempt an item that is otherwise not exempt.  Kansas has no such exemptions.

As can be seen the timing of a bankruptcy when a tax refund is expected depends on many factors.  Local practice and state law being the major considerations.

Consult us.  As your attorney, we will help you maximize the amount of tax refunds you can lawfully keep and minimize the amount you lose to the bankruptcy trustee.

Hat tip to my blogging colleague, Kevin Gipson of New Orleans, who wrote the original version of this post in Bankruptcy Law Network.