Bankruptcy and Tax Refund? How to Save Money

It comes every tax season; you probably anticipate a big tax refund check. This refund is like a reward that you can use in different ways.

However, if you’re facing serious financial difficulties and don’t have great accounting in place, filing for bankruptcy may be a viable option.

Did you know that tax refund is the most valuable asset that trustees can take from you?

Exemption Laws never protect tax refund during bankruptcy. Trustees will chase after your tax refund because that cash can be used to pay creditors with minimal effort.

They no longer need to list your property for sale and distribute the sales proceeds to your creditors. This is the primary reason a trustee will first try to find out if you have a tax refund.

The tax refund is part of the bankruptcy estate

Once you file a bankruptcy, all the assets that you own will become part of the bankruptcy estate. The tax refund is part of those assets.

A bankruptcy trustee is designated to represent your creditors, collect, and liquidate your assets to repay your creditors. In most chapter 7 bankruptcy cases, there are less cash or assets to pay your creditors.

However, if you already owe a huge tax refund amount, it will become an easy target for whoever is appointed as a trustee But, with little planning and understanding a few tips, you can succeed in keeping most, if not all, of the tax refund amount.

Exception to that general rule: Earned income credit

Did you know that you can benefit from a few exceptions to the rule that a trustee is entitled to all tax refunds not spend or received before bankruptcy filing?

For instance, in Colorado, any tax refund associated with additional child tax credit and earned income credit is untouchable. The rest of the tax refund is subject to turnover.

You intend to keep your refund? Spend it

The perfect way of ensuring that you don’t lose your tax refund is by filing tax refund at the right time.

Once you receive your tax refund, spend all of it before you file for bankruptcy. Your attorney will advise you to keep a good record of how your tax refund was spent.

You can use this amount to meet a variety of expenses. These include most of your usual household expenses such as;

  • Mortgage payments
  • Food
  • Rent
  • Utilities
  • HOA dues
  • Medical and dental expenses
  • Car loan repayment
  • Educational expenses
  • Insurance
  • Clothing
  • Car repairs and maintenance

It’s wise to have minimal or no tax refund money in your bank accounts on the day you intend to file for bankruptcy.

Besides, you might be eligible to save a certain fraction of your tax refund amount using your retirement account. However, you need guidance from a qualified tax or bankruptcy attorney.

Avoid spending your tax refund money on luxury goods, pay off a credit card debt, repay a family member or a friend, or any other unsecured debt.

This might trigger an objection from the trustee. If the objection is accepted, you will be required to turn over your tax refund regardless of whether you spend the entire amount or not.

In case you don’t receive your tax refund early enough, the trustee will be entitled to the entire tax refund amount when you get it.

When you receive the tax refund while in bankruptcy…

You’re likely to have very little tax refund amount remaining by the time you file for bankruptcy.

Remember, tax refunds that you receive for wages earned before filing for bankruptcy are treated as part of the bankruptcy estate. These refunds are subject to liquidation if there are no exemptions.

Fortunately, it’s the attorney’s responsibility to sit down with you before filing for bankruptcy, discuss all the available assets, and create a plan that can maximize the exemption laws to your benefit.

Experts like Ric Dean, CEO at Caffeinated, assert that you should consult professionals and make well-calculated moves to avoid costly mistakes during the bankruptcy.

For instance, you can use the IRS’ withholding calculator to know the amount of deductions you should claim.

Note that if you opt to file for bankruptcy between August and December, the trustee will definitely request a copy of the previous year tax refund as soon as you file your tax returns.

If he realizes that you will receive a tax refund, he or she will request for a certain portion of the refund to repay your creditors.

To avoid this tax refund loss, it’s wise to file for bankruptcy by making all the necessary adjustments on your payroll. This will allow you to keep money in every paycheck and avoid handing over the entire tax refund amount to the trustee.

Haven’t you received your tax refund? Don’t worry

If you had a huge tax amount the previous year, it’s advisable to look for your W-4 and make the right exemptions adjustment.

This will ensure that only the necessary taxes are withheld from your pay. Since filing for bankruptcy before you receive your tax refund means you don’t want it, it’s wise to keep the amount of tax refund minimal.

Instead of transferring all your tax refund amount to the trustee, wouldn’t you desire to have a little money coming to your paycheck monthly?

It’s a wise idea, isn’t it?

Consult your lawyer and find a legal way of achieving this objective.

Hire a lawyer to avoid mistakes

During bankruptcy, asset exemption and protection are complex subjects. A simple mistake can result in loss of your entire tax refund amount.

As said earlier, every step you make before or after filing for bankruptcy will impact the possibility of retaining your tax refund.

Why not hire a professional who can offer the right guidance on what should be done?


Bankruptcy isn’t an easy road to freedom from financial challenges. However, with the right guidance, you can have minimal tax refund before you file for bankruptcy. You can also wait until you receive the refund. Otherwise, a larger portion of your tax refund will be used to repay your creditors.