Will I Lose My Tax Refund If I File Bankruptcy?

Inquiring minds want to know if they can keep that long anticipated tax refund if they file bankruptcy before they receive it. Sometimes a refund can be several thousand dollars that a family has been counting on getting to cover needed expenses like health care or car repairs or non-dischargeable student loan debt. A client should know whether they will keep or lose their refund prior to filing a bankruptcy. So, let’s talk about the odds.

First, when you file a bankruptcy case you should know that everything you own is property of the bankruptcy estate that the trustee can use to pay your creditors. Even if you file in the middle of the year and are not yet owed a tax refund, a bankruptcy trustee can claim a percentage of the refund you receive the next year for the tax year in which you file. As an example, if you file bankruptcy in September and then file your tax return the following April, claiming a refund of $5,000, the trustee could claim 75% of the refund (9 months out of 12).

Second, you can increase your odds of keeping more of your refund in some circumstances. Federal and State laws provide many exemptions to individuals who file bankruptcy. An exemption is a law that lets you keep all or a portion of some property you own rather than allowing the trustee to use it or sell it.  In Oregon, if you’ve lived here for at least two years, you have a choice of exemptions. You can choose the exemptions under federal law or the exemptions under state law. If you have lived here less than two years, you should consult with a professional to determine which exemptions apply to your case. At Basham Law Firm, we can help you determine which exemptions you can and should use to protect your assets from sale.

Third, assuming you are a current resident of Oregon and have been living here continuously for the last two years, you could use Oregon’s “wild card” exemption under ORS 18.345(1)(o) or the federal “wild card” exemption under 11 USC § 522(d)(5). The federal exemption can be far more generous than Oregon’s exemption, so it’s important to understand the differences.  Oregon allows a debtor a $400 wild card exemption.  It’s called a wild card exemption because (like the card game) you can use it on any property you want, except that you can’t use it to increase an already enumerated exemption, like a car exemption.  If you and your spouse file a bankruptcy together, you both can claim Oregon’s wild card exemption, for a total of $800 that you could apply to a tax refund.  Not great, but it’s better than nothing.  Under the federal wild card exemption, you can use up to $11,500 of any unused homestead exemption plus $1,225 for a total of $12,725. Those figures double if you and your spouse file a bankruptcy together.  Of course, if you use all of your federal homestead exemption on your home, then you would only have the $1,225 wild card exemption ($2,450 in a joint case). Still, that’s better than the Oregon wild card exemption.  Applying the federal wild card exemption to your tax return could end up allowing you to keep all or most of your refund.

Fourth, if some or all of your tax refund is from earned income credit, you are entitled to exempt that amount if you use Oregon’s exemptions under ORS 18.345(1)(n) even if the Oregon wild card exemption is not enough to exempt the rest of the refund.  There is no specific federal exemption for earned income credit.  As a result, if you use the federal exemptions, you will have to use the federal wild card exemption to keep as much of the refund, including the earned income credit, as possible.

Finally, if it turns out that you can’t take full advantage of the exemption laws, you may need to wait to file your bankruptcy, receive your tax refund first, and spend the refund on necessary items before filing the bankruptcy.

Filing bankruptcy is an important step that should not be taken lightly without consulting a professional with knowledge of the exemption laws that apply. Call Basham Law Firm today to schedule a free strategy meeting at (541) 385-0914.