Many people are entitled receive tax refunds each year for overpayments to the IRS and Minnesota State Department of Revenue from taxes withheld from their paychecks. Sometimes, these refunds can be quite substantial. A debtor’s right to receive a future tax refund is considered property of the “bankruptcy estate.” In a chapter 7 bankruptcy case, property of the bankruptcy estate is all of the debtor’s money and property that is subject to being taken by the bankruptcy trustee to pay the debtor’s creditors. In many cases, most, if not all, the debtor’s money and property is “exempt,” or legally protected from being taken to pay their creditors.
In a chapter 7, the trustee’s job is to determine which property is non-exempt (not legally protected) and take it to pay creditors. Alternatively, in a chapter 13 bankruptcy case, the debtor keeps their property but must pay to their unsecured creditors at least as much as those creditors would’ve received if the debtor had hypothetically filed a chapter 7 case (the value of the nonexempt property).
Whether a debtor’s expected tax refund is exempt depends largely upon which laws they use to exempt their property. Debtors who file for bankruptcy in Minnesota have the option of using the exemptions (laws that protect the debtor’s property) provided under the Federal Bankruptcy Code, or alternatively, any other applicable State statute or Federal non-bankruptcy law to protect their property. Choosing which exemptions to use in order to protect as much of the debtor’s property as possible can be complicated and it is best to consult an experienced bankruptcy attorney when making such a decision.
The Federal Bankruptcy Code specifically protects certain categories of property, such as the debtor’s primary residential home, a modestly-valued vehicle, basic household furniture, clothing and retirement accounts, all of which are considered essential to meet the debtor’s basic needs. Additional property of the debtor that is not considered essential for the debtor’s basic needs include additional cars, snowmobiles, ATVs, excess cash in the bank, and tax refunds. There is no specific exemption specifically protecting these types of non-essential property under the Federal Bankruptcy Code. Therefore, in order for the debtor to protect their future tax refund under the Bankruptcy Code they must use a special “wildcard” exemption. This exemption can be up to $13,900, and can be used to exempt any of the debtor’s property that is not specifically protected by another exemption. The amount of wildcard exemption amount available depends upon the amount of equity in the debtor’s homestead property (real estate on which they actually reside). Calculating the precise amount of wildcard exemption amount that is available is a bit complicated, but essentially, the less equity in the debtor’s home, the greater the amount of wildcard amount that is available to protect the debtor’s otherwise non-exempt property. Debtors who don’t own real estate or have no equity in their property will have the full wild card amount available to them. In many cases, even if the debtor has a little equity in property, they will still have a sufficient amount of the wildcard exemption available to protect most, if not all, of their otherwise non-exempt property, including their anticipated tax refunds. Under the Bankruptcy Code, even debtors with a good amount of equity in their homestead property, still have, at minimum, $1,325 of wildcard exemption value to protect non-exempt property.
If the debtor files for bankruptcy and uses State and other applicable Federal non-bankruptcy exemptions to protect their property, this wildcard exemption is not available. Just like under the Federal Bankruptcy Code, there is no other Minnesota State or Federal law that specifically exempts a debtor’s right to receive future tax refunds. In many of these cases, the debtor’s expected tax refund is mostly, if not completely, non-exempt and unprotected. However, State law provides an exception to this rule for portions of the tax refund that are attributable to need-based public assistance. Therefore, the portion of a debtor’s refund that is attributable to any Federal or State Earned Income Tax Credit, Federal Additional Child Tax Credit, and Minnesota K-12 tax credit, for example are exempt and protected. However, the courts have ruled that property tax refunds are not exempt. Whether the bankruptcy court will rule that any particular portion of a tax refund is exempt under Minnesota State law depends upon whether the debtor can prove that the refunded amount is based on the debtor’s actual financial need.
But, regardless of how much of the tax refund can be exempted under State and Federal Law, how much of the tax return is actually property of the estate to begin with? The answer is that it depends upon when the debtor files their bankruptcy case. Any anticipated tax refund due to the debtor from any tax years preceding the year the debtor files their case are fully property of the bankruptcy estate. The anticipated tax refund for the tax year in which the debtor files their bankruptcy case (which they will actually receive the year after they file) is “prorated” to the date that the debtor files their case. This means that the portion of tax refund that the debtor has earned up until the date of filing is property of the estate, while the portion of the tax refund they earn after the filing date is not. Anticipated taxes for tax years after the year in which the debtor files their case are not property of the bankruptcy estate. For example, let’s say a debtor files their bankruptcy case on June 1st, 2020. If they are still awaiting receipt of tax refund for the tax year of 2019 (the tax returns were filed in April of 2020), the entire amount of the refund for that year is property of the bankruptcy estate. When the debtor files their 2020 tax returns in 2021, only half of the 2020 tax refund will be property of the bankruptcy estate. This is because they filed their case exactly halfway through the year of 2020, so only the portion of the refund they receive is property of the bankruptcy estate. The debtor’s 2021 tax refunds, and refunds for subsequent years, will not be property of the bankruptcy estate.
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This is a general overview of how future expected tax returns are treated in bankruptcy case. A person considering filing for bankruptcy should consult an experienced bankruptcy attorney before filing their bankruptcy case, to get more specific advice and information on how their property, including any future tax refunds, will be treated in bankruptcy and to ensure that as much of their property is protected, as possible. See us at LifeBackLaw.com!
