As the economic effects of the Covid-19 pandemic continue to ripple across our economy, more and more consumers will face the prospect of a bankruptcy filing. While the long-awaited vaccine gives hope for many consumers, it also means that many lenders and creditors will resume their normal collection activity, including foreclosures, repossessions and garnishments. As the moratoriums and financial aid end, many households still have not have fully recovered from the financial impact of Covid 19. While some of these households may receive a significant income tax refund, it may not be enough to dig themselves out of their financial hole.  With decades of experience in bankruptcy, Leiden & Leiden offers the following suggestions for debtors facing bankruptcy and expecting an income tax refund.

Most of the time, an income tax refund can be protected from creditors in a bankruptcy case, provided that it is fully and accurately disclosed to the Bankruptcy Court.  Unfortunately, some bankruptcy filers are unaware of the protections accorded to them in bankruptcy, and wind up doing more harm than good in the way that they manage their refund. This applies whether the refund is received immediately prior to the bankruptcy filing or is expected to be received after the case is filed. Bankruptcy trustees are required to review income tax returns as part of their case examination and will inevitably inquire of the debtor as to how the refund was spent, or when it is expected to be received.  Hopefully these recommendations will prevent any problems for the debtor in bankruptcy, or their family members.

1)    Be candid with your bankruptcy attorney about the refund that you expect and provide previous returns so that your attorney can determine if the refund can be protected, or how much of the refund can be protected.

2)    Make sure that you are up to date in all of your state and federal income tax return filings! It is a requirement of the Bankruptcy Court that all outstanding returns must be timely filed. Notify your bankruptcy attorney if you are not up to date in your income tax filings.

3)    File accurate returns.  Because debtors will be questioned under oath about their income tax returns, it is essential that the returns be filed in a manner which will be consistent with the information disclosed in the bankruptcy petition. Both the Bankruptcy Court and taxing authorities will expect consistency between the returns that are filed, and the information disclosed in the bankruptcy petition. Marital status, the number of dependents, and any self-employment income will be scrutinized by the bankruptcy trustee.   Any false or misleading statements in the income tax returns may result in a referral by the trustee to the appropriate taxing authorities. Additionally, debtors may face the dismissal of their bankruptcy case if it can be proven that intentionally false statements were made in the filing of the returns.

4)    Do not repay any loans to friends or family members! An individual may have received loans from friends or family in the final months of the year, with the expectation that those loans would be paid off from their income tax refund. This type of debt repayment must be disclosed in the bankruptcy petition and could potentially subject the payment recipients to legal action from the bankruptcy trustee, seeking to recover the money.  Too often debtors make this mistake, when they could have simply held the refund and repaid loans as they saw fit after their case is concluded.
If you may not be able to exempt some or all of your income tax refund, you will need to discuss your options with your bankruptcy attorney. These options would include a delay in the filing of the case, as well as a plan for how the income tax refund can be spent in a good faith manner prior to filing. For instance, the refund could be used to catch up past-due payments on secured debts, such as car loans or home mortgages.  The refund could also be used to pay for insurance and utilities. The refund can also be used to pay the filing fees and attorney’s fees associated with the bankruptcy petition, as these payments will be disclosed to the Bankruptcy Court. If you expect an income tax refund of the next few months, and are also considering a bankruptcy case, insist on discussing your expectations for how that refund will be used with your bankruptcy attorney.