Bankruptcy and Tax Refunds

Tax refunds are treated differently depending on whether a debtor files bankruptcy under Chapter 7 or Chapter 13 of the Bankruptcy Code. In Chapter 7 bankruptcy tax refunds owed to the debtor are considered an asset of the bankruptcy estate. This means that if a debtor files bankruptcy before they receive their tax refund, once they get it they will have to turn it over to the Trustee.

In Chapter 13 bankruptcy tax refunds are treated differently depending on the district in which the case is filed. For example, in the Northern District of Texas the trustee will allow the debtor to keep the first $2000 of their tax refund. Any amount over $2000 must be turned over to the trustee. In the Eastern District of Texas if a debtor gets a tax refund for less than $2000 then they can keep the refund. However, if the refund is more than $2000 then the entire refund must be turned over to the trustee.

Tax refunds that are seized by trustees are paid to the creditors in the case. In Chapter 7 bankruptcy the trustee pays the proceeds to the unsecured creditors. In Chapter 13 bankruptcy the trustee increases the amount available to the unsecured creditors by the amount of the tax refund. This means that applying the tax refund to the Chapter 13 plan does not result in the debtor getting out of bankruptcy early. It simply increases the amount available to be paid into the plan. The exception to this rule is when the debtor’s plan provides payment to all allowed claims. In this case seizure of the tax refund by the trustee should result in the debtor finishing their Chapter 13 bankruptcy plan early.