If filing for bankruptcy, tax returns and refunds may be affected in terms of when the return must be filed and the amount that the individual can receive for the year and in years to come, depending on the type of bankruptcy that is filed. Individuals considering filing for bankruptcy may discuss planning and the consequences of filing with a Dallas bankruptcy lawyer.
Current Returns Must Be Filed First
Many individuals hope to file for bankruptcy first, then reap the benefits of a hefty tax refund after bankruptcy, but this is not possible. In order to file for bankruptcy in the first place, the law requires individuals to have already filed their current tax returns. So for example, an individual filing for bankruptcy in summer 2013 would need to have already filed 2012 tax returns.
Those filing for bankruptcy must file tax returns for the current year so the Internal Revenue Service (IRS) can assess any back taxes owed and collect them first. What’s more, the return is used to gauge the individual’s financial situation, and creditors have a right to such information as well.
Individuals who have not filed their current tax returns before submitting a bankruptcy petition can expect to have the request denied.
How Bankruptcy Affects Current Tax Returns
When an individual files for bankruptcy, he or she will be assigned a trustee to handle the case. Upon approval of the bankruptcy petition, the trustee will contact the IRS and notify the agency of the case. Then, any refunds due on the individual’s current tax returns will be seized and applied to the estate to pay off back taxes, creditors and other debts.
If an individual already received a tax refund for the current year before filing for bankruptcy, this could pose a problem for a petition depending on how the money is spent. Tax refunds spent on superfluous items or extravagant purchases could lead to a denial of the individual’s bankruptcy petition.
Individuals considering bankruptcy should use tax refunds to pay bills, debt payments and other necessities to avoid petition rejection. Extravagant spending could be a sign of fraud; creditors and a bankruptcy trustee will ask why the refund money was not spent to pay debts.
Bankruptcy and Future Tax Returns
Whether future returns and refunds are affected depends on the type of bankruptcy filed. If an individual filed for Chapter 13 bankruptcy, the repayment plan may demand that for the first few years following the filing all or a portion of the tax refunds after bankruptcy be turned over and used to pay off debts.
With Chapter 7 bankruptcy, however, only tax refunds for income earned before filing are affected. The time at which the individual files for bankruptcy could result in a portion or all the refunds being seized. If, for example, the individual files for bankruptcy halfway through the year, the trustee can seize just half of that year’s tax refund, and the rest will go to the individual. If the individual files after the first quarter, a quarter of the refund may be seized and the rest refunded to the individual. All future refunds go directly to the individual, as with any other return.
According to data from the United States Courts, there were more than 1.2 million bankruptcy filings in the U.S. in 2012. More than 48,000 of those were in Texas alone. A Dallas bankruptcy lawyer can assist those wishing to file for bankruptcy and can offer guidance regarding tax refunds after bankruptcy and the relationship between bankruptcy and tax returns in the current year.