Exempting tax refunds

It's a busy time of year for most bankruptcy attorneys. Especially in my region of the country where we aren't allowed to put our clients on a payment plan for the fees. Many will use their tax refunds to fund their bankruptcy case filing. But what about those who file bankruptcy but haven't received their tax refunds yet? Most folks are concerned whether or not the refund can be protected. The process by which assets are protected in bankruptcy is known as "exempting" it. Exemptions are the statutory rules of law that allow debtors to keep certain amounts and certain types of property. The answer to the question of "can I keep my refund?" is almost always yes with some certain exceptions.

To exempt an asset there has to be an exemption that covers it and the value of the property must not exceed the limitation of the exemptions. While there used to be unlimited exemptions for certain types of property they have, at least here in Minnesota, been declared unconstitutional by the courts for those exemptions found under the state statutes. Further, there are no exemptions available under the state statutes specifically for that kind of asset anyway. Not to worry though as we here in the great state of Minnesota have the option of using Federal exemptions found in the United States Bankruptcy Act which is under Title 11 of the United States Code. Under the federal exemptions there is a "wild card" exemption that can be applied to anticipated tax refunds (as well as other types of property where there is no specific exemption for that particular species of asset). It isn't unlimited but it is fairly generous and most folks will be able to protect the refund no problem.

Some debtors think that if they wait to file their tax returns that the refund does not factor into the bankruptcy case as an asset of the bankruptcy estate. Nothing could be further from the truth. It is an assets that while you may not have it in hand at the time your file your case you are entitled to once you file the appropriate return. Not filing the return does not extinguish your present day future possessory interest in the refund. So...when we file cases for our clients we get their best estimate from them so it can be fully disclosed on the schedules and properly exempted. If not, some trustees will take the position that the refund is property of the bankruptcy estate and theirs to administer for the benefit of creditors unless it is properly exempted. Therefore, it is always best to made an educated guess, disclose the asset and exempt it to the extent that there are exemptions available. In the odd case where all or part of the refunds may not be exempt the trustee is entitled to the refund (or that portion thereof that is not exempt) once the refunds have been received by the debtor. If the debtor fails to cooperate and turn over the funds the bankruptcy trustee would then bring a motion to require turnover of the funds. If the debtor still does not comply would then bring a motion to revoke the bankruptcy discharge. Neither is desirable, of course, and a revocation of discharge is a catastrophe. Debtors complaining that they received the money and spent it already is never a good defense in cases where the refunds were not exempt on the filing of the case. Remember..if you got the refunds prior to the case filing there is no problem although if it was a large refund the trustee may have questions regarding what you did with the refund which can open up a whole another can of worms if friends, family members were paid as preferred creditors soon before filing, etc. That though is another topic for another time.

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