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Filing bankruptcy? Who gets the tax refund?

If you are thinking about filing bankruptcy but are concerned about what might happen to a tax refund you are expecting, you are right to be concerned.  There are two sets of laws that apply to assets in bankruptcy, one for the state, and one for the federal.

“New York state does not protect tax returns, whereas the federal ‘wildcard’ exemption allows a person to protect certain assets that are not already protected under another exemption,” said Christopher J. Grover, attorney, Jeffrey Freedman Attorneys, PLLC.  “A tax refund is an asset that can be protected by the ‘wild card’ exemption.”

This “wildcard” exemption allows debtors to protect up to $12,725 ($1,225, plus up to $11,500 of unused federal residency exemption) in assets including tax returns, cash, bank account balances, and any other equity in property not covered by another exemption.

“The federal rules have a ‘homestead’ (residency) exemption allowing debtors to protect $22,975 per person of the equity they hold in a home they own,” Grover said. “Whereas, New York state allows the debtor to protect $82,775 per person in home equity.”  The federal exemptions allows you to “trade” any unused portion of the residency exemption up to  $11,500, and use it as “wild card protection.” 

The most important asset for most people is their house, which helps set the priorities in determining how to use allowable exemptions.  Debtors who have more equity in their home than the federal exemption allows them to protect can take the New York state exemption instead, so that the debtor is able to keep the equity he or she has built up in the home.

“If, however, a person doesn’t own a home or doesn’t have much equity in their home so that there is money left over in the residency exemption, then we use the federal exemptions to maximize  the ‘wildcard’ exemption to protect other assets — such as a tax refund,” Grover said.

Bankruptcy laws are not exactly simple and straightforward, so there are other ways to protect tax refunds in specific cases.  For example, if a person is behind on their mortgage or property taxes, they can hold off on filing until they get their tax refund, then use the money to pay mortgage or tax arrears.  This way, the homeowner gets caught up on their secured debts and the tax return gets spent down on such “allowable” expenses.

These small details can make a big difference in your financial status after filing bankruptcy, which is why it is critical to have a knowledgeable attorney help with your case.