If you have declared Chapter 7 bankruptcy, that tax refund may not be yours. The fate of your tax return actually depends on when you file for bankruptcy and when you receive your refund.
The most important thing to remember is that the Bankruptcy Code considers your tax refund to be part of your bankruptcy estate -- that is, it is an asset, and your Chapter 7 petition liquidates your assets to pay off your creditors. The refund differs from other assets obtained or earned after you have filed: You can hold on to other assets; they are yours. Tax refunds, however, may be closely related to activity that occurred before the bankruptcy was filed, and that will put the money back into the estate.
Generally, the Chapter 7 trustee has three courses of action, all dependent on which tax year you are looking at. Say you file your petition this week, the first week of April 2015. If you have received or will receive a refund for your 2014 taxes, the trustee will include it in the estate. It makes sense if you think about that refund as being money that the government held onto for you during 2014 -- a savings account of sorts, just like the savings and checking accounts initially included in your list of assets.
Your refund for 2015 will work differently. The trustee will add the portion of the refund based on income earned prior to your bankruptcy filing, the first week of April. From that date on, the refund is yours. That includes refunds for every year going forward.
Using the same example, you may not have to give up your 2014 refund. If you spend it, neither the cash nor the purchases are included in the bankruptcy estate. One caveat, though: Spend the money on necessities, like a mortgage or utilities bills, food and clothing, medical bills, etc.
What happens if you spend it on something else? We'll cover that in our next post.
Source: Nolo.com, "A Tax Refund Is Part of Your Bankruptcy Estate," accessed April 3, 2015