If you file for bankruptcy under Chapter 13, you may need to provide your tax refund to the bankruptcy trustee so that they can use it to pay your creditors. However, in some situations, you may be able to get your tax refund excused from being included in the repayment plan.
It is unlikely that a filer will be permitted to keep their tax refund during bankruptcy.
All of a debtor’s disposable income goes into the repayment plan during a Chapter 13 bankruptcy. A bankruptcy trustee likely will consider a tax refund to be disposable income because it was not included in the calculations of your necessary expenses. You can try to show the court that you were depending on the refund to make your repayment plan work. Usually, though, a debtor will not be able to include a specific provision in their plan that provides for keeping the refund. A debtor more commonly can argue that they need to keep the refund based on an increase in their necessary expenses, which the plan did not take into account.
Excusing Tax Refunds in the Initial Plan
You can try to draft an initial version of the plan that proposes excluding tax refunds from it. This may lead to objections from creditors and the bankruptcy trustee, who may view a refund as surplus cash. To increase your chance of getting this type of plan approved, you may want to ask for only a limited amount of the refund to be excused. Thus, if you receive a larger refund than expected, you will not go beyond the requirements of your plan and receive a windfall by shielding more funds from creditors.
You also may have a stronger chance of getting a plan that excuses a future refund approved if you can state a strong, specific reason for this provision. Sometimes a debtor may have a substantial annual expense for which they typically allocate a tax refund.
Needs and Limits
A filer may be able to keep their tax refund if they can show that they have a need for it, and the plan limits the amount that they may keep.
A court is usually reluctant to accept this type of plan because excluding a tax refund from a Chapter 13 repayment plan can create loopholes for a debtor. If they receive additional income, they might be able to include the income in the return and then receive a larger refund. A debtor who is expecting to receive a substantial tax refund also may have misstated the amount that they need to cover their necessary expenses, which may cause a court to look skeptically at that part of the plan.
Modifying a Repayment Plan to Excuse a Tax Refund
If you want to excuse a specific tax refund from your repayment plan, you will need to pursue a separate plan modification in that year. You will need to state the amount of the refund and explain that you need the money for something that is both necessary and unforeseeable. For example, you cannot excuse a refund to cover your ordinary ongoing expenses, such as groceries or utilities. On the other hand, you might be able to get a refund excused if your car breaks down and needs major repairs, or if someone in your family develops a health condition that results in additional medical expenses. You may want to record how you spent the money from the refund if the court gives you permission to keep it. This can help prevent future challenges to your plan.