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The Issues to Consider in Determining If a Tax Refund is Protected in Bankruptcy

Posted on Monday (January 25, 2010) at 8:30 am to Bankruptcy Tips Consumers Should Know
Chapter 7 Bankruptcy
Tax and Bankruptcy Issues

 tax refunds and bankruptcy on longislandbankruptcyblog.com
Written by Craig D. Robins, Esq.
This post is part of a series of articles this week addressing every aspect you will need to know about bankruptcy and tax refunds. 
The Issues to Consider in Determining If a Tax Refund is Protected in Bankruptcy Are:
    1.    Are you filing for Chapter 7 or Chapter 13?
    2.    Are you filing on your own or with your spouse?
    3.    Did you file your bankruptcy before December 31, or will you be filing in the new year?
    4.    Did you already get your tax refund?
    5.    Do you own a home that you are also trying to protect in the bankruptcy?
    6.    Do you have other liquid assets such as cash and money in the bank?
Tax Refunds in Chapter 7 Cases
Most of this blog post addresses tax refunds that you may receive if you are filing for Chapter 7 Bankruptcy.  I will address tax refunds in Chapter 13 cases later in the week.
Do You Have a House?
New York has an unusual exemption scheme as it applies to protecting homes and protecting liquid assets.  The way the law works, you can’t protect both.  You have to choose:  either protect the house with the New York homestead exemption  or protect your liquid assets with the various liquid assets exemptions.
If you have a lot of equity in your home, then you will certainly want to use the New York homestead exemption.   If you do, then you cannot use the liquid assets exemption, which means that you can’t protect the tax refund.
The New York Liquid Assets Exemption
In New York, each individual consumer who files for bankruptcy relief can protect certain assets:  Bankruptcy Exemptions in New York .  Each debtor can protect up to $2,500 of liquid assets.  This includes:
        —    Cash
        —    Money in the Bank
        —    Entitlement to Tax Refunds
        —    U.S. Savings Bonds
Thus, if you have a total of $500 in the bank and in cash at the time you file your bankruptcy petition, you can protect the first $2,000 of a tax refund.  That means that in close cases you have to look at the value of your liquid assets on the very day you file your petition. 
Sometimes a trustee will require that you provide copies of bank account statements that indicate what your balance was on the date your petition was filed.
The $2,500 liquid assets exemption is per person and can be doubled if you are filing with a spouse, for a total of $5,000.
There is no distinction between Federal refunds and state refunds.
What Happens to a Joint Tax Refund If You File Bankruptcy Without Your Spouse?
In the State of New York, each spouse is entitled to one-half of the tax refund for bankruptcy purposes.  Last year I wrote a detailed review of the law about this.  See Who Owns the Tax Refund in a Bankruptcy Case: Trustee or Spouse? Apportioning the Refund of a Non-filing Spouse .
Here’s how a refund is allocated between debtor and non-filing spouse:  Let’s suppose you file for bankruptcy and your spouse does not, and let’s assume that you can protect $2,000 of a tax refund because you have $500 in the bank (remember $2,500 is the total for liquid assets).  What happens if the joint tax refund is $7,000?
Since each spouse is entitled to one-half of the refund for bankruptcy purposes, then your share is one-half of 7,000, which is $3,500.  You can protect $2,000 of that, which means that you would have to turn over the unprotected part to the trustee, which is $1,500.
TIP:  This means that if you expect a large refund, you will want to have as little in your bank account as possible on the date of filing.
Quick Links to All Tax Week Blog Posts About Tax Refunds and Bankruptcy:
Informative Article About Eliminating Taxes in Bankruptcy:
Article About Tax Consequences and Bankruptcy:
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Craig D. Robins, Esq. is a Long Island bankruptcy lawyer, who is focused primarily on helping individuals and families, find solutions to their debt problems. Read more »


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