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If I file bankruptcy, do I get to keep my tax refund?

Tax refunds in bankruptcyTax refunds and bankruptcy.  Is it safe?

Every year, around the time that tax refunds start coming in, there are a lot of unnecessary tears shed at bankruptcy hearings in Omaha and Council Bluffs.  Why?  Because there is a limit on what can be protected under the exemption laws of every state.  Nebraska and Iowa have different levels of protection.

Breaking it down.  All tax refunds are NOT the same

The traditional tax refund in bankruptcy

The phrase “tax refund” means different things to different people.  Traditionally, receiving a tax refund meant getting your own money back, that is, the money you paid in to the system.  For example, if you had federal and/or state income taxes withheld from your paycheck, then depending on your income bracket, you could get some or all of your own money back via a refund check.

Nebraska bankruptcy protection for tax refunds

This traditional type of tax refund is subject to dollar limitations in Nebraska.  Actually, there isn’t a specific tax refund exemption, but rather a wildcard exemption of $2,500 per person ($5,000 per couple) that can be utilized to protect a tax refund.  Essentially, you can use your wildcard exemption to protect whatever personal property that you have, including an anticipated tax refund.  Thus, if you are an individual filing bankruptcy (not a joint case), you can apply your wildcard exemption to protect up to $2,500 of a traditional tax refund.

Iowa tax refund exemption in bankruptcy

Iowa, on the other hand, does have a specific tax refund exemption.  However, the limit is $1,000 per person!  Anything about that will likely be taken by the bankruptcy Trustee!

EIC- Earned Income Credit is SAFE!

On a brighter note, both Nebraska and part of Iowa (only the Bankruptcy Court for the Southern District of Iowa….Council Bluffs is in the Southern District) completely exempt tax refunds that are the result of the earned income credit.  This is fantastic news for a lot of people.  So, if you have a very large tax refund, that portion of the refund that results from EIC is totally safe.  Additionally, if you have another exemption (like the Nebraska wildcard exemption), you can use this IN COMBINATION with the EIC exemption.  Therefore, in many cases, the total tax refund may be protected.

Other tax credits are NOT protected!

Only EIC is protected in full.  Other types of credits, such as the child tax credit, is not considered exempt.  In fact, almost all other tax credits from a variety of sources do not get any special treatment or protection from the bankruptcy trustee.  Therefore, it is important to carefully understand what is and what is not protected in a bankruptcy proceeding BEFORE filing a case.

Many people lose their tax refund in bankruptcy because of poor planning or bad advice.

Don’t let this happen to you!  Speak to a qualified bankruptcy attorney about this issue.  Ask him or her if you will lose your tax refund if you file bankruptcy.  Many times, just delaying the filing of a case until after you receive the refund is all that it takes.  Legitimate ways to spend your tax refund before filing bankruptcy include using it for food, necessary and reasonable transportation expenses and other important and necessary expenses.  BUT, this is a tricky and sensitive area.  Using a tax refund improperly can cause HUGE PROBLEMS.  Paying back relatives, for example, is a not permitted! For a more detailed explanation of Dos and Don’ts about tax refunds and bankruptcy, check out this recent article written by Erin M. McCartney, a senior associate attorney at John T. Turco & Associates.

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