Filing for a chapter 13 bankruptcy is a big step. It could be a good opportunity to get your financial affairs in order, but it does come with some implications. If you are planning to file for bankruptcy, then it is natural for you to be concerned about the different ways in which the filing will affect your financial life moving forward. For many, one of the primary concerns is going to be the impact that the plan is going to have at tax time.
Chapter 13 and tax refunds
With a chapter 13 bankruptcy agreement, the idea is for the individual to pay all of their disposable income into settling their debts. In the plan, you determine your necessary monthly expenses, and the remaining income beyond that figure is considered your disposable income. All of that is supposed to go to the trustee for the management of your debt repayment.
If you receive a tax refund, then that is probably going to be considered disposable income and it will be taken by the trustee. The idea is that in the plan, you have already determined that you can pay your necessary expenses with your monthly income while also making the regular payments for the chapter 13.
For the most part, a person that is under the obligations of a chapter 13 will have their refund turned over for the use of the bankruptcy agreement. However, there are some exceptions where the individual might be able to keep the tax return.
Having a tax return excused
If you are in the middle of a chapter 13 bankruptcy, there is the possibility of having a tax return excused. If in a given year, the petitioner is expecting a tax return and they believe that they may need the money for something, then they could request a plan modification to let them keep the expected tax return. The important thing to understand is that the modification will only apply to the one tax return, and even if it is approved, tax returns in future years may still be forfeit.
The modification is subject to the approval of the court, and they are only likely to grant the approval under certain circumstances. Generally, the money must be for something that is necessary and unexpected. If the request is to catch up on a utility that you have fallen behind on, then approval is unlikely to be granted. As a part of the plan, you are supposed to be able to pay these expenses from your regular income. If you are falling behind on regular expenses, then it could indicate that the plan is not feasible.
A good example of a request that will be approved is for something like necessary medical expenses or the cost of a work vehicle that needs to be repaired. These are expenses that you have to pay, and they are of the nature that they arise unexpectedly. In other words, you could not have foreseen the expense and worked it into the chapter 13 plan.
Keeping your tax return as a part of the plan
For some people, it might be possible to include language into the chapter 13 bankruptcy that allows them to keep their tax returns. However, if the plan repays less than 100% of your debts, it is very unlikely that you will be able to keep your tax returns. That being said, if you can demonstrate that you have some need for the money every year and that the need is necessary, it is possible that an exception will be allowed.
To try claiming that your tax return is a part of the income that you necessarily need is a risky play and it is also unlikely to work. It is hard for a person to show that they are going to receive a refund of a certain amount every year, and the court is likely to be skeptical of the idea of a refund being a part of the person’s regular income. It could be seen as an indication that you are unable to meet your monthly expenses and therefore, unlikely to meet the obligations of the agreement.
For most people that file a chapter 13, the best thing to do is to just accept that you are not going to be getting tax returns until your obligations are fulfilled. If you need the money one year, then it might be possible to get an exception, but you only want to try if you really need the money. As a preventative measure, you could choose to reduce your tax withholding to make the refund smaller.