When completing the petition for bankruptcy, questions tend to arise regarding tax refunds. First, any asset owned at the commencement of a bankruptcy case is property that needs to be protected. Withholdings from an employee's paycheck to pay future taxes are property. Rarely is a trustee going to seek to recover withholdings, but a trustee will commonly demand turnover of a tax refund if the bankruptcy attorney did not properly disclose and exempt it. If the tax refund is large and cannot be entirely exempted, then a chapter 13 bankruptcy may be a better option than a chapter 7. (Exemptions are provided under state law and the Bankruptcy Code to allow a debtor to exclude the value in certain types of property.)
Tax Witholdings and Disposable Income
The second concern relates to a bankruptcy debtor's disposable income. The term "disposable income" is a term of art that has a complex definition in the Bankruptcy Code, but simply stated, it is the money left over after paying all necessary expenses. Tax withholdings are one of those necessary expenses. If there is a large tax refund at the end of the year, than the debtor's net income is artificially low. If there is a significant amount of disposable income, than a person may not qualify for a chapter 7 bankruptcy or it could be found that the debtor did not file bankruptcy in good faith.
If you have any bankruptcy questions, don't hesitate to contact the attorneys at Scura.