Fact: In Chapter 7, a tax refund is what we call a "contingent asset" which means that it is an asset that you are currently entitled to, but will not receive until some future date. Once a tax refund is received, it is converted to a cash asset. So you will want to list and exempt the next tax refund you expect to receive after the date your case is filed. In other words, if you file April 1, 2012, have received your 2011 tax refund 2 weeks earlier, you will want to estimate and list your expected 2012 refund (which you wouldn't get until early 2013). You also must list any tax refunds for prior years that you haven't received yet.
Most debtors can exempt their tax refund. Tax refunds might not be exempt if it is a large refund and the debtor already has a lot of other assets that are exhausting available exemptions.
In Wisconsin, the only exemption available for tax refunds is the federal wildcard exemption. Debtors who elect to use state exemptions for any reason (usually to protect equity in real estate in excess of $40k) cannot exempt their tax refund.
In Chapter 13, tax refunds are perceived as future disposable income. In the Eastern District of Wisconsin, the convention is that some debtors must pay in half of their refund, others may keep their refunds.
Above median debtors are entitled to keep their refunds because their tax deduction is computed on the line 30 of the Means Test based on actual tax liability. It is presumed that the debtor must adjust their tax withholdings to effectively make their tax refund zero in order to afford the plan payment as required under the Means Test.
Below median debtors never make it to line 30 of the Means Test, so their tax deduction is based on their budget schedules, which is based on tax withholdings. Since a person can over-withhold, the trustee gets half of the refund, if any.
Why only half? If the debtor gets to keep half, it provides more incentive for the debtor to maximize their refunds on their tax returns, so both the debtor and unsecured creditors get the biggest slice of the pie as possible.
Above median debtors can be required to submit 1/2 of their tax refunds, too. This happens anytime the tax liability on the Means Test is calculated by some other method than the standard formula, or if the debtor does a post-confirmation amendment of the plan (because post-confirmation amendments no longer rely on the Means Test, but on the budget).
An experienced bankruptcy attorney can look over the facts of your case and predict fairly accurately the fate of your tax refunds in both a Chapter 7 and Chapter 13 environment before you make any commitments. Want to find out what bankruptcy could mean for you? Call (920) 490-6160 now to schedule a free consultation.
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