It’s tax season again, and in the bankruptcy world that means only one thing–people are loosing their tax refunds to Chapter 7 Trustees again.   The sad part is that this should almost never happen.  This is the result of sloppy legal work.  Yet, year after year I witness helpless debtors lose their tax refunds because their bankruptcy attorney failed to take the time to properly list the refund on the bankruptcy schedules and to determine if the refund was exempt or not. 

The problem with filing bankruptcy cases in the months of November to April is that the tax returns are often not filed, and the bankruptcy attorney must estimate the amount of the refund.  Tax refunds can change from year to year due to a change in income or the number of dependents claimed or other factors such as early retirement withdrawals.  The best indicator of the amount of the refund is found by examining the prior year’s tax return.  Is the income the same?  Are the number of dependents the same?  Is the filing status the same?  Does a divorce decree provide for claiming a dependent in alternating years?  Was there a business loss to offset wage income?  Clearly, there are many factors that can change the amount of a refund from year to year. 

In Nebraska, two exemption laws protect tax refunds.  The “Wildcard” exemption of Neb. Rev. Stat. 25-1552 protects up to $2,500 ($5,000 for married debtors) of any personal property, including tax refunds.  The other exemption statute is found at 25-1553 which protects federal and state Earned Income Credit refunds. 

The problem is that the wildcard exemption of 25-1552 is also used to protect bank accounts, guns, vehicles, and other personal property.  Bankruptcy attorneys frequently forget to schedule the tax refunds when they file cases in November and December, and they use up the wildcard exemption on other assets.  So, what is the first question a Chapter 7 Trustee asks when the debtor finally appears for their court appearance in January?  You guessed it, “What is the amount you expect to receive for your tax refund?”

Chapter 7 Trustee’s are paid on a commission basis.  That means that they are paid to take unprotected property away from a debtor so that something can be paid to the creditors.

The best practice is to prepare all tax returns prior to filing the bankruptcy so that the amounts of the tax refunds can be determined.  If you cannot exempt all of the refund, the best option is to wait to file the bankruptcy until the refunds have been received and spent.