That post filing feeling is just so great. Those creditors who have dogged you for years are put to bed. No more obnoxious calls and no more threatening letters.
Next year comes around and all that bankruptcy stuff becomes a speck in the rearview mirror. You’ve moved on with your life, resting blissfully in your debt free peace.
And then the tax man cometh.
The Tax Man
If the debt was simply forgiven and you weren’t filing for bankruptcy, you would have a hefty tax bill come next year. Lucky for you, there are no tax consequences for the debt that was eliminated when you filed.
There’s also a good chance you’ll even be getting a nice, juicy tax refund next year as well. So you have that to look forward to.
But wait; it’s not as easy as that. A little voice conjures up the memory of something your bankruptcy attorney said last year… Something about your refund…. But what was it?
Slice It and Dice It
When you file for bankruptcy, the trustee is entitled to a portion of your tax refund the following year. So when you file your taxes and get a refund check, you are required to turn those checks over to your trustee. His or her portion will be taken out, and you will get a smaller check back with what is left over.
So how much do you lose?
The trustee can take the portion of your refund that you have already earned when your bankruptcy case is filed.
“But what do you mean, ‘already earned?’ It’s not like I get the money until next year anyway.”
This is true, but since you are dealing with the government, they have a neat little trick around this reality to get their share of the money.
The bankruptcy trustee is entitled to any money that you are due when your bankruptcy is filed. If you lived in a fantasy world where you could file taxes at the same moment you filed for bankruptcy, that money would be due at the time of filing. It doesn’t matter that you can’t actually file and get your money until the following year.
So however much of the calendar year has passed when you file for bankruptcy, the trustee can take that much of your tax refund. If you file early in the year, your trustee only gets a small percentage. If you file late in the year, he or she gets almost the whole thing.
In other words, the trustee can take the same percentage of your tax refund as the percent of the year that has already passed when you file for bankruptcy. Fun, isn’t it?
Where Does It Go?
So what does your trustee do with your money? It gets distributed to your creditors, minus the trustee’s fees of course.
And what can you do about it? If you know you are filing for bankruptcy, strategize with your tax professional on how to receive a small refund next year. That way, the trustee won’t get so much of your money.