Americans got a break from the typical April 15 tax filing deadline this year as a result of the coronavirus pandemic. The deadline was extended by three months, but it remains July 15.
So it’s something you’ll have to do very soon if you haven’t yet.
At the same time, many Michiganders who have lost their jobs may be considering filing for bankruptcy, which may lead to questions about how a bankruptcy works into the tax filing process.
They are good questions, and ones you should understand the answers to before completing your tax returns and before starting your bankruptcy proceeding.
How a Bankruptcy Works Into the Tax Filing Process
Before we go any further, we need to make one thing clear: We are not providing tax advice. Many of the questions you may have are more ideal for your accountant.
However, when it comes to tax returns and bankruptcy, here are the most important things you need to know from a legal perspective:
- In order to start a bankruptcy case, you have to have filed all of the returns that are supposed to be filed within two years preceding the case. In other words, we will need your last two years of returns.
- COVID-19 relief stimulus money is not counted as income in relation to a bankruptcy filing. (See more about this in our post regarding the stimulus checks.)
- Individuals who file a Chapter 7 bankruptcy can almost always keep their tax refund.
- You can usually keep your tax refund in a Chapter 13 bankruptcy as well, but you will need documentation showing what the money would be used for.
Chapter 7 Bankruptcy and Tax Returns
Generally speaking, a Chapter 7 bankruptcy can wipe out debt completely, so you would not have to repay the debts that were discharged in the case.
In a Chapter 7 case, you can protect up to $14,000, which may include your tax refund. For example, if you are expecting a $10,000 tax refund and also have $1,000 in the bank and $3,000 in stocks, we may be able to protect all of it in a Chapter 7 bankruptcy.
Married couples may protect up to $28,000, or $14,000 for each person.
How Taxes are Involved in a Chapter 13 Bankruptcy
A Chapter 13 bankruptcy creates a 3- to 5-year repayment plan as opposed to eliminating the debts completely. (See more about Chapter 13 bankruptcies in our related post.)
Typically, three categories of filers cannot file for Chapter 7 or it would not be ideal for them. They are:
- Individuals who earn too much money to file for a Chapter 7 bankruptcy
- Individuals who have equity in their assets and don’t want to lose their assets in a Chapter 7
- Individuals who are behind on their mortgage or auto loan payments but want to keep their house and car
In regard to tax filing, a Chapter 13 bankruptcy is a little more complicated than a Chapter 7.
To create the repayment plan, we go through your net monthly income and subtract any reasonable expenses down to the penny, such as grocery shopping bills. The filer would then only pay what’s left over.
In addition to paying whatever monthly payment you have left over, you also have to pay any tax refunds. In other words, that refund gets added to what you have to repay.
The idea is that your employer has been taking a certain amount of money out of each check and sending it to the government; if the employer had taken out the exact right amount, you would have had more money to send to the court. For that reason, that refund would be accounted for in the bankruptcy — unless you have an unexpected, reasonable, necessary expense that the refund could be used for.
Here’s an example: Let’s say your driveway is crumbling and creating a hazard, but it would cost $3,500 to fix it. You therefore want to use your anticipated $3,000 tax refund to repair it. You would give us a copy of your taxes showing your refund as well as an estimate of what it would cost to get the driveway repaired. Our firm would submit that you should be able to keep that refund to pay for the repair.
Our law firm has an approximately 90 percent success rate in being able to help you keep your tax refund in this type of scenario.
Another instance where we may be able to help you keep your tax refund in a Chapter 13 bankruptcy is if you have too much equity in a piece of property but don’t want to lose it.
For instance, you may owe $50,000 on your house but it’s worth $100,000. Congress passed a law saying that you can protect a certain amount of equity, but it also makes provisions to keep people from essentially using tax money for million-dollar homes.
Therefore, there’s a limit on how much equity you can have, and you have to pay creditors back at least $1 more.
Clearing Tax Debt in Bankruptcy
“Can I include taxes I owe from previous years in my bankruptcy?”
That’s a question we hear often from our clients, and here’s the long and short of it.
In a Chapter 7 bankruptcy, it’s difficult to wipe out past taxes owed. Sometimes we can wipe out penalties and interest, and in some cases we may be able to eliminate old taxes, although it can be hard to do.
In a Chapter 13 bankruptcy, we may be able to wipe out some of the old taxes, penalties, and interest, but whatever taxes are still owed would have to be included in that 3- to 5-year repayment plan.
For more information about bankruptcy and tax returns from a legal perspective, call us at (734) 692-9200 or message us through our website.