Tax season is again upon us - as evidenced by the instruction booklet I received in the mail this week - which brings up some potentially complicated issues for those who have a pending bankruptcy.  The implications of receiving a tax return during an open bankruptcy action are frequently overlooked, but can be very serious.  John O'Connor of the National Bankruptcy Forum recently wrote about tax return-related issues in two articles on that site. In the first, "Be Careful With Tax Refunds in Bankruptcy," Mr. O'Connor wrote that tax refunds are an asset that is part of the bankruptcy estate, and the trustee may take it. from you. Tax refunds are "the number one asset that bankruptcy trustees successfully go after."  If a debtor is entitled to a tax refund, the amount of the refund is considered property of the debtor regardless of whether they have filed their return yet.  Failure to disclose and then try to exempt the return will expose it to potential liquidation by the bankruptcy trustee.  However, if the return is disclosed and property exempted, the debtor will likely be able to keep it.  The debtor's ability to keep the return hinges on state exemption laws, making it necessary to consult with a bankruptcy attorney regarding this issue.  In some cases, the expected receipt of a large tax refund may necessitate delaying the bankruptcy filing or turning over the non-exempt portion of the refund to the trustee.

In a second article, "What happens to property I acquire after filing for bankruptcy?", Mr. O'Connor again discussed this issue, writing "[i]f you are entitled to a tax refund, the amount of the refund becomes your property regardless of whether you have filed your return. Courts have reasoned that the source of the right to the refund is based on taxes overpaid on pre-bankruptcy earnings. The right to the refund vested prior to bankruptcy and therefore becomes property of the estate."

If you are considering bankruptcy or have already filed a bankruptcy petition, and are expecting a significant tax return, discuss the issue with your bankruptcy attorney.

-Drew Broaddus