What happens to my tax refund in a Chapter 7?

A couple of days ago I talked about the tax refund issue that is involved in both a Chapter 7 or a Chapter 13 bankruptcy. Today I will talk about the issue that arises only in a Chapter 7 (sort of). To qualify for a Chapter 7, your household income must be lower that the median income for your family size in the area where you live. This information can be found at the Trustee’s website on means testing. If your gross income is too high, you can go through a second time and deduct certain expenses. These include taxes taken from your paycheck.

If you pass the means test on the second round, the U.S. Trustee still can look at your income and expenses and see if you could actually pay a significant amount into a Chapter 13 plan. If you actually have over $160 in disposable income despite passing the means test, then the trustee may object and move to kick you out of the Chapter 7 (either as a dismissal or conversion to a Chapter 13).

Part of the trustee’s analysis is looking at your tax refund. If you received a substantial refund (I heard one trustee say $1,200.00 was the range they began looking), then they may demand that the excess taxes paid be attributed to your income. So, if you receive a $6,000.00 refund, you arguably could have $500.00 more per month to pay creditors. In practice, I have not seen this kind of challenge happen often, but it is a potential issue.