SIGNIFICANT TAX REFUND COULD HAVE NEGATIVE IMPACT ON BANKRUPTCY FILING

As tax season approaches, many Sacramento area residents look forward to getting their refund checks over the upcoming weeks. Whether filing for Chapter 7 or Chapter 13, however, local residents must keep in mind that any income received is taken into account when qualifying for bankruptcy.

Few people realize that by receiving a significant tax refund they may no longer qualify for the bankruptcy. In order to qualify for Chapter 7 the individual must pass one of 2 income requirements. The first is the median income test. This means in order to qualify for Chapter 7 a person must earn less than the “average household income” for the same family size in his or her geographic region for the 6 months before the month in which they file the bankruptcy. The tax refund comes into play in this case because the median income test must account for all sources of income in the time period. Thus, if a person receives a significant tax refund they may no longer satisfy the median income test.

The second way to qualify for Chapter 7 bankruptcy is under the means test. The means test is a complex equation and comparison of a person’s debt to income ratio. In this test a person who makes more than the average income for his geographic region may still qualify for the bankruptcy provided their debts and monthly expenses rise to a significant portion of their income. Again, the receipt of a significant tax refund could effect the numbers enough so that the individual does not qualify under the means test either.

Fortunately, the equation to determine income is based on the six months before the month in which the individual files Chapter 7 or Chapter 13. Thus, if a person is aware of the complexities involved in filing for bankruptcy and talks to an attorney far enough in advance they can strategically plan when to file the tax return so that the income received from the tax return does not fall into the qualification equation.

For example, if Anna makes $3,000.00 a month she would most certainly qualify for Chapter 7 under the median income test. Anna would have made $18,000.00 over the six month period before her filing which falls below the median income in the Sacramento metropolitan area. However, if Anna received a $5,000.00 tax refund in February and waited to file the bankruptcy until March then her income would present as $23,000.00 for the six month period. Anna might not qualify for the bankruptcy if she waits until March because her income is legally overinflated due to the tax refund. If Anna receives the refund in February and files in February she will not have to include her refund into the equation though because she only made $18,000.00 the six months before the month in which she filed.

As you can see, this requires some thought and analysis before proceeding with the bankruptcy filing. Anyone who is considering bankruptcy and anticipates getting a tax refund must be extremely careful. You should contact a bankruptcy attorney immediately to discuss the options you have and the impact that your tax refund may have on the filing. As a Sacramento Bankruptcy Attorney I routinely handle these matters and am prepared to discuss these and any other questions individuals may have before considering filing Chapter 7 or Chapter 13.