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Some Facts About Bankruptcy, Taxes, And Tax Refunds


For many Illinois families, the spring is a time of additional financial plenty or an additional financial need. Some people receive rather large income tax refunds. In fact, many Chicago workers over-withhold during the year to get a larger refund. But for some others, tax time has the opposite meaning, as it adds even more money to their existing IRS debt.

People in both situations sometimes hesitate to file a necessary debt relief action. Many Indiana families count on their refunds to provide a financial boost, and they are understandably reluctant to hand them over to a bankruptcy trustee (person who oversees the bankruptcy for the judge). On the other end, many people believe that they cannot file bankruptcy on past due taxes. Neither of these things is true.

Chapter 13 and Tax Returns in Illinois

Technically, when the debtor files a voluntary petition, all the debtor’s property belongs to the trustee. Sometimes, in bankruptcy paperwork, the trustee refers to the debtor-in-possession. “All property” includes an actual or anticipated tax return.

Rules vary greatly among different jurisdictions, but typically, if the refund is less than $2,000, the trustee allows the debtor to keep it.

This issue comes up a lot, and not just with regard to tax returns. Assume Debra Debtor has fifty creditors (which is a normal number for a Chapter 7) and she receives a $2,000 tax refund. If the trustee seized it, each creditor would receive about $30, after factoring in the trustee’s legal expenses and bounty for recovering the money. In most cases, that sum qualifies as a “drop in the ocean.” It would not be in the creditors’ best interests for the trustee to pursue the matter, and that is the standard.

There is another approach. Both Illinois and Indiana have rather large wildcard exemptions. So, it may be possible to protect all or part of the refund and avoid this discussion altogether.

Bankruptcy helps people keep their tax refunds. Typically, the money is either exempt or immune from trustee action. And, instead of giving all or part of it to moneylenders, the taxpayers keep the entire amount, in most cases.

Chapter 7 and Past-Due Taxes in Indiana

In a source withholding environment, income tax delinquency is extremely rare. But freelancers or moonlighters hold about a third of the jobs in Illinois, so tax problems are increasingly commonplace. Although this debt is unsecured and therefore dischargeable, it is in a special category, so the Bankruptcy Code’s requirements for discharging this tax debt are very specific.

  • – Three Years: To receive a discharge in Chicago, the tax debt must be at least three years old. This rule is trickier than it sounds, because Tax Day is not always April 15 and the taxing authorities have been known to object to discharge over one or two days.
  • – Income Tax: Payroll taxes, property taxes, and any other non-income tax obligations are not dischargeable under any circumstances. There is no “income tax” definition in the Bankruptcy Code, so the taxing authorities usually have the last word on this point.
  • – Two Years: The returns must have been on file at least two years prior to the bankruptcy petition filing date. Substitute returns which the taxing authorities prepare for delinquent taxpayers do not count.
  • – 240 Days: A taxing authority or authorized debt collector in Indiana must not have assessed the tax within the last 240 days. In plain English, that usually means that the taxpayer has not received a collections notice in the past eight months.

Bankruptcy also halts most adverse actions, such as wage garnishment and account levies. However, bankruptcy does not dissolve income tax property liens.

Connect With Experienced Attorneys

Bankruptcy helps people keep their tax returns and shed tax debt. For a free consultation with an experienced bankruptcy attorney in Chicago, contact the Bentz Holguin Law Firm, LLC. We have offices in both Indiana and Illinois.



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