How Bankruptcy Affects Taxes

Belleville 618.236.7000
Granite City 618.656.7941

Radio Segment Transcript

J: If you’re in a bankruptcy and you’re due a tax refund, what happens there?

JH: Well, if you’re in a Chapter 7 bankruptcy, which is where you are basically eliminating your debt within a relatively short period of time, you get to hang on to a certain portion of your tax refund, depending upon how much other property you own. Because when you file a bankruptcy, for a Chapter 7, you are allowed to hang on to a certain amount of property, and those are set by state law and they’re called exemptions. In Missouri and in Illinois, everyone has a certain number of exemptions, for example, for a family of 4 in Missouri, the potential exemption to reduce the amount you have to pay in on a tax return is about $3100. Now that’s assuming you don’t have anything else you need to protect with that money, like money in a savings account or a checking account or somewhere else, but it’s quite possible as you go through the bankruptcy you may be able to hang on to a good portion of it. Again, you need to talk to an attorney about that, it’s not a guarantee, but you have to bring in those documents and talk to an attorney. Some people will want to spend their tax returns before they file bankruptcy, and I want to let people know that you have to be really careful about that, because the Court is going to ask you what you did with your money. Did you play fair? Did you pay some of your creditors? You probably don’t want to be paying Mom and Dad the money that you owe them because the Court will probably ask Mom and Dad for that money back.

J: Really – they can go back at that point if you’ve paid people and get that money?

JH: If you’re repaid somebody called an “insider,” which is basically anybody with which you have a relationship, in the last year before you filed bankruptcy, yeah, they can go back and ask for that.

J: I had no idea – that’s the first time I’ve ever heard that!

JH: It depends how much it is; if it’s $50 to Grandma they’re probably not going to care, but if it’s $10,000 to Dad for paying off the car, then you might have a problem. But that doesn’t mean necessarily that you can’t fully address the debts in a bankruptcy, because you can probably work out a repayment plan in a Chapter 13 and still not get Dad in trouble.

J: I’m just thinking out loud, Jim, but is the reason for that because, say you have $10,000 and you’re trying to hide that money and you pay your brother and tell him, “Hey, man, just hang onto this until I’m through with the bankruptcy” – is that the basis for that law?

JH: I think the basis for the law is that it wants to treat all creditors equally. I think that Congress felt that we’d all like to pay our family members first because we have to see them at Christmastime and at dinner, but it’s really fair to pay everybody – the credit card companies and everyone else – in the same way. So they take that money back and then they divvy it out evenly.

J: So what if the case comes up where the government says that you cannot get rid of your back taxes through bankruptcy, and you’re stuck with thousands of dollars. What do you do with that if they say that can’t be discharged?

JH: Well, if they say it can’t be eliminated because it’s not older than three years, etc., what you can do, at least in a bankruptcy context (and there may be other alternatives outside of the bankruptcy context that you may want to talk to a tax professional about, because there are some alternatives like a payment agreement that the IRS may have with you). But in a bankruptcy context, in general, what you can do is take the amounts that you owe, for example to the IRS – let’s say you had a big tax bill this year of $12,000 and we file bankruptcy for you tomorrow – you’ll be able to take that $12,000 and spread the payments out over a period of three to five years in a Chapter 13 bankruptcy. At the end of that bankruptcy, the money that you owed at the very beginning of the case is going to be paid off and eliminated. Now, there is some debate under the new rules whether or not there will be a little interest left over at the end of the case for you to hold onto and still have to pay at the end, but while you’re making those payments to the IRS, during that 5-year period of time, they can’t collect on you while you’re in the bankruptcy. Bankruptcy is one of the few things that will stop the IRS absolutely dead in its tracks.

J: OK, so you guys help people who may be actually going through bankruptcy -- is the website. Jim, when should somebody contact you? I’m sure that’s a fear for a lot of people, thinking, “If I go see a bankruptcy attorney, I’m going to be in trouble.”

JH: I think they should come in and see me when they’re not able to pay their bills, when they’re going to payday loan places to make sure they can pay the utilities. One good test is to ask yourself whether or not you would lend money to yourself, and if the answer is no, that might be the time to go in and talk to somebody about what your options are in dealing with your debt. If you have a foreclosure pending, you’ve got to get in and talk to an attorney, because once the house is sold, we can’t protect it. If you have a car that has been repossessed, get in and talk to an attorney, because there’s deadlines that we have to meet in order to possibly get the car back for you. So if you have those kinds of situations and you find yourself in financial stress, get in and talk to a bankruptcy attorney. The stuff you talk to the bankruptcy attorney about, if you decide not to file, is protected, it’s confidential. So go in and talk to somebody, generally most attorneys will talk to you for free. We talk to all of our clients for free for at least an hour, sometimes two, sometimes three, depending on how much information they have, and we’ll lay out your options for you. We’ll be happy to set up an appointment for anybody about what their rights are. It’s free, we’re not going to pressure you to file a bankruptcy, there are no hidden strings or costs – just come on in and we’ll help you out.

Memberships & Associations


Belleville Location

The Bankruptcy Center
5312 West Main Street
Belleville, IL 62226
Tel: 618.236.7000

Granite City Location

The Bankruptcy Center
2021 Johnson Road, Suite 1
Granite City, IL 62040
Tel: 618.656.7941


The Law Office of Ronald A. Buch is a debt relief agency, helping people file for bankruptcy relief under the Bankruptcy Code.