Tis the season for tax refunds!
It goes nearly without saying that a tax refund – whether a debtor in bankruptcy has physically received it or not – is property of the debtor’s bankruptcy estate and vulnerable to being taken by a chapter 7 trustee and distributed among creditors. Often times, a tax refund can be shielded from the reach of a trustee by invoking the debtor’s “wildcard” exemption. In North Carolina, the wildcard exemption is $5,000 per spouse, but is only available if a debtor is not using all of his available homestead exemption. Also, a wildcard exemption can be easily used up in protecting other assets like car.
More interestingly, is the question of how a tax refund is allocated between spouses, especially if only one spouse is filing bankruptcy. If the debtor-husband works outside the home and the non-debtor wife stays home with the kids, is a tax refund flowing from a joint tax return owned equally by the husband and wife? Some have argued that, since the husband was the one paying the tax in the first place (since he was working), the refund he receives from overpaying those taxes should be considered his alone. If that’s the case, then a $7,000 tax refund will be subject to a trustee helping himself to at least $2,000 of that money (assuming that the husband is able to use his full $5,000 wildcard exemption).
If, however, the $7,000 is divided 50/50 between the bankruptcy husband and the non-filing wife, then only $3,500 of the refund will be considered property of the bankruptcy estate and it is much more likely that the debtor will be able to protect all of the refund. Fortunately, in our district, that is how the judges view tax refunds. A tax refund arising from a jointly file tax return is the joint property of both husband and wife, regardless of who was paying the tax in the first place.