When you file a Chapter 7 bankruptcy, the court appoints an individual called the trustee who reviews the case to see if there are assets that can be taken to help pay the creditors of the debtor. One of the assets that the trustees look at is pending tax refunds. The normal position of the trustees and the bankruptcy court in Virginia is that the full amount of the refund is due to the individual after December 31 even if the tax returns have not yet been filed. This is based on the fact that all of the taxes have been withheld by December 31st and the tax refund is a refund of the taxes that were withheld in excess of the individual's tax liability. Since an individual can adjust the amount of taxes being withheld during the year, it makes sense that the tax refund, due to excess taxes being withheld, would be considered an asset in a Chapter 7 case.
The issue arises when the tax refund is not due primarily to an over-withholding of taxes during the year but due to Earned Income Credit. This is actually a benefit that was created by Congress to encourage individuals with children to work. If an individual has dependent children and their income from wages is below a certain amount, they actually receive additional funds from the Federal Government above what they have paid in for taxes. This Earned Income Credit can be anywhere from a few hundred dollars to several thousand dollars and is essentially a form of welfare payment for low income parents.
While most welfare benefits, like food stamps or WIC, are not in the form of actual cash payments, Earned Income Credit is a cash payment. In a Chapter 7 bankruptcy, a trustee is unable to take welfare benefits or Social Security benefits to pay creditors. However, in Virginia, the amount that an individual receives from Earned Income Credit must be protected, otherwise it can be taken to help pay creditors. In addition, since there is no specific exemption for Earned Income Credit like there is for a car or the family gun, this benefit must be protected using the Wild Card exemption. In Virginia, an individual is limited to $5,000 for their wildcard exemption and $500 for each dependent child and these are life time limits. This means that a low income person filing bankruptcy in Virginia could be forced to turn over money that the Federal government has given them as a benefit for working.
There are other states that have exemptions for the Earned Income Credit. Virginia's legislature should look at revising the state's exemptions to protect this benefit for those who can least afford to turnover money.
If you are considering filing for bankruptcy and receive Earned Income Credit as part of your tax refunds, you need to seek the assistance of an experienced bankruptcy attorney before you file. Contact Hampton Roads Legal Services at 757-340-3100 to schedule a free consultation on how to become debt free without losing your refunds.