Can Bankruptcy Stop a Tax Offset?
Filing for bankruptcy can stop a tax refund offset initiated by a private creditor such as a credit card company or collection agency. However, if the reason for the tax refund offset is due to back federal taxes, spousal or child support, filing for bankruptcy may not stop the offset. Back taxes, spousal support and child support arrearages are also not dischargeable in bankruptcy.
Automatic Stay
When you file bankruptcy, the bankruptcy court grants you an automatic stay against all collection actions by private creditors. The automatic stay applies to all current and future collection actions. This means if a private creditor is currently garnishing your wages, or offsetting your taxes, the garnishment and tax offset must stop once you file for bankruptcy. The automatic stay prohibits creditors from starting any new collection actions against you. The automatic stay typically lasts until the court discharges your bankruptcy. Creditors cannot collect on debts discharged in bankruptcy.
Pre-Bankruptcy Federal Taxes
If you owe a federal tax liability assessed before you filed for bankruptcy, but you are owed a refund in the current year, the IRS may still offset your federal tax refund. For example, you file your federal taxes on April 15, and have a refund due of $5,000. Upon processing your return, the IRS discovers you owe back taxes from five years ago totaling $1,000. You file for bankruptcy on May 1. Since both the tax debt and the tax refund --- referred to as pre-petition liability and pre-petition credit --- occurred prior to your bankruptcy filing, the IRS can offset your federal tax return for $1,000 for the back taxes owed. It must then return the remaining $4,000 tax refund to you, or your bankruptcy court trustee.
Post-Bankruptcy Federal Taxes
If you owe a federal tax liability that occurred before you filed for bankruptcy and you are owed a tax refund after you file for bankruptcy, the IRS claims it has the right to offset your taxes, but most bankruptcy courts disagree. For example, you file for bankruptcy on January 1. On April 15, you file your federal taxes and have a refund due of $5,000. Upon processing your return, the IRS discovers you owe back taxes from five years ago for $1,000. In this case, the back taxes are a pre-petition debt, while the tax refund is a post-petition credit. The IRS holds that it still has the right to offset, and it may do so, while most bankruptcy courts hold that the IRS does not have the right to offset.
Spousal and Child Support
If you have domestic support orders such as child support or spousal support that are in arrears at the time you file for bankruptcy, the U.S. Department of the Treasury's Financial Management Service (FMS) can still offset your federal taxes. FMS will send any amount of your refund remaining after deducting your domestic support order arrearages to you, or your bankruptcy trustee.
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