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What Happens to Tax Refunds in a Bankruptcy?


Are Tax Refunds Affected By a Bankruptcy Or Consumer Proposal? If you’re struggling under the weight of debt and don’t see how you’ll ever catch up, it can be tempting to just ignore it and hope that it goes away. The good news is that there are several ways to deal effectively with your debt. […]

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Are Tax Refunds Affected By a Bankruptcy Or Consumer Proposal?

If you’re struggling under the weight of debt and don’t see how you’ll ever catch up, it can be tempting to just ignore it and hope that it goes away. The good news is that there are several ways to deal effectively with your debt.

One option is to file for bankruptcy. But what happens to your tax return? We will explain what happens to your tax refund during a bankruptcy or consumer proposal.

What Happens To Your Tax Refund During Bankruptcy?

When you file for bankruptcy, most of your assets are handed over to your Licensed Insolvency Trustee (LIT) and will be sold to provide cash to pay back your creditors. However, some assets are exempt from seizure (up to a certain value), such as food, necessary clothing, furniture, pension and insurance policies, and tools of your trade or profession.

Any tax refunds you receive for the years preceding bankruptcy and the year of the bankruptcy filing are considered non-exempt assets and are turned over to your LIT to help pay off your debts.

What About Unfiled Returns From Years Prior To Filing Bankruptcy

If you have outstanding unfiled returns from the year or years preceding your bankruptcy filing, they must be filed immediately, and any refunds that you are entitled to are considered part of your non-exempt assets. They will be sent directly to your LIT and used to settle your debts, unless you have a balance owing to CRA on account of income tax debts. In this instance, Canada Revenue Agency (CRA) will keep the refund to apply to your debt.

Returns From The Year You Filed For Bankruptcy

When you file for bankruptcy, your LIT must file a pre-bankruptcy return on your behalf, covering the period from January 1 to the date of your filing. They are also required to file an in-bankruptcy tax return, if you have assets such as RRSPs that was liquidated to help pay off your debts. Finally, either you or your LIT must file a post-bankruptcy return covering the period between the date of bankruptcy and December 31 of that same year. If there is a refund from the pre-bankruptcy income tax return, and there is no debt owed to CRA, the refund will be paid to the LIT. If there is a refund on the post-bankruptcy income tax return, it will be paid to the LIT.

What About a Consumer Proposal?

Because a consumer proposal does not require you to surrender your assets, any tax refunds you are entitled to will be paid to you and not your LIT. However, you still need to file any outstanding tax returns.

What Will Happen to My Canada Child Benefit (CCB)?

If you declare bankruptcy and are receiving the Canada Child Benefit, you will get to keep it. According to the Income Tax Act, such benefits “shall not be subject to the operation of any law relating to bankruptcy or insolvency.” However, you must report it as part of your income, the amount of which may affect how long you stay in bankruptcy.

The Takeaway

If you’re struggling with debt, remember that bankruptcy should not be entered into lightly, because it means losing many of your assets, including any tax refunds you are entitled to. Always make sure to examine other avenues of debt relief carefully before you decide to file for bankruptcy. Our team of Licensed Insolvency Trustees can help you weigh your options and determine the best next steps.

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Baker Tilly Ottawa Ltd.