Earned Income Credit (EIC) and Bankruptcy

You might be entitled to a large tax refund if you qualify for earned income credit or "EIC," but did you know that if you can’t protect or "exempt" an anticipated tax refund in bankruptcy, you'll lose it? It's possible because a tax refund you're owed but haven't yet received is considered an asset in bankruptcy. Learn why your state's exemption laws determine whether the bankruptcy trustee assigned to your case can take your EIC and how to protect it.

What Is an Earned Income Credit?

An EIC is a tax credit designed to provide a tax break to qualifying individuals and families with low incomes. Because it's a tax credit, it reduces your taxes. If your EIC is more than your tax liability, you keep the excess amount as a refund.

Are Earned Income Credits Bankruptcy Assets?

Yes. When you file for Chapter 7 or Chapter 13 bankruptcy, any tax refunds you're entitled to receive can be at risk even if you haven’t received them yet, including your EIC. Luckily, because the EIC is designed to help people in need, some states have bankruptcy exemption laws that specifically protect EIC refunds.

You can keep the EIC portion covered by the bankruptcy exemption. Any "nonexempt" amount not covered must be given to the trustee, who will use it to pay creditors.

Protecting an Earned Income Credit in Bankruptcy

You'll want to start by checking your state’s exemption laws. If your state doesn’t offer a specific EIC exemption, you might be able to exempt it using a wildcard exemption. A wildcard exemption can be used to protect any property in bankruptcy.

However, not all states have wildcard exemptions, and some have conditions that might prevent you from using them. In that case, another option would be to check whether you can use the federal wildcard exemption, which is substantial. Some states allow residents to use the federal bankruptcy exemptions instead of the state exemptions.

Nonexempt Earned Income Credit Options

If your state doesn’t have an exemption that will protect your EIC, consider delaying your bankruptcy filing until after you receive your refund and spend it. When you receive your EIC refund, you can use it to pay living expenses such as food, rent, or gas. This way, the trustee can’t go after your refund because you’ve already spent it.

If you go this route, consider keeping records of your expenditures showing you used the funds for typical expenses. Also, it's prudent to consult a local bankruptcy attorney to determine your earned income credit options before filing for bankruptcy and the problems you might encounter if the money is in a bank account when you file the case.