Understanding What Happens to Your Tax Refund in Bankruptcy in Canada
The process of filing for bankruptcy can be overwhelming with many legal intricacies to navigate. One such concern is understanding how bankruptcy affects tax returns, specifically, what happens to your tax refund. This article explores the laws and regulations that govern this aspect of personal bankruptcy in Canada.
Before Bankruptcy Filing
Your tax situation before you file for bankruptcy plays a significant role in determining what happens to your tax refund. If you have unfiled tax returns for years preceding your bankruptcy, your bankruptcy trustee (now called a Licensed Insolvency Trustee) is obligated to ensure that these returns are filed with the Canada Revenue Agency (CRA). The CRA will then send any refunds to your trustee. Conversely, if there is an amount owing on the tax return, this becomes a debt that is addressed as part of your personal bankruptcy.
Year of Bankruptcy Filing
The year of bankruptcy filing is a pivotal period. Any refunds for this year are forwarded to your trustee by the CRA. Notably, there are two tax returns for this time frame: a pre-bankruptcy and a post-bankruptcy tax return.
- The pre-bankruptcy tax return covers the period from January 1st to the date you file for bankruptcy. Any tax debt for this period is included in your bankruptcy. Conversely, if there is a refund, it is forwarded to the trustee.
- The post-bankruptcy tax return spans from the date of bankruptcy to December 31st of that year. If there is an amount owing for this post period, it is your responsibility to pay it as it is a new debt after bankruptcy was filed. However, if there is a refund, it will be sent to the trustee.
Both pre and post returns are filed by your Licensed Insolvency Trustee.
Years after Bankruptcy Filing
Tax years following the commencement of your bankruptcy are not affected. If there is a tax refund for these years, it will be issued to you. However, if there is an amount owing for that year, it is your responsibility to settle that amount.
Canadian Child Tax Benefits
During personal bankruptcy, you will continue to receive the Canadian Child Tax Benefits as they are considered part of your income and not an asset like a tax refund. This also applies to some provincial credits.
Trustee’s Role in Tax Return
Per the Canadian Income Tax Act, your Licensed Insolvency Trustee is required to file your personal income tax return for the year in which you filed bankruptcy. Any income tax refund resulting from this tax return is considered an “asset” and is accordingly sent to the Trustee by the CRA. The refund is then deposited into the Trustee’s trust account for the benefit of your creditors.
Pre-Bankruptcy Tax Return
The trustee is required to prepare and file a pre-bankruptcy income tax return, which covers the period from January 1st of the year of bankruptcy up to the actual bankruptcy date. If you owe money on this return, this tax debt will be discharged in your bankruptcy proceedings. If there is a refund, it will be sent to the Licensed Insolvency Trustee.
Post-Bankruptcy Tax Return
The post-bankruptcy income tax return, which will cover the period from the day after you filed bankruptcy to December 31st of the same year, is usually prepared by the trustee. If you owe money on this return, you will need to pay it since it’s considered “post-bankruptcy” debt. However, if there is a refund, it will be sent to the Licensed Insolvency Trustee.
Note that the trustee, although usually prepares the post-bankruptcy return, is not obligated to do so. Unlike your pre-bankruptcy tax return, the responsibility for filing the post-bankruptcy return is actually yours.
Prior Year Tax Refunds
Furthermore, any income tax refunds resulting from previous taxation years would also be sent to your trustee by the CRA. For instance, let’s say you filed bankruptcy in 2020, and you were re-assessed by the CRA for the 2023 taxation year, resulting in a refund. The 2023 income tax refund would be sent to your trustee.
Consequences of Unfiled Tax Returns
Unfiled tax returns can lead to complications in the bankruptcy process. If you have unfiled tax returns for years prior to your bankruptcy, your Licensed Insolvency Trustee will ensure that the tax return is filed with the CRA. The CRA will then send any refunds to your trustee. If there is an amount owing on the tax return, it becomes a debt that is dealt with as part of your personal bankruptcy.
Choosing the Right Trustee
Selecting a competent and experienced bankruptcy trustee is essential for a smooth bankruptcy process. A good trustee will confidently handle your personal bankruptcy proceedings in a professional manner, providing you with peace of mind.
In conclusion, understanding what happens to your tax refund in bankruptcy and how it is affected is a crucial part of the filing process. It is important to be aware of these potential impacts and plan accordingly. Consulting with a knowledgeable Licensed Insolvency Trustee can provide valuable guidance and assistance throughout the bankruptcy process.
