The Earned Income Credit and Bankruptcy

The earned income credit (EIC), is a tax credit available for low income workers with minor children. The EIC reduces the taxes owed, and in cases where the credit exceeds the tax liability, is refunded. In a bankruptcy, the issue is raised as to whether the credit is part of the petitioner's exempt assets or is part of the estate property distributable to creditors. A few states have created laws that exempt the credit; however, the federal code does not expressly do so.

How the EIC Works

The EIC was created for the low income workers who have minor dependent children. The credit is not available to those who do not work or who have no minor children in the home. Those eligible for the credit can receive it even if no taxes were withheld by their employer. This occurs when the wages are very low and there are several children in the home. The credit is part of a work-incentive program to encourage parents to work outside the home instead of receiving other federally funded assistance. The more children there are in the home, the larger the credit received. However, the maximum EIC cap is $5,000.

EIC Turnover in a Bankruptcy

How much of the EIC is turned over to the bankruptcy trustee depends on when the petition was filed. If the petitioner filed early in the year, but after he or she received the previous year's earned income credit, only that portion of the EIC is turned over to the trustee. The amount of turnover increases as the year progresses. If the bankruptcy filing precedes the tax return filing, then all of the EIC from the previous year is subject to turnover.

Even if the EIC must be turned over, the trustee has the discretion to decline the credit. This may be the case where the credit refund is substantially small and would not materially satisfy any of the creditors. For example, in Indiana, trustees generally do not go after EIC refunds that are less than $2,000 to $3,000.

EIC Exemption States

There is no federal exemption for earned credit income. However, a few states have made the credit exempt from creditor seizure. Below are a few states that exempt the earned income credit from bankruptcy estate property.

• Florida
• Illinois (Northern District)
• Iowa
• Maine
• Minnesota
• Mississippi
• Nevada
• New Jersey
• Ohio
• Oklahoma
• Oregon

Kansas recently introduced a bill to exempt EIC from bankruptcy. The bill passed both state houses in early 2010.

Many advocates for federal EIC exemption assert that turning the money over to creditors frustrates the intent of the credit's creation, which is to help the working poor provide for their children.

Find an Attorney

If you have received a earned income credit and are filing for bankruptcy, your EIC may be subject to turnover to a bankruptcy trustee if you do not live in a state that has designated the EIC an exempt asset. Talk with a bankruptcy attorney to determine what assets are exempt in your state.