Coordinating the Timing of Your Bankruptcy and Your Tax Refund

It’s that time of year when people begin preparing to file their taxes and begin planning on where to spend that anticipated refund. We want to be sure you use your refund in a manner that will be help your bankruptcy go smoothly.

If you won’t be able to exempt all of your tax refund in Chapter 7 bankruptcy, and you receive them before you file, you may be able to use the refunds to pay some expenses or purchase some items. In that way, you don’t “lose” the refund in bankruptcy. If you plan to do this, be careful. Follow the below guidelines:

Use Tax Refunds for Reasonable and Necessary Expenses Only

Your trustee is likely to ask you to what you spent the refunds on, so it’s a good idea to hang on to receipts and keep an accounting, so that you have the information ready if your trustee requests it. You should only use your refunds for reasonable and necessary expenses. If you spend your refund frivolously, such as on luxury purchases or travel, you may have issues with your trustee or creditors.

Exercise Caution if Using Tax Refunds for Normal Living Expenses

While normal living expenses, such as rent and utilities, may be reasonable and necessary, be cautious about using your refund for those expenses if you have monthly income with which you normally pay those expenses. If you don’t spend your refund on regular monthly expenses, it may cause your trustee to question how you spent your regular monthly income.

Do Not Use Tax Refunds to Repay Friends or Family

You should avoid using your tax refunds to repay debts owed to friends or family members. If you do so, you create a “preference,” which means you spent money on friends or family members instead of repaying your creditors, who are legally entitled to payment. Your trustee can go after your friends or family to recover the money and give it to your creditors.

Approved Expenses Include:

  • mortgage payment, rent, or home repair
  • utilities
  • food
  • clothing
  • medical care
  • car payments, maintenance, or
  • education

Expenses That Are Not Allowed Include:

  • luxury goods
  • travel/vacation
  • repayment to a friend or family member, or
  • repayment of one credit card or loan

If you buy luxury goods, the trustee could seek to deny your discharge because of bad faith. If you pay back one of your creditors and ignore the others, the trustee may find that you have made a preferential payment. This means that you have favored one creditor over another. The trustee can force the person or company who received the money to return it to the estate. Therefore, if you spend your tax refund, make sure to spend it on necessary expenses and keep very good records of how you used the money.

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