What Not To Do With Your Refund If You Are Filing For Bankruptcy

Bankruptcy law has many twists and turns, and one area of possible distress involves actions taken just before filing your petition.  Some actions that are taken just before filing can cause grief, while the same actions taken just after filing are no problem at all.

Tax Refund, Bankruptcy and Creditors

One area of concern that we always speak to our clients about during tax season is what they should do with their tax refund.  In most cases, if they file while expecting a tax refund, they are allowed to keep the full refund because it fits within one of the exemptions.  Exemptions are things you are allowed to keep even though you file for bankruptcy.  The federal exemption is over $10,000 per person, and most tax refunds are less than that amount.  When a husband and wife file together, and both work, they can keep up to $20,000.

The problems usually arise in the case where someone files late in the tax season, or after April 15th, and they have already received their tax refund.  The twist here is that if they were still waiting for it, or if it had arrived and was still in their bank account, it would still be safe under the exemption.  The problem arises because people who file for bankruptcy have often borrowed money from family or friends and then pay them back when the refund arrives.  Now it is no longer money in the debtor’s bank account or a tax refund on its way, it is now money paid back to an old debt.

When an old debt is paid back to one creditor and not to another, the creditor receiving the money is preferred over the others, and the bankruptcy law prohibits preferences.  Family and friends are creditors as well as the banks and stores one might also owe money to.  If the re-payment is made within 90 days of the filing, the Trustee who administers the case can get that money back from the creditor who received it, with the theory being that it will then be passed around to all the creditors in a fair manner.  If the creditor is an actual family member, the money can be retrieved for one year.

The twist, of course, is that had the debtor left the money in the bank until after the bankruptcy was filed and then paid back the friend or relative it would have been no problem because it was done after the filing.  This may seem rather absurd and it is, but that is what the law provides.

Read also: What Happens If I Leave a Creditor Off of My Bankruptcy?

Homestead and Car Exemptions and Tax Refund

When the debtor has a house and has to use the exemption to keep the house, the debtor may not have enough of an exemption available to cover the refund.  In that case, we often recommend waiting to file until the refund is spent.  Here we have somewhat the same problem, because the debtor has to be careful how the money is used.  Again, paying back relatives and friends will cause the same problems, so they have to spend it only on family and household expenses.

One other interesting twist to the idea of things that happen just before filing causing problems which would be fine if done just after filing came in a case I handled several years ago.  A client needed to file for bankruptcy, but his children had bought him a new car for $20,000 just the week before he came to see me.  The maximum exemption for a car at that time was $4,000.  If he filed for bankruptcy, he would have lost the car and he did not want that to happen.  The twist is that if the children had given him the car the day after he filed, it would have caused no problem at all.

There is nothing wrong with some planning in situations like those described in this post.  The important thing is that if you are about to file for bankruptcy do not take any major actions with money or property before you discuss them with an attorney familiar with bankruptcy law.

Read also: What Not to Do Before Filing Bankruptcy in NYC, Should I Give My Stuff Away Before I File For Bankruptcy

About Allan Bloomfield

For over 30 years, my focus in practicing law has been to help people overcome what seems to them to be insurmountable financial difficulties. I have helped thousands of people file both Chapter 7 and Chapter 13 cases, and in most cases, they are able to keep all of their assets, including homes, cars, their retirement accounts and personal property.