Protecting Your Income Tax Refund

March 23, 2011

The traditional wisdom regarding bankruptcy and tax refunds is: get it and get rid of it before filing bankruptcy. The bankruptcy trustee can’t take what you don’t have, right?

In the law there are rarely absolutes. In some cases the trustee can demand money that you no longer have in your possession. A common example of this is a preference payment to an insider creditor (e.g. repaying a loan to your mother from your tax refund). The trustee can sue you or your creditor for the turnover of the money.

The simplest way to avoid any potential loss of your income tax refund is to discuss the situation with your bankruptcy attorney. In many cases your attorney can exempt all or a portion of your tax refund, so you can keep the cash money after you file bankruptcy. First, you are required to identify the property in your bankruptcy schedules, and then apply the applicable exemption law to protect it. Failure to list or exempt this asset may render the entire amount unprotected and lost to the bankruptcy trustee.

If your exemptions will not protect all of your income tax refund, you should consider spending the difference to benefit your family. The best guidance is to spend the money on goods or services that are reasonable and necessary. While your attorney can help you decide on specific purchases, the following categories are generally safe:

1. Household expenses such as utility bills, mortgage or rent payments, car payment,
auto insurance, and needed auto repairs/tires
2. Personal expenses such as food and clothing, dental work, and medicine
3. Priority debts like child support arrears and tax debts

Luxury good purchases like electronics, vacations, and jewelry should be avoided. Likewise gifts to family members or friends, spending sprees, and gambling should all be avoided. Any payment from your tax refund that you plan to make to a creditor should be discussed with your attorney.

Your income tax refund is your money! You can ensure that this money benefits your family by discussing your situation with your bankruptcy attorney.
 

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