The tax season is the busy season for bankruptcy filings. That is because it is the one time of year where people in financial distress have some money, their tax refunds, and thus can “afford” to file bankruptcy. However, tax refunds raise a number of issues. I was at a Trustee’s hearing recently, and sure enough the Trustee asked every single person if they received a tax refund, and what they did with it.
Most of the people, including my clients, answered that they used part of their refund to pay their bankruptcy lawyers. That is a good answer, and one which the Trustee accepted. The Bankruptcy Court and Trustees recognize that paying the lawyer is a bona fide expense and have no issue with the refund being used this way. One poor soul had the misfortune of saying that she used the tax refund to pay back relatives. The Bankruptcy Court and Trustees do not recognize those payments as bona fide. From their point of view, there is no difference between your uncle and Citi Bank. They are both unsecured creditors and both need to be treated the same. Fortunately, the amount of money that was paid to the relative was not very large. After multiple follow-up questions, the Trustee decided not to pursue it. However, this is an issue that requires great care.
The issue of tax refunds is a relatively straight forward one. Generally speaking a tax refund will not save a person in financial distress and even large tax refunds will be spent in the ordinary course of people living out their lives. The Court and the Trustees understand this. As long as it appears that the money that is being spent in the ordinary course of life, and not because the Debtor is trying to get rid of all the money before filing bankruptcy, then these general expenditures will be allowed. However, transfers to friends and family, either as gifts or payment of debts, will not be allowed. Using the money to pay down a mortgage or car loan, other than regular monthly payments, would be a problem. Going to Las Vegas to gamble away $10,000.00 would not be well received. Common sense goes a long way here. But handled properly, even very large refunds, and the things they buy, can be protected.