When you attend a 341 Meeting of Creditors in bankruptcy court, the trustee is going to ask, “What did you do with your tax refund?” Since it is currently tax refund season, both chapter 13 and chapter 7 trustees are asking this question.
If you have a bad answer to this question, it could negatively impact your case.
Bad Answer to the Tax Refund Question
Here is an example of a bad answer. “I received $5,000.00 and I used it to go on vacation right before I filed bankruptcy.” Taking a vacation right before filing bankruptcy and using money that could have gone to creditors in an indication of bad faith.
Perhaps you are asking yourself, “Who would be dumb enough to spend money on a vacation right before filing bankruptcy?” The truth is that almost no one tries this. I’ve been practicing bankruptcy for over 12 years and I’ve only seen one potential case where the debtor used the refund to go on a cruise right before she wanted to file. In that rare situation, I declined to file the case because it was not in her best interest.
In a chapter 7, a trustee could move to dismiss your case when there is evidence of bad faith. In a Chapter 13, the trustee could force you to pay your unsecured creditors the same amount of money that you spent on the luxury.
Good Answer to the Tax Refund Question
In contrast, an example of a good answer to the bankruptcy court question of where you used the tax refund is that you used the money repairing a roof, repairing windows, buying food, catching up on utility payments, buying clothes for the children, making car repairs, buying medicine for family members or catching up on house payments. Anything that can be construed as a necessity for survival will work. Saving receipts of these types of expenses is extremely helpful.
Its the luxuries that get people into trouble.
The Most Common Tax Refund Nightmare
The most common answer that gets people into trouble is, “I used my tax refund to repay a loan to my mother.” Using a refund to repay a loan to a family member is a clear example of a preference. Let’s say you gave a $5,000.00 refund to your mother to repay a loan from her. In this situation, a chapter 7 trustee would file a lawsuit against your mother to recover the $5,000.00 that you paid her. Once the trustee recovered the money, they would then distribute that money pro rata to creditors that have filed claims in your bankruptcy case. In a chapter 13, you could set up a plan to repay your creditors the same amount of money that they would receive in a Chapter 7 to protect your mother from a lawsuit.
Any specific questions you have about bankruptcy and tax refunds should be answered by an experienced bankruptcy attorney to keep you out of a potential mess.
1. The problem with tax refunds in a chapter 13.
2. Can I keep my tax refund when I file chapter 13?
3. Why can’t you do rapid tax refunds in chapter 13?