Tax Refunds in Bankruptcy - Why are they great and dangerous?

We are just winding down the tax refund season here in June.  By now most people have filed their 2010 taxes and have gotten their refunds.  However, for the debtor who files their bankruptcy within 180 days of receiving the tax refund, the benefit of receiving a tax refund can be put in jeopardy.

Here's how it works.  Say you receive a $6000 tax refund in April and use it to file a bankruptcy in May.  In June, the bankruptcy trustee will ask your attorney for information about how much your tax refund was and how it was spent.  So here's how it goes:

Jane spent here tax refund on:

Bankruptcy Attorney $2200.00
Pay off loan from Mom:  $2000.00
Paid off Macy's Charge Card:  $1800.00

Here's what the trustee would say:  The amount of money spent by Jane on the bankruptcy attorney is exempt and cannot be seized by the trustee.  However, the loan to an "insider"  is not exempt.  Neither is the payment to Macy's.  Bottom line, Jane is consider to have received $3800 in cash that is subject to the jurisdiction of the trustee.

Here's the problem, Jane needs an exemption to keep this money - so how does she do it?  Well....she can use the Illinois "Wildcard" exemption for $3800, but now she only has $200 left and still needs to exempt about $2000 of her furniture and other personal possessions.  Bottom line, in this case, Jane ends up "paying" the bankruptcy trustee $1800 because she doesn't have enough exemptions to keep her tax refund.

What's the morale of the story - tell your bankruptcy attorney how much you are expecting in tax refund, file your taxes promptly and provide a tax return copy to your attorney so that he or she can counsel you on how to spend or save your tax refund.

For more information about bankruptcy email:  info@nelsonlawoffice.com