You may be anticipating a large tax refund when you file your taxes this year. For some, these refunds can add up to thousands of dollars. Someone who is contemplating filing bankruptcy may be under the misimpression that they cannot keep their tax refund because it may be too much. It is often the case that people in debt normally turn to their friends and family in times of their financial distress. As a result, many people feel a moral obligation to repay a family member who has helped them in the past.
Without consulting an attorney, they make the mistake of giving their tax refund away to family members or friends to whom they owe money. People who are planning to file bankruptcy do not realize that, by repaying that gift from a family member or friend with their tax refund, there may be some negative consequences.
1) Repaying friends or family with tax refunds may prevent the individual from receiving a discharge in Chapter 7, or
2) Repaying friends or family may pull the family member or friend who received money from the bankrupt individual into some sort of potential lawsuit inside the bankruptcy.
Obviously, those are not positive outcomes for your finances or for your relationships with your friends or family, which is why you must be very careful spending your tax refunds.
When a person files for bankruptcy relief, they are allowed certain exemptions. An exemption basically indicates the type and amount of property that your creditors (and the bankruptcy estate) cannot take from you. In essence, it is the property that you get to keep or the amount of equity you get to keep in your property. The types of exemptions you are allowed to claim vary depending on where you lived prior to filing for bankruptcy protection.
As a general rule, if you have lived in Tennessee for the past two years you would be entitled to claim Tennessee state exemptions. Under Tennessee law, an individual is entitled to claim an exemption of $10,000.00 in personal property. This type of property includes your tax refund! This means that a married couple can claim up to $20,000.00 in exemptions for their personal property – which includes a tax refund. Thus, many times, you are able to protect, or shield your tax refund from the bankruptcy Trustee and are allowed to keep it. Once the exemption is allowed and the case proceeds to a certain point, you can then do whatever you choose with that tax refund and the bankruptcy has no effect on it.
The problem many people face is giving friends or family members a portion of their tax refund before filing bankruptcy. The bankruptcy petition states that you must disclose any payments you make to a creditor that in the aggregate total more than $600.00 in the 90 days prior to filing for bankruptcy protection. Thus, if you owe a family member or friend money and pay them back with your tax refund before you file bankruptcy, you must list this transfer on your petition. If these payments are deemed to be “preferential payments” by the Trustee then the Trustee can sue your family member or friend for a return of those payments.
The petition also requires someone who files bankruptcy to list gifts given to family members if the aggregate of the gift is more than $200.00 within a year of filing. In addition, the petition also requires you to list all property that you transferred within two years of filing the bankruptcy. Thus, if you gift your tax refund (or a portion of your refund) to a member of your family or transfer your refund to a friend or family member, the transfer can be set aside by the Trustee and your family member or friend could be required to turn the money over to the Trustee because it may be deemed a preferential transfer or a fraudulent conveyance. If it is not turned over to the Trustee, your family member or friend could be sued by the Trustee and forced to defend a lawsuit.
It is imperative that you speak with a competent attorney before transferring any portion of your tax refund. There are many pitfalls that may be preventable with the right legal advice prior to filing. Many times, the simplest solution is to just hang onto your tax refund until after you file your bankruptcy case. If you are thinking of filing bankruptcy, before you do anything with your tax refund, consult an attorney.