How to Spend Down Tax Refunds in Chapter 7 Bankruptcy

If you can't exempt your tax refunds in Chapter 7 bankruptcy, you might be able to spend them down before you file.

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Question

I cannot exempt all of the tax refunds that are part of my bankruptcy estate. Is there any other way I can keep them?

Answer

If you won’t be able to exempt all of your tax refunds in Chapter 7 bankruptcy, and you receive them before you file, you may be able to use the refunds to pay some expenses or purchase some items. In that way, you don’t “lose” the refund in bankruptcy. If you plan to do this, be careful. Follow the below guidelines.

(To find out what tax refunds are part of your bankruptcy estate, see Can I Keep My Tax Refund in Chapter 7 Bankruptcy? To learn how bankruptcy exemptions work, see Bankruptcy Exemptions.)

Use Tax Refunds for Reasonable and Necessary Expenses Only

Your trustee is likely to ask you to what you spent the refunds on, so it’s a good idea to hang on to receipts and keep an accounting, so that you have the information ready if your trustee requests it. You should only use your refunds for reasonable and necessary expenses. If you spend your refund frivolously, such as on luxury purchases or travel, you may have issues with your trustee or creditors.

Exercise Caution if Using Tax Refunds for Normal Living Expenses

While normal living expenses, such as rent and utilities, may be reasonable and necessary, be cautious about using your refund for those expenses if you have monthly income with which you normally pay those expenses. If you spend your refund on regular monthly expenses, it may cause your trustee to question how you spent your regular monthly income.

Do Not Use Tax Refunds to Repay Friends or Family

You should avoid using your tax refunds to repay debts owed to friends or family members. If you do so, you create a “preference,” which means you spent money on friends or family members instead of repaying your creditors, who are legally entitled to payment. Your trustee can go after your friends or family to recover the money and give it to your creditors. (To learn more, see The Bankruptcy Trustee and Preference Claims.)

by: , Attorney

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