As a bankruptcy attorney in Phoenix, I find that most people considering filing for bankruptcy have no idea that how they spend their tax refund is a very serious issue. In fact, it is so important that it can affect when someone files for bankruptcy.
Bankruptcy laws prohibit you from spending tax refunds frivolously. If you receive a tax refund and spend it on frivolous items within 90 days of filing for bankruptcy, the court may demand that you pay it back into the bankruptcy for your creditors. It is best to spend it on necessities like rent, food, gas and utilities. Don't spend it on creditors you intend to discharge, like credit cards and medical bills, because the bankruptcy court may seize it back and redistribute it amongst all your creditors. And if you do intend to file for bankruptcy, you're really just throwing that money away by paying the creditors you intend to write off.
Tax refunds received during your bankruptcy will be seized and distributed amongst your creditors. So if you are expecting a tax refund, it's best to file bankruptcy after you have received it and spent it on regular expenses, not frivolous items. The timeframe for scrutinizing your tax refunds lasts well after your bankruptcy is discharged, until you receive your next refund. The bankruptcy court will likely seize that refund too, so many of my clients choose to have the least amount possible withheld from their paychecks after filing bankruptcy to avoid that scenario.
Be aware that you could get into real trouble regarding your tax refund if you are not careful. A couple of weeks ago when I was in a 341 Meeting of the Creditors with a client, we observed another bankruptcy proceeding go sour. The woman filing bankruptcy told the trustee that she had received a $5000 tax refund a few days earlier, which her daughter took out of her checking account. The trustee announced that she was going to hire an attorney and sue her daughter to get the money.
The lesson is to always be upfront about your activity and consult an attorney about bankruptcy so you don't make mistakes like that. Filing for bankruptcy is a serious issue, and not to be taken lightly. An attorney will guide you through the process and ensure you don't make costly mistakes.
One final question I'm often asked: Can you safely spend your tax refund on a bankruptcy proceeding, if needed? Yes. More than 200,000 households around the country will do that this year, according to a new study by the National Bureau of Economic Research, USA Today reports.