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Be wary of using tax refunds when considering bankruptcy

As we enter the second month of the New Year, tax-filing season is starting to kick into high gear. For some here in Wisconsin, that means the possibility of receiving a nice little tax refund from last year’s hard work – money that may be meant for a vacation, new spring wardrobe or even as part of a down payment on a new car. However, for those struggling with debt, this money could be earmarked to pay down a loan or to temporarily satiate creditors.

If a person is considering bankruptcy at the time of a tax refund, it is important to be cautious about how and where the money is spent. When the time comes to file for bankruptcy, a trustee will be assigned to review the bankruptcy estate and help sort out the financials. These trustees rarely view extravagant or unnecessary spending of tax refunds in a positive light; taking one last vacation prior to bankruptcy is not a good idea if there is mounting debt. On the other hand, spending on life’s necessities – food, clothing, mortgage or even a car payment – will likely be approved by the trustee.

Regardless of how one plans to spend the money, it can be prudent to keep very detailed records. A trustee will likely want to trace how the money from the tax return was spent specifically so it can be separated from the remaining finances. This can be difficult, for example, if the tax refund is deposited into a bank account that sees a lot of transactions coming in and out – the commingling of funds muddies the waters. One way this could be avoided would be to open a new account just for the refund, so all transactions going in and out could be traced.

The type of bankruptcy – chapter 7 or chapter 13 – can also have an affect on how the refund will be handled. Each person’s situation is different, and so it can be important to obtain counsel from an experienced attorney before stepping out onto the path towards financial recovery.

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