Tax Refunds in Bankruptcy – Don’t Spend Them Without Talking to Your Lawyer First!

It’s tax refund season. If you are currently in a bankruptcy, you should not spend your tax refund before talking to your lawyer! Otherwise the court may deny or revoke your discharge. That is a double-whammy — you’ll have a bankruptcy on your credit report but not wipe out the debts!

The Eighth Circuit Bankruptcy Appellate Panel recently reaffirmed this basic principle. An Iowa man had filed Chapter 7 bankruptcy. The bankruptcy trustee advised him at the meeting of creditors hearing that he should not spend his pending tax refund until the trustee had a chance to determine if some or all of it should be paid to creditors. He also warned not to spend it even if the court granted a discharge in the meantime. To top it off, he gave out a memo that specifically repeated these directions.

Like watching a train wreck in slow-motion, you know what happened next. The debtor received his discharge and then his tax refund. Predictably enough, he spent it. But, as we’ve said here before, the discharge doesn’t close the case. He said he thought the discharge order meant that the trustee did not want the refund anymore and said he didn’t read the written notice he was handed. Oops!

The bankruptcy court found that he had been given plenty of warning so that he knew or should have known not to spend the refund. It revoked his discharge for failing to turn over property of the bankruptcy estate to the trustee. The BAP affirmed that decision.

Now here’s the kicker: The amount of money at issue was only $1,556.11. So our poor guy in Iowa lost his ability to wipe out his debt — no doubt several times as much — over less than $2,000. It just doesn’t pay to ignore the little things in bankruptcy court.