Tis the season for tax refunds.  In this season, a number of people find themselves in an odd conundrum.  Their debts are eating them alive and they are preparing to file for bankruptcy, but they have a small tax refund from the IRS coming and so they are instructed to “spend it on exempt purposes.”   This conundrum does not just apply to tax refunds.   In a surprising amount of cases, a person my find himself with more money than he is allowed to have on the date of filing shortly before filing.  The tricky part about this is that you are allowed to spend the money, but you are not exactly allowed to do with it as you wish.  For example, you can’t (read also: should not) give the money to a family member or friend in repayment of a debt (this would be considered a preferential payment), you should not give it to someone to ‘hold on to’ until your bankruptcy is over (this would be considered a fraudulent transfer, believe it or not), and you most definitely should not use it to purchase something that the trustee will consider a non-exempt asset and so take away from you.

Instead, you should use the money for exempt purposes.  This blog post will discuss what ‘exempt purposes’ mean for someone living, and filing for bankruptcy in Arizona. (NOTE: This is exclusively about Arizona exemptions, so if you have never lived in Arizona, and you don’t now, this will be an overview of how it works in Arizona, but it won’t help YOU, as all states have different exemption laws.).

So, what to do with the money, then?  Well, first of, you can pay your current monthly bills (not your creditors, but rather your utilities, mortgage, rent, car-payment, phone bill, whatever it may be).  Do NOT pre-pay anything!  Then, go shopping for groceries and supplies (think toilet paper).  In Arizona, you can have up to 6 months worth of groceries and supplies on the date of filing.  Be sure to keep receipts for everything you buy, and if you go an a grocery shopping spree within a couple of days before filing, be sure to list it on your asset schedule.  You want to be able to show the trustee that you used the money for something you are allowed to have, something that is protected.  Therefore, stay away from buying anything shiny (think jewelry), anything that uses electricity (think big old flat screen), and anything that you could sell again after your bankruptcy is done.

Now, what if you are getting a sizeable refund, more than what you could reasonably spend on groceries and supplies.  Well, there are a few options, the most basic ones are as follows:

  • Pre-pay your mortgage/pay down on your principal:  In Arizona you are allowed to have up to $136K of equity ($150K if you have had the house for more than 10 years) in your HOME.
  • Prepay you car payment: As long as the equity in your car is no more than $5K, there is no problem.  ONLY do this if you intend on keeping your car.
  • A better alternative, especially if you are currently in a position where making the monthly car payment is a struggle from month to month, is to use the money to purchase a car, free and clear.  As long as the car is not worth more than $5K, you get to keep it, no questions asked.  This will then allow you to surrender the other, financed vehicle as part of your bankruptcy, and live car-payment free.  This can be a huge burden off your back, and in light of the current market, you CAN get a pretty decent car for $5K. 

These are some of the most common examples of ‘exempt purposes’.  The most important lesson of this blog post is that there is a right way to plan for your bankruptcy, that is recognized and allowed by the law, and then there is a wrong way, and the wrong way can lead to a number of headaches down the road (including but not limited to having the trustee knock on your mom’s door telling her that she has to return the money you just paid her back).  If  you are contemplating bankruptcy, it is important to speak to an attorney as early in the process as possible, so you can be sure to avoid some of these common mistakes, and put yourself in the best possible starting position after your bankruptcy, without unwittingly defrauding your creditors.

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