Tax Refunds can be a big deal when factored into a bankruptcy filing — for two main reasons.
Be Mindful of the Bankruptcy Exemptions for Tax Refunds
First, tax refunds can only be protected up to a certain amount. When you file for bankruptcy, you can protect various assets, and tax refunds is one of them — but only up to a certain amount.
In what is very good news for New York residents, the exemption for tax refunds will increase after January 23, 2011. See: The New, New York Bankruptcy Exemption Statutes for 2011 . I will post a detailed article in the next few weeks about protecting a tax refund while utilizing the new, New York state exemption.
Basically, each person who files who need to protect their home with a homestead exemption, can also protect up to $1,000 worth of cash, money in the bank, and tax refunds.
For those who do not need the homestead exemption, they may be able to use the federal exemptions, which up until now has not been a choice for New York bankruptcy filers. The federal exemptions provide for a wildcard exemption that can enable you to protect other miscellaneous assets up to $11,975 per person That is very generous!
Be Wary of the Effect of the Refund on the Bankruptcy Means Test
Second, the tax refund is considered income for purposes of calculating the means test, and adding the tax refund to the means test can make it harder for some people to become eligible for Chapter . For those filing Chapter 13, a tax refund can result in having to pay a larger Chapter 13 monthly payment. See: How a Tax Refund Can Mess Up Your Bankruptcy Means Test 
Tax Refunds and Bankruptcy is such an important topic that last year I devoted an entire week’s worth of posts to the subject: Tax Refunds and Bankruptcy — Everything You Need to Know . I will write a few additional posts this year.
Be Careful How You Spend Your Refund If You Are Planning to File for Bankruptcy
In the meantime, if you get your tax refund, be careful how you spend it. You should not repay any loans to friends or family members because doing so could be considered making a “preferential payment.”
A preferential payment is when you “prefer” a certain creditor, even unintentionally, and that creditor gets more than he or she would have gotten otherwise. If you file bankruptcy within a year of paying back a family member, under certain circumstances, the bankruptcy trustee has the right to sue the family member to recover the money and bring it back into a “bankruptcy estate” so that it can be distributed in a fairer manner to all creditors.
Also, don’t spend the money frivolously by taking a vacation or buying luxury goods. Doing so can be considered inconsistent with the good faith necessary to receive a bankruptcy discharge.
So what can you spend your refund on? Bankruptcy attorney’s fees is one. Many of my clients are able to file for bankruptcy relief in the Spring, because that is when they typically receive their tax refund.
Tax refunds can also be spent on household repairs, car repairs, food, clothing, mortgage or rent payments, car payments, property taxes, fuel oil, child support arrears and some other reasonable items. However, seeking advice from an experienced bankruptcy attorney is your best bet.