The first third of the year is one of our busier times, with people tackling their financial troubles as a New Year’s resolution and also one of the times we have to be most careful with the timing of a bankruptcy filing, because of the pending arrival of tax refunds. While most people aren’t filing bankruptcies this spring (I hope), borrowing some of the advice I give to my clients regarding their disposition can be useful to those without great financial distress, or useful to keep that distress at bay.
When a person files a bankruptcy, all of their property (and property rights, with a few exceptions) that they owned as of the date of filing become part of the bankruptcy estate, which is then used as the basis for getting money to creditors.
Debtors (the people filing the bankruptcy) can exempt, usually under state law, certain amounts of value in certain types of property, thus keeping it and protecting it from being used to generate money for creditors. This is how people can file bankruptcy and keep most of their stuff, with a few wrinkles, of course.
Included in this pile of property rights is the right to receive an income tax refund. The prospect of giving up their tax refund is not something that most people enjoy, so often we will delay a bankruptcy filing to allow a client to use the refund wisely and not surrender it to their case.
How they spend the refund is also important and if a debtor has paid the money to the wrong parties, that transaction can be reversed in the bankruptcy case, adding annoyance and expense to the already humbling bankruptcy experience.
While it is unlikely that you will have your tax refund expenditures reversed, spending your refund unwisely can leave you on the road to bankruptcy, or at least make the ride bumpier than it has to be. Some priority tips:
- Start with catching up on any core living expenses, especially your mortgage or car payment. These and your utilities are the foundation of your daily life, so take care of those first if need be.
- Apply some of the money to your debt reduction plan. You do have one of these, right? Reducing or eliminating payments on high-interest debt will create money for you year-round, not just once in the spring, providing that you don’t re-grow the debt later.
- Plan for your upcoming “spike” expenses. Taking a family vacation this summer? Know you need some new tires soon? Setting the money aside now will keep you from financing the purchase later, once again saving you money all year long.
- Save some money for retirement or college. If you are eligible to open a Roth IRA, you can have that money grow tax-free till retirement and perhaps start a good habit along the way. Missouri offers a tax deduction for money contributed to their Education IRA and 529 plans, giving you an incentive to save and a head start on next year’s refund.
These priorities form the basis of almost every financial plan I have ever been exposed to. Cover the basics, develop and execute a debt reduction plan, then save for emergencies, single expenses and retirement/college.
You may have noticed that buying a new flat-screen TV was not on the list above.
While nobody appreciates watching Charlie Sheen melt down on 54 inches of high-definition liquid crystal glory more than I do, I would wait until after I had addressed the above concerns before spoiling myself so thoroughly.
Take care of the other items and there will be time and money for “winning” and tiger blood soon enough.
