While it seems strange, sometimes folks in need of bankruptcy relief have money that they need to spend before their case can be filed to maximize their fresh start by getting set up in the best possible way. Even if you don’t have a bunch of money to spend before filing your case, it’s important to know what to avoid in the months leading up to your filing, so you don’t inadvertently make your case more complicated than it needs to be.
Written by Attorney Eva Bacevice.
Updated September 23, 2020
While it seems strange, sometimes folks in need of bankruptcy relief have money that they need to spend before their case can be filed to maximize their fresh start by getting set up in the best possible way. This is especially true during tax season when many low-income Americans receive significant tax refunds and tax credits they’ll need to spend before their case can be filed. Even if you don’t have a bunch of money to spend before filing your case, it’s important to know what to avoid in the months leading up to your filing, so you don’t inadvertently make your case more complicated than it needs to be.
Why would someone need to spend down money before filing Chapter 7 bankruptcy?
A Chapter 7 bankruptcy filing gives you many benefits. It gives you the opportunity to walk away from some, or all, of your debts. Whether or not you can discharge a debt entirely depends on the type of debt. You can fully discharge any unsecured debt, like credit cards, or medical bills. Some debts are considered nondischargeable, such as alimony and child support, and very often student loans. Filing bankruptcy also sets the automatic stay in motion, which stops any garnishment or repossession as soon as the case is filed.
When you file for Chapter 7 bankruptcy you will be filling out an official bankruptcy petition and forms that require you to list all of your assets and liabilities as of the date that you file. You’ll list all of your assets (things you own) on Schedule A/B. You’ll be signing under penalty of perjury that you’ve included all of your information to the best of your ability. This includes any cash that you have or any money in your bank account. You can protect most (or even all) of your assets through exemptions, which are rules in bankruptcy that allow you to protect your assets up to varying dollar amounts.
Every state has its own set of exemption laws for bankruptcy. There are also federal bankruptcy exemptions available, and some states allow the filer to choose whichever they prefer at the time of filing. In both state and federal bankruptcy exemptions, there are exemptions for many specific property items, like your car or household possessions. There usually isn’t a specific exemption for cash or savings accounts. Often that can only be protected through a wildcard exemption, if available.
Whether you can protect your cash and bank accounts depends on whether your state has specific tax refund protections (like Earned Income Tax Credit or theChild and Dependent Care Tax Credit), allows some wildcard exemption amount or whether you are using the federal exemptions. Even so, you might not have enough left of your wildcard to exempt all of a tax refund or cash in the bank. It’s important to know that if you’re filing your Chapter 7 bankruptcy close to tax season that you should list any expected tax refund as anticipated on your Schedule C exemptions form. Simply filing your tax return after your bankruptcy case is not enough to protect the funds, they must be explicitly listed and exempted on your forms.
Things you can spend your money on
If you find yourself in circumstances where you have too much cash or funds in a bank account to fully protect with available exemptions, it’s important to know how to spend down the money before filing your case in ways that are allowed. First, any money going toward your regular monthly living expenses should be fine, so you can make sure to pay all of those bills before filing your Chapter 7. Additionally, you can also buy necessities for yourself and your family, like clothes, household supplies, and furniture. It’s important to keep these purchases reasonable, however, because if you spend a large amount right before filing your case, these purchases very well might be examined by your Chapter 7 trustee.
Another item to consider would be a car that you can purchase outright, so long as its value is less than the exemption amount allowed for vehicles. This is an easy filing expense to justify if you’re surrendering your current car in your bankruptcy. This allows you to walk away from any obligation to continue payments on that car loan or lease and you’ll have the peace of mind knowing that you have alternative transportation already secured.
Best practices while spending down money before filing bankruptcy
As mentioned above, any purchases that are made right before filing for Chapter 7 bankruptcy may be examined by your Chapter 7 trustee to determine that these were allowable purchases. As such, there are some best practices to keep in mind if you’re spending down income in anticipation of filing bankruptcy.
Things you should avoid
Just as there are things you can spend money on before filing for Chapter 7 bankruptcy, there are also payments you should avoid. You should avoid making any unreasonable or unnecessary purchases at this time. There isn’t a specific definition attached to unreasonable or unnecessary but it’s good practice to avoid luxury or high-end purchases and generally stay within the realm of your monthly income. You should always keep your receipts and have those available to show to your trustee if asked.
You should avoid spending money on non-exempt assets. If your goal is to spend money to protect as much as possible then you’re not achieving it by shifting assets from one form that isn’t protected (cash or bank account) into another unprotected item. Ideally, you should spend funds in a manner that allows you to maximize your exemptions to protect as much as possible.
Don’t pay back family members
It’s also very important to not use your money to pay back family members or friends that you owe within a specific period of time before filing Chapter 7 bankruptcy. If you treat one creditor in a manner better than the others this can be seen as a preferential transfer, which is not allowed by the bankruptcy court. It makes perfect sense that you might feel differently about money that you owe a family member or friend than a credit card company, but in the eyes of the bankruptcy court, they are treated the same.
There is specific terminology surrounding these issues that you should know. Any payment or transfer to a creditor within a particular time period before filing bankruptcy is called a preferential transfer. This period of time for any payment(s) exceeding $600 to a single creditor is within the 90 days before filing your case. The look-back period extends to a year before you file if you are dealing with an “insider” creditor, such as a relative or someone with an influential relationship with you. A bankruptcy trustee has the ability to avoid (or undo) the transfer. After the trustee unwinds the transfer and obtains the funds back, they can then put the money back into the bankruptcy estate, and spread it fairly among the creditors. You’ll also need to look out for any fraudulent transfers, which are transfers made with the intent to hide assets or transfers of property for less than the fair market value before bankruptcy.
Finally, it’s also not a good plan to take cash advances or withdraw cash to simply spend it. You’ll need receipts for everything you spend the cash on. And, even if you’re hoping to come out of your bankruptcy with one credit card relationship intact, you can’t choose to pay off one to keep at the expense of the others, as that is still considered a preferential payment.
What happens if I did something I shouldn’t have done?
Ideally, once you know about these potential issues you can avoid getting into any of these gray areas of spending before filing bankruptcy. Or if you haven’t filed yet, you might be able to wait out the look-back period before you file. If, however, you’re finding out about this after you’ve already paid back your mother, there are some steps you can take. If possible, undo the transfer to get the money back, and make sure to disclose this to your trustee. In a worst-case scenario, the trustee could sue to recover the money and if the funds are non-exempt, they could be redistributed to the bankruptcy estate. Additionally, the trustee can demand any funds the filer can’t account for. While none of these results sound appealing, it still beats the alternative because if you are found to be hiding assets or intentionally committing bankruptcy fraud, that can result in the loss of your property, your bankruptcy discharge, and even lead to a criminal investigation. Your best course of action is to disclose any problematic payments and try to correct them during your bankruptcy case.
Bankruptcy exists as a remedy to help people out when they’re in a bad financial situation. To fully benefit from the debt relief, it’s important to make sure that you’re getting the most out of it while following the necessary rules of the Bankruptcy Code. If you find yourself having more cash or savings than you can protect there are ways that you can spend down those assets before you file to maximize what you can protect, while still reaping the benefits provided by the bankruptcy system.