Does Using Your Tax Return for a Bankruptcy Case Make Sense

How Applying Your Tax Return to a Bankruptcy Case Could be a Prudent Financial Planning Strategy

 

Tax Refund for Bankruptcy

Bankruptcy and Your Tax Refund

For many trapped in the cycle of credit card use and minimum payments, the question of how to use a tax refund is not a simple one.  Having access to cash is appealing.  In the short term, a tax refund may allow you to buy groceries without a credit card as well as make payments on your credit card balances.  On the other hand, you could also apply your tax returns to your credit cards and begin to chip away at your credit card debt.  The first path is almost never a sound one.  A tax refund is a once per year occurrence–the money will soon be gone but your credit card debt will remain.  Applying your tax refund to your credit card debt might make sense in some situations but, for many unfortunate people, that use of a tax refund would benefit creditors while providing no .  Let’s consider a couple of hypothetical situations.

[perfectpullquote align=”left” cite=”” link=”” color=”blue” class=”” size=”22″]”If your credit is already poor, filing a bankruptcy case can put you on the quickest path to rebuilding your credit”[/perfectpullquote]

First, let’s assume that you owe $5,000 in credit card debt with no other significant unsecured debt and you are current on all of your debt obligations.  If you receive a tax refund of $3,000 and you exercise the discipline required to plunk all of that down on your credit card obligations.  The result here could be good.  Your debt to income ratio will improve and you will be better situated to pay down the credit card debt over the coming months.

Second, let’s assume that you owe $15,000 in credit card debt and another $10,000 in unpaid medical bills.  You are consistently behind on your credit card bills and are routinely penalized with late fees and interest charges.  The same $3,000 refund will not put you in a better position to address your debts–rather it is something like dropping a teaspoon of water upon a raging fire.  Your financial position and credit score were poor prior to your receiving your tax return and will not be substantially improved by handing your tax return to your creditors.  Moreover, just as in the prior example, spending your refund on day to day living expenses offers no hope of long term improvement in your financial position.

Thus, in the first hypothetical, paying down debt with your tax refund is sensible.  In the second, it is not.

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Tax Return and Bankruptcy – A Viable Solution

The debtor in our second hypothetical, with $25,000 of unsecured debt and a $3,000 tax return could be better served by filing a chapter 7 bankruptcy case.  A case under chapter 7 of the United States Bankruptcy Code would allow that debtor to get a fresh start.  Most consumer chapter 7 bankruptcy cases last a few months and debtors never see the inside of a court room (rather, they simply meet with a trustee at a meeting of creditors that lasts only minutes).   While certain types of debt are not dischargeable (e.g., student loans, domestic support obligations and some tax obligations and criminal fines), most common unsecured debt (like credit card debt and medical debt) is dischargeable.

By using part of the $3,000 tax return to file a chapter 7 bankruptcy case, the debtor in our second hypothetical has a drastically improved debt to income ratio and more available cash from month to month.  That newly available cash flow can serve to improve quality of life and enable the debtor to begin to accumulate savings and prepare for retirement.  While the filing of a bankruptcy case does adversely affect one’s credit score, if your credit is already poor, filing a bankruptcy case can put you on the quickest path to rebuilding your credit by responsibly paying down your debts as they become due.  Contact a Pittsburgh Bankruptcy Lawyer today to find out whether a bankruptcy case could improve your financial future.

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We are a debt relief agency, we help people file for relief under the United States Bankruptcy Code.

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