Tax Refund Trouble? Here’s How to Stay Out of Hot Water in Bankruptcy Court

It’s tax refund season—and if you’re thinking about filing for bankruptcy, there’s one question you’re almost guaranteed to hear during your 341 Meeting of Creditors:
“How did you spend your tax refund?”

This isn’t just small talk. Your answer could significantly impact your bankruptcy case—especially if it hints at misuse of funds.

What Not to Say: The “Bad Faith” Answer

Let’s start with an example of what not to say:
“I got a $5,000 refund and spent it on a vacation just before filing.”

Sounds harmless? Not quite. This raises a big red flag. Courts see using that money on non-essential luxuries as acting in bad faith—especially if the funds could have gone toward repaying creditors.

Luckily, this isn’t common. In over 12 years of practice, I’ve seen just one person try it. Spoiler: I advised her not to file.

Still, if you’re in Chapter 7, such a move could get your case dismissed. In Chapter 13, you might be required to repay that amount to your unsecured creditors anyway.

What to Say Instead: Smart, Necessary Spending

Now here’s a solid answer that won’t derail your case:
“I used my refund to catch up on utilities, fix my car, buy clothes for the kids, or pay for needed home repairs.”

Courts understand life’s essentials. Spending your refund on food, medicine, or overdue rent/mortgage payments is not only reasonable—it’s smart. Bonus tip: save your receipts to show proof of these necessary expenses.

The Most Common Pitfall

The biggest misstep? Repaying a family loan.
Let’s say you gave $5,000 to Mom to pay her back—kind gesture, right? Legally, it’s called a preference. In Chapter 7, that means the trustee can sue your mother to get that money back and distribute it fairly among all creditors.

In Chapter 13, you might still protect your family by agreeing to repay creditors that same amount.