If you are considering bankruptcy, you may not want to use your tax refund to pay your friend or family member back. Bankruptcy has certain rules and regulations to prevent fraud and other unfair situations. Paying family members back with your tax refund before you file for bankruptcy can create problems with your bankruptcy case. It is considered to be an unfair “insider” payment.
The bankruptcy code allows for the reversing of payments to relatives, friends, or other “insiders” that occurred within one year before your bankruptcy filing date. By “reversing” the payment, the trustee (the government overseer of your case) will usually just make you pay that amount towards your bankruptcy creditors. Although you may have just borrowed money from a family member recently to “get by,” repaying your family member with your tax refund can be a huge mistake.
An example of reversing a relative payment would be as follows. If you paid back $4000 to your father within one year of filing bankruptcy, the bankruptcy trustee can just make you pay $4000 into your bankruptcy filing. Your bankruptcy case would get much more expensive to complete if you had to pay $4000 to your creditors through the trustee!
If you do not pay the trustee, then the trustee can go after your family member to get the payment back. If the trustee cannot collect the payment from any source, you could have your bankruptcy discharge revoked sometime in the future. If your discharge is revoked, it would be as if you never filed for bankruptcy.
In certain situations, the application of this law may seem harsh. It is very common for families to operate as a singular economic unit. Therefore, the one year barring of repaying family members can seem a little extreme or excessive.
In reality, however, it is simply too difficult to regulate and protect the bankruptcy system without these restrictions. It is fraud or at least unfair to favor one creditor being repaid over another creditor. Bankruptcy seeks to treat all creditors evenhandedly according to the bankruptcy code. Payments to relatives are a classic method of depleting resources before filing for bankruptcy. Although some people may be treated too harshly for a relative repayment, the concept of the one year restriction is still sound. It prevents a great deal of fraud, unfair dealing, and the hiding of assets during bankruptcy.