Bankruptcy can be very effective in eliminating debt and getting your life back on track. But for those trying to file for bankruptcy without a lawyer, mistakes can be costly (Read Should I Hire a Bankruptcy Attorney?). Unfortunately, once the bankruptcy is filed, mistakes become very difficult to fix. Here are the most common mistakes I’ve seen made by people filing for bankruptcy without a lawyer, and how to avoid them.
1. Money in your bank account
Having too much money when you file for bankruptcy can be very costly. When you file for bankruptcy, you can exempt (protect) a small amount of money in your bank account. In Arizona, you can protect up to $300 in one bank account. If you are married, then you and your spouse can each protect up to $300 in one bank account. Any money in your bank accounts in excess of that amount is not protected, and the bankruptcy trustee can and will take it.
So, if your paycheck was deposited into your bank account the day before you filed for bankruptcy, the bankruptcy trustee will take most of that money. You may think, well, I’ll just withdraw the money from my account. But that is even worse. Money you are holding in cash is not protected at all, so the trustee will get all of it. You will be required to provide your bank statements to the bankruptcy trustee, so she will know if you withdrew any money from your bank account. Money you are holding in the form of a check is also not protected. So, if you receive a paycheck in paper form and don’t cash it before the bankruptcy is filed, the trustee will still take all of that money. On top of this, if the trustee believes you were trying to conceal assets, she may request that your discharge be denied. In worst cases, concealing assets can also result in criminal charges.
2. Payments to friends or relatives
If you owe money to friends or relatives, it is natural to want to pay off the debt before filing bankruptcy. But doing this is a huge mistake. Any payments you make to friends or relatives within 1 year before bankruptcy will be undone by the trustee. Basically, the trustee will be able to get the amount you paid from the person that you paid. So, the friend or relative you paid will end up with nothing. Obviously, that could make your next meeting a bit awkward.
The same rule applies if you don’t owe anything to your friend or relative, but just give them money to help them out. The trustee can get that money back, unless you have a legal obligation to support the friend or relative.
In some situations, the trustee will be able to go back 2 years from the date of the bankruptcy and get back the money you paid your friends or relatives.
There are some exceptions, and some payments will not be undone. If you pay a friend/relative a small amount, say give them $100 as a birthday gift, the bankruptcy trustee is unlikely to undo the payment. Also, if you get something of equal value in exchange for your payment, then the payment will not be undone. For example, if you reside with your relative and pay him rent for the current month, that payment cannot be undone. But, if you haven’t paid rent to your relative for the last year, and decide to pay the backrent before filing bankruptcy, that payment will be undone.
If you did make a prohibited payment before filing bankruptcy, the bankruptcy trustee may give you an option to pay the money directly. Your friend gets to keep the money, but you have to pay the trustee what you paid the friend. This may help avoid an awkward situation the next time you see your friend. But, you end up paying twice. So, it is really not a good option.
In short, avoid making payments to friends or relatives before filing for bankruptcy.
3. Property transfers to friends or family
This is an extension of mistake No. 2. If you give anything to friends or relatives within 1 year (or sometimes 2 years) before filing bankruptcy, that transfer will be undone. So, for example, if you transfer your car to your child, or buy your child a car, the bankruptcy trustee will be able to get that car, sell it, and pay the money to your creditors.
You can sell property to friends or relatives before bankruptcy. But, the sale has to be for market value, and there must be proof that you actually received payment. So, if you have a car worth $5,000, and sell it to your friend for $4,900, you have nothing to worry about. But if you sell the same car for $2,000, then you did not get market value, and the bankruptcy trustee can get the car from your friend. The trustee would have to pay your friend the $2,000 though.
4. Tax refunds
Tax refunds for the year in which the bankruptcy is filed, and for all prior years, can be taken by the bankruptcy trustee. So, if you file for bankruptcy in 2019, and then get a tax refund for 2018 or any prior year, the bankruptcy trustee will take the entire refund. If you file your tax returns on time, then you will only have to worry about one prior year—for example, in 2019, you have to worry only about the 2018 tax refund. To avoid losing this tax refund, you will have to get it and spend it on appropriate expenses before you file for bankruptcy.
You can also lose a part of your refund for the year in which you file for bankruptcy. So, if you file for bankruptcy in 2019, in 2020 the bankruptcy trustee can take part of your 2019 tax refund. How much the trustee will take depends on when during the year you filed for bankruptcy, and how much of your total income for the year you earned prior to that date. So, if you work the entire 2019 at about the same income, and file for bankruptcy in July of 2019, you’ll lose about half of your 2019 tax refund. If you file for bankruptcy in September 2019, you’ll lose about three quarters (3/4) of your 2019 tax refund. If you get a tax refund every year, losing a part of your refund for just one year may be unavoidable. But, properly timing the bankruptcy may help you minimize how much you will lose.
5. Real estate that is not your home
Any real estate that you own, but in which you do not reside, is not exempt (not protected) in bankruptcy. This would include rentals, summer homes, or parcels of land. You have to determine if you have equity—if the value of the real estate is more than the mortgages on it. If the answer is yes, the bankruptcy trustee can take the real estate, sell it, and pay the money to your creditors. If you do not have equity, i.e. the mortgages are about the same or more than the value of the property, then you should not lose the property in bankruptcy.
6. Personal injury claims
If you are injured before the bankruptcy is filed, the bankruptcy trustee will get all money you may receive for your injury. The exception is any money you get before you file for bankruptcy. This comes up most often with car accidents. Often, the injured person will need medical care, and may not be able to work. The injured person will file a claim against the other driver’s insurance company, and may file a claim with his own insurance company. But, it can take many months or even years to get payment from the insurance company. In the meantime, the medical bills are mounting, and there may be other bills as well. The injured person may need to file bankruptcy to deal with the bills. But if the insurance company has not yet paid when the bankruptcy is filed, the injured person will never get any of the money. Instead, the bankruptcy trustee will get whatever the insurance company pays, and will use the money to pay creditors.
If there is even a small possibility that you have a personal injury claim, you need to evaluate it very carefully before filing for bankruptcy.
7. Inheritance received after bankruptcy
If you become entitled to an inheritance within 180 days after the bankruptcy is filed, the bankruptcy trustee will get your entire inheritance, or as much of it as needed to pay off your creditors. Two things are important to note. First, it doesn’t matter if you knew about the inheritance—even if you did not know about it, you would still lose it. Second, it doesn’t matter when you actually get the money, as long as you become entitled to get it within 180 days of the date the bankruptcy is filed. So, if the person who leaves you an inheritance dies 100 days after you file for bankruptcy, then you will lose the inheritance, even if the money is not distributed until years later.
So, before filing for bankruptcy, it’s important to know if you may be entitled to an inheritance.
Bonus issue: Wages earned but not received before bankruptcy is filed
This is not so much a mistake, as something that can happen, and so you should be aware of it. In Arizona, 25% of the wages you get are not exempt (not protected). This means that if you work before bankruptcy is filed, but do not get paid for that work until after you file for bankruptcy, you can lose 25% of the wages for this work. Most people get paid on a 1- or 2-week delay. So, no matter when you file for bankruptcy, there will always be some wages you get after bankruptcy for work done before bankruptcy. Most of the time the bankruptcy trustees in Arizona will ignore these non-exempt wages. However, every now and then, they will ask for the non-exempt portion of these wages, especially if the amount is more than a couple hundred dollars.
Can these bankruptcy mistakes be corrected?
The short answer is yes. How you can correct them depends on whether you caught them before or after filing for bankruptcy. If you caught them before filing for bankruptcy, then you can simply make the necessary adjustments. For example, if you have too much money in your bank account, you should wait to file for bankruptcy until after that money is spent.
But what if the mistake cannot be corrected? For example, say you have a rental property that you want to keep. Or you realize that you will get an inheritance after you file for bankruptcy. In such cases, Chapter 13 bankruptcy may be a solution. In Chapter 13 bankruptcy, the trustee will not take any of your property, and you can make payments on some of your debt. For more, see Common Question About Chapter 13 Bankruptcy. Chapter 13 bankruptcy can get complicated, so it’s best to talk to a bankruptcy lawyer about it.