In part 1 we learned about one of our clients who decided to pay off her tax debt with a credit card prior to filing for bankruptcy. Sounds clever enough, doesn’t it? After all, she took recent tax debt which cannot be eliminated by filing for bankruptcy, and turned it into credit card debt, which can be eliminated when filing. We will learn exactly what’s wrong with that scenario now.
There are a couple of different legal rules in operation here, both of which make it impossible for her to get away with what she did.
First, the court treats as fraud any charges you make when you know they will get eliminated in bankruptcy. Any time you make a significant charge on a credit card and file bankruptcy shortly thereafter, the court will view this as fraud and make you pay it back.
Second, a special law was added to the bankruptcy rules back in 2005. It specifically states that if a dischargeable credit card is used to pay off a non-dischargeable debt, the debt becomes non-dischargeable. In other words, when a credit card that can be eliminated in bankruptcy is used to pay off a debt that will not be eliminated, the credit card can no longer be eliminated in your bankruptcy. This is exactly what our client did when she paid off her taxes with her credit card.
So we are back to the moral of the story. If you are in the process of filing for bankruptcy, don’t do anything without asking your attorney first. If you feel like you discovered a clever way to eliminate a debt or protect and asset, just ask her first. There are plenty of things you can do before filing, and plenty more that you can’t.