Tax refunds fuel bankruptcy filings; counselor notices shifts in attitudes as bankruptcy becomes more commonplace

March 27th, 2009 by Mike Hinshaw

Tax RefundReports from Florida suggest folks are using this year’s tax refunds in a way that may have been unthinkable only a few years ago while at least one Detroit paper is saying that filing bankruptcy is losing its long-associated stigma of shame.

Writing March 11 in the Orlando Sentinel, staff writer Richard Burnett cites several sources indicating that tax season has also become bankruptcy season: Traditionally, tax refunds have gotten socked away in savings or gone to pay worrisome bills, perhaps a down payment on a new car or equipment–or even an indulgence such as a vacation or luxury item.

But this year, more people are using their refunds to pay for filing bankruptcy.

“Hit by job losses, health problems or heavy mortgage debt,” writes Burnett, “some cash-strapped consumers are counting on refunds to handle the legal costs of filing personal bankruptcy.

‘I’m not kidding when I say nearly every client I have is telling me they are going to use their tax refund to pay for their bankruptcy case,’ said Walter Benenati, an Orlando consumer bankruptcy lawyer. ‘And I don’t see that trend changing any time soon.’ ”

Burnett cites the case of a man who works at Walt Disney World “who was making decent money” but got his hours reduced when the financial crisis hit–then got a double punch when “his bills skyrocketed.” The man said his refund was not enough to cover the entire cost of the filing, but that he had filed early, on purpose, to have the refund ready to use. ‘It wasn’t that much, but it did help some,’ he said.”

Burnett also quotes local bankruptcy lawyer Anne-Marie Bowen, who doesn’t think it’s good money management but recognizes that it’s “tough for people in a financial jam to resist tapping their tax refund because the typical $2,000 to $3,000 refund can cover bankruptcy costs.”

Another bankruptcy attorney Burnett quotes, Jonathan Alper of Lake Mary, indicates that this wave of filings comprises the full spectrum:

“Personal bankruptcies during the recession have run the gamut — rich to poor, executives to construction workers, said . . . Alper . . . .” who went on to debunk the idea that current bankruptcies are catching up with flippers and liars who got caught gaming the system. ‘This is like the typhoon that is sinking all ships,’ he said. ‘We have a lot of people who really did things the right way. They didn’t do anything speculative or imprudent. In many cases, we’re working with small-business owners who had clients who fell on hard times and just couldn’t pay them.’ ”

Two days earlier, in the Detroit News, Jaclyn Trop filed a report with this lead:

“Declaring personal bankruptcy may not carry the same stigma it once did.

“As unemployment rates skyrocket and home values plummet, new attitudes toward debt may explain why more people are letting their homes and other assets go rather than working out a debt repayment plan in the nation’s bankruptcy courts.

‘It’s not being looked at as a personal failure but a product of the times,’ said credit counselor Rachel Hood of Consumer Credit Management in Farmington Hills.”

Trop finds a regional pattern that is emerging nationwide: As the economy worsens, Chapter 7 filings are increasing, not only relative to Chapter 13 filings but also in overall numbers. That’s significant for a couple of reasons. First, the so-called reform of the bankruptcy laws in 2005–pushed hard by the credit card lobby–made it tougher to file Chapter 7. The credit card companies labeled it an essential change to discourage abusers from walking away from credit card debt. Second, the economy has soured so badly that even with stiffer requirements more people are meeting the means test [see more on qualifying for Chapter 7 ].

“Chapter 7 filings for individuals, which liquidate a debtor’s property and convert it to cash for creditors,” writes Trop, “increased by more than 25 percent in the first three quarters of 2008 compared with the entire 12?months of 2007.

“According to data from the Eastern District of Michigan bankruptcy court, which serves the Detroit, Flint and Bay City metro areas, Chapter 7 filings rose from 23,734 for all of 2007 up to 29,933 for the first nine months of 2008 (detailed data is available only for the first three quarters of 2008).

“But while Chapter 7 filings have been increasing, Chapter 13 filings, which allow debtors to keep their assets through a repayment plan, have shrunk from 42 percent of all personal bankruptcies in 2006 to 25 percent for the first three quarters of 2008.

“The uptick in Chapter 7 filings comes despite a change in the federal bankruptcy code in 2005 that makes it harder to qualify for liquidation-style bankruptcy, and encourages Chapter 13 filings, which forgive less debt and require payment plans in most cases.”

Trop summarizes that because “more people are eligible to file Chapter 7 [it] means that incomes are plummeting, too, as work hours are reduced and jobs are cut.”

Trop also quotes the credit counselor again: ” ‘It’s harder to file for Chapter 7, but more people are qualifying,’ Hood said.”

And as far as bankruptcy in general goes? Hood also told Trop that people “are not quite as upset lately. It’s becoming more and more common. People are resigned to that being a fact of life at this point.”