Chapter 13 Bankruptcy Protection of Tax Refund the Matter of in Re Gibson

Tax Refunds After Filing for Chapter 13 Bankruptcy

In Chapter 13 Bankruptcy the Chapter 13 Bankruptcy Trustee will often attempt to seize or attach the tax refund of the Chapter 13 Debtor. The position of the Chapter 13 Trustee is that the tax refund received by the Debtor is additional disposable income that ought to be contributed to the Chapter 13 Bankruptcy Plan. Even in jurisdiction in which a tax refund is considered exempt, or for which there are available exemptions to protect the tax refund, the Trustee will likely argue that the tax refund, as disposable income, should be delivered to the Trustee in order to contribute such monies to the Chapter 13 Bankruptcy Plan.

In some instances the contribution of the tax refund to the Chapter 13 Bankruptcy Plan operates as a sort of credit. For example, if the Debtor’s Chapter 13 Bankruptcy Plan offers a repayment of 100% to the unsecured creditors and no other creditors are being paid through the Plan then any contribution of tax refund monies will reduce the balance owed to such creditors pursuant to the Chapter 13 Bankruptcy Plan.

However, if the debtor is offering a 10% repayment to the unsecured creditors pursuant to the Chapter 13 Bankruptcy Plan, and no other creditors are paid through such Plan, often the Trustee will not apply the tax refund monies as a reduction of the 10% the Debtor is paying to the unsecured creditors, but simply pay a larger dividend to the unsecured creditors than that provided for in the Chapter 13 Bankruptcy Plan. For example, if the 10% dividend to the unsecured creditors offers to pay a total of $5,000 to such creditors, and the Chapter 13 Bankruptcy Trustee receives tax refund monies in the amount of $1500, the Trustee may eventually disperse $6,500 to such creditors. If an additional tax refund is received in the amount of $2,000, the Trustee may eventually disperse $8,500 to such unsecured creditors.

This treatment of tax refunds is a dramatic hardship for the debtors seeking relief through Chapter 13 Bankruptcy. There are a number of methods to counter the position of the Chapter 13 Bankruptcy Trustees, at least in the Middle District of Florida, Tampa Division. One method is for the Debtor to adjust his or her withholdings in order to defeat the possibility of any tax refund from the Internal Revenue Service. Another method is for the Debtor to claim that the refund is necessary to fund a necessary expense that was not accounted for when the Chapter 13 Bankruptcy was filed. For example, if the Debtor needs the tax refund monies to pay for repairs to a disabled air conditioning unit, or the Debtor needs repairs to the roof of his or her dwelling, the Debtor or Bankruptcy Attorney can make application to reserve the tax refund for such purposes.

A third method to defeat the actions of the Chapter 13 Bankruptcy Trustee may be found in the United States Bankruptcy Court, in the Eastern Division of Illinois, in the case of In Re Gibson. In Gibson, the Debtor claimed his grandson as a dependent and received a child tax credit and earned income tax credit when he filed his tax returns. The debtor paid 50% of is refund every year to the mother of his grandson for the grandson’s support. In 2016 the Debtor prorated his share of the tax refund, divided it by 12 and added that amount to his monthly income in Schedule I and his current monthly income or CMI. The Debtor then deducted the expenses he incurred to support himself and his dependents, producing a monthly Chapter 13 Bankruptcy Plan payment of $525. His proposed Chapter 13 Plan offered to pay the Chapter 13 Trustee $525 per month for 36 months.

The Chapter 13 Bankruptcy Trustee objected to the Debtor’s Chapter 13 Plan. The Trustee argued that the Debtor must pay all tax refunds he received during the course of his Chapter 13 Bankruptcy, in addition to the monthly Chapter 13 payments. The Bankruptcy Trustee also argued that the Debtor’s payment of 50% of the tax refund to the mother of his grandson for the grandson’s support was objectionable.

The Bankruptcy Court referred to the case of In re Morales, a Northern District of Illinois case decided on February 27, 2017. The Bankruptcy Judge provided a summary of Morales. The Bankruptcy Court stated:

“Under Section 1325(b), if the trustee objects, a debtor’s plan cannot be confirmed unless the debtor devotes all of his projected disposable income to the plan. Disposable income is current monthly income (CMI) minus reasonably necessary expenses. CMI is the average of the debtor’s gross monthly income for the six months preceding the petition date. CMI includes all income whether received weekly, monthly, annually, or on an irregular basis. Income received from tax credits must be included in CMI. If income is not received on a monthly basis, the debtor must determine the amount received annually, divide that number by 12, and disclose the resulting figure as monthly income on Schedule I. The debtor must also include this amount in his CMI.”

The Bankruptcy Judge, Carol A. Doyle, continued:

“Once the CMI is calculated, Section 1325(b)(2) permits the debtor to deduct from it the expenses reasonably necessary for the support of himself and his dependents. As with his income, the debtor should prorate his annual or irregular expenses into monthly amounts. He may subtract his expenses from all the income he receives, including income received annually through tax credits or income tax refunds. The amount left after the debtor deducts his reasonable expenses from his CMI is his projected disposable income-the amount he must pay to creditors under his plan. If the debtor calculates his CMI and reasonably necessary expenses correctly, he need not pay any tax refunds to the trustee during the course of the plan.”

Bankruptcy Judge Doyle then addressed all four of the Bankruptcy Trustee’s objections. First, the Trustee argued that the Debtor may not prorate his annual tax refund and the extra $100 he receives per month is illusory. Second, the Trustee argued that prorating the income renders the Bankruptcy Plan unfeasible because the Debtor would not have sufficient cash flow to make the plan payments. Third, the Trustee argued that the debtor’s calculation of expected income from tax refunds was not accurate. Fourth, the Trustee objected to the Debtor’s support payments to his grandson’s mother.

Judge Doyle found none of the Bankruptcy Trustee’s arguments to be valid. Judge Doyle wrote that the Trustee’s contention that the prorated income is illusory, is “not only meritless, it is self-contradictory.” Continued Judge Doyle, “The trustee contends that the debtor must include the tax refunds and tax credits in CMI, but she objects when he does just that by including the income in Schedule I and his CMI.”

The Judge also found that the argument the pro-rating of the income renders the Chapter 13 Bankruptcy Plan unfeasible was also unpersuasive. The Judge argued that the Debtor could simply adjust the timing of the payment of expenses so that he could timely make the plan payments. The Debtor did in fact timely make all of his plan payments.
The Bankruptcy Judge then addressed the third contention of the Chapter 13 Trustee that the Debtor’s calculation of expected refunds from tax returns was not accurate. The Trustee complained that the amount of the Debtor’s tax refund differed significantly in the prior three years, and the only method to ensure that all possible disposable income in the future was paid to creditors was to require the Debtor to pay all future tax returns to the Bankruptcy Trustee.

The Bankruptcy Judge replied to the third contention of the Bankruptcy Trustee:

“The trustee’s position is based on the faulty premise that Section 1325(b) requires a debtor to pay all possible future disposable income to the trustee. It requires no such thing. Instead, as the Court held in Hamilton v Lanning, 130 S Ct 2464 (2010), the debtor must calculate his plan payment based on income in the past 6 months (or in the case of annual income, the past 12 months) and current expenses. These amounts are used to calculate projected disposable income unless changes are “virtually certain” to occur. If there are significant unexpected changes in income or expenses after confirmation, Section 1329 permits parties to seek modification of the plan. Under Lanning, the debtor’s most recent income-for 2016-is the best estimate of his income to use in calculating projected disposable income. There is no basis in this case to conclude that the debtor’s disposable income is virtually certain to be higher or lower in the future than in 2016. By using his most recent information regarding his income to calculate his plan payments, the debtor has complied with Section 1325(b) and Lanning”.

The Bankruptcy Judge then addressed the final argument presented by the Chapter 13 Trustee. The Bankruptcy Judge held that the Debtor presented credible evidence of the Debtor’s agreement with the grandson’s mother and the reasonableness of the expenses to cover the grandson’s expenses during the summer. The Chapter 13 Trustee offered no contradicting evidence.

The Bankruptcy Court in In Re Gibson allotted the remainder of its decision to attacking the practices of the Chapter 13 Trustee. Judge Doyle wrote:

“Trustee Marshall has a practice of insisting that certain debtors (those proposing to pay unsecured creditors less than 100% of what they are owed) turn over all tax refunds received after confirmation without deducting any expenses from them. Even debtors whose refunds constitute tax credits the government offers to low-income workers are treated this way. Yet she has no similar practice for debtors who do not receive tax refunds or credits but instead receive all of their annual income through wages. The effect of her practice, whether intended or not, is that debtors with the same annual income are treated differently solely on when they receive the income. Section 1325(b)(2) in no way authorizes this sort of discrimination. All debtors are entitled to deduct reasonably necessary expenses from the income they receive, whether they receive that income regularly as wages or only once a year in the form of tax refunds or tax credits”.

Judge Doyle continued her assault upon the Chapter 13 Trustee in footnote 5:

“Trustee Marshall’s practice, which no other chapter 13 trustee in this district follows, has a real negative impact on those debtors least able to protect themselves. Pro se debtors are most likely to have the lowest income and so receive tax credits like the earned income credit. Because they are Pro se, they are far less likely to challenge the trustee’s practice. Unaware that the trustee’s practice is wrong as a matter of law, they will simply accede to her demands about how their plans should be structured”.

Jay Weller is a Bankruptcy Attorney who has almost exclusively practiced Bankruptcy Law since 1993. Weller Legal Group PA is considered by most to be the premier Bankruptcy Law Firm in the Tampa region. Offices are located in Clearwater, Lakeland and Port Richey, Florida.

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