Tax Refund Kept Out of Hands of Chapter 13 Trustee

Chapter 13 trustees in the Northern District of Illinois require that debtors turn over tax refunds every year during the court of a Chapter 13 plan. This makes sense: If you receive a tax refund of, say $2,400 each year, that is $200/month extra that you are sending to the IRS; $200/month that could be sent to the trustee to pay creditors. Many people count on their tax refund to make home repairs or catch up on bills; but the idea in Chapter 13 is to have monthly budget that covers repairs and pays all expenses on a current basis. To avoid turning over the refund every year, debtors can reduce withholding so they have more disposable income every month.

So the principal of turning over the tax refund each year is well established. But what about a tax refund that comes in near the beginning of a case? Let’s say the debtor files Chapter 13 in December, and the next April gets a refund of $2,400? Does the debtor have to turn over the whole $2,400 to the trustee? Trustees have argued Yes, on the basis that the money is coming in during the case, so it’s income that has to be turned over. But a debtor could make the argument that the $2,400 is based (mostly) on income and withholding that took place before the case was filed. It’s not extra income that would have been available during the Chapter 13. As a result, the tax refund (or 11/12 of the refund, if the case was filed at the beginning of December), should stay with the debtor.

That’s just the argument we made in a recent case in the bankruptcy court in the Northern District of Illinois. In Case No. 15B 41268 (we don’t disclose the name of our client), the debtor did file at the beginning of December, and was entitled to a large tax refund in April. The trustee demanded the whole refund, but we successfully argued that 11/12 of the refund was from before the bankruptcy, and the debtor should be able to keep 11/12 of the refund. The court ruled in our favor, and our client was able to keep over $15,000 that otherwise would have been turned over to the trustee.