TAX refunds are a hot issue for bankruptcy trustees for bankruptcies filed between the last quarter and the first quarter of the year. If the bankruptcy case is filed in January, 2010, the chapter 7 trustee is interested to know if debtor expects tax refunds, how much, and if debtor can exempt the refunds. Tax refunds are receivables of debtor and should be listed in schedule B as property of debtor. Debtor can keep tax refunds only to the extent that he can exempt them in his bankruptcy petition. If there is no exemption, the entire tax refund becomes property of the chapter 7 trustee. Debtor is required by law to transfer the tax refund to the trustee upon receipt unless he is able to exempt them in his petition. To illustrate, client expects a tax refund of $12,000. At the 341 A hearing, trustee asks debtor if he anticipates receiving a tax refund and how much. Client states that he expects to get $12,000. Who owns the $12,000, debtor or the chapter 7 trustee? If debtor has used up all of his exemptions, then he is out of luck. He cannot keep the $12,000. Upon receipt, he must transfer the entire $12,000 to the trustee. If debtor has enough exemptions left, he can amend his schedule B and D to declare and exempt the $12,000. If he is able to do this, he gets to keep the entire $12,000. This is the procedure in a Chapter 7 case.
Chapter 13 cases work differently. Chapter 13 trustees in Los Angeles require debtors to include tax refunds for the first 3 years as part of the chapter 13 plan as a requirement for confirmation of the plan if the debtor’s household income is over the median in the State of California. This is a source of irritation for debtors because they rely on tax refunds to make major payments. However, debtor is in no position to disagree with the trustee if he wants his plan confirmed. This practice by Chapter 13 trustee is fairly common nationwide but its legality was challenged by the IRS recently in Michigan. In 2008, the Bankruptcy Court there adopted a standardized confirmation order in Chapter 13 cases which included a provision requiring the IRS to pay all future refunds to the trustee during the pendency of the Chapter 13 case. The IRS complained that compliance with the order created a substantial and growing administrative burden. After trying to comply with the standard order, the IRS asked the District Court to intervene. The government voluntarily dismissed the action without prejudice a few days later after the US Trustee asked for time to mediate a solution between the government and the trustees and bankruptcy judges. That effort failed prompting six judges in the district to sign a letter to the US attorney general asking the tax division to reconsider filing suit on behalf of the IRS. The letter said that "The bankruptcy court’s jurisdiction and authority to enter such an order is clear under 28 USC.SS 1334 and 157, and 11 USC. SS 105(a), 106(a), 1306(a), 542(a), 1322(a)(1), 1325(c) and 1327(a). Of course, every order creates a burden. Nevertheless, the law requires compliance until the order is reversed or modified on appeal. (Celotex Corp. v Edwards)… Accordingly, there is no substantial cause for the Tax Division to institute a collateral attack on thousands of our court orders. They are final orders, and debtor and creditors have since relied on their finality. They are …necessary and appropriate aspect of our chapter 13 process…"
The government disagreed and filed action saying that the tax refund provision in the standard confirmation order violated sovereign immunity. The District Court agreed with the IRS saying that bankruptcy judges may not order the IRS to pay future income tax refunds claimed by Chapter 13 debtors to trustee, instead of to debtor. But that’s in Michigan. Here in Los Angeles, Chapter 13 trustees can still get future tax refunds in Chapter 13 cases.
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Lawrence Bautista Yang specializes in bankruptcy, business, real estate and civil litigation and has successfully represented more than five thousand clients in California. Please call Angie, Barbara or Jess at (626) 284-1142 for an appointment at 1000 S. Fremont Ave., Bldg. A-1 Suite 1125 Unit 58, Alhambra, CA 91803.
( Published March 27, 2010 in Asianjournal Los Angeles p. C4 )
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