Can I Keep My Tax Refund in a Chapter 13 Case?

This week’s blog is a common question we get from Chapter 13, Reorganization clients.  In a Chapter 13 case, the Bankruptcy Court requires that the debtor file a copy of his tax return each year that the bankruptcy is pending with both the IRS and the bankruptcy trustee, because the bankruptcy plan payments are based, in most cases, on the debtor’s income and the trustee may increase the payments to unsecured creditors if the debtor’s income increases significantly year to year.  Similarly, the debtor can ask for a decrease in payments if his income drops year to year.  A Chapter 13 bankruptcy is a fluid thing that has flexibility to change under certain circumstances as it winds its way through its three to five-year life.

In the United States Court for the Middle District of Florida, Tampa Division, (and in many other jurisdictions across the Country) the Court requires that the tax refund must be paid to the bankruptcy trustee to be disbursed to creditors, as an additional disbursement and not as part of the regular plan payments.  For example, for a debtor who pays $500 per month, a $3,000 refund will be additional disbursement to the creditors, rather than cover 6 months of required payments – the debtor must continue to make his $500 monthly payments even after paying the $3,000 refund to the trustee.

The logic behind this policy is that the refund represents an asset of the debtor – income that has been overpaid to the United States Treasury – and would have otherwise been available for distribution to creditors.  In other words, the refund is both income and an asset available for distribution.

How can a debtor keep his refund?  There are two options:

First, the debtor can contact his employer and decrease his withholdings, which will result in more take-home pay during the year, and a smaller refund at the end of the year.  If the debtor’s gross income stays around the same year to year, it should have no impact the debtor’s bankruptcy plan payment, which is based on gross income, and the decrease in withholding will provide the debtor additional money in the budget during the year!  Just make sure to decrease withholdings enough that there will be no money due to the IRS at the end of the year!

Second, the debtor can ask the trustee and the Court for permission to keep the refund.  Typically, the trustee and the Court will allow the debtor to keep the refund to pay for unforeseen expenses, like home repairs, car repairs, medical issues, and other short-term setbacks or unexpected bills.  The process is relatively quick, starting with an informal request to the trustee.  The trustee will review the request, including proof of the expenses, and either grant it, grant it in part (the debtor keeps part of the refund and pays the rest to the trustee) or deny the request.  If the trustee grants in part or denies the request, the debtor can then file a motion with the Court to keep the refund. Keep in mind, however, the trustee’s decision is likely to be persuasive on the Court.

If you are in a Chapter 13 Reorganization and want to keep your income tax refund, or if you are considering bankruptcy as a means to eliminate or manage your debt, please contact us to schedule a free initial consultation to discuss your options at 727-261-0224 or email me directly at shawn@yesnerlaw.com. Please also subscribe to the Crushing Debt Podcast, on Apple Podcasts, Spotify, and other podcast players, including Amazon Echo (“Hey Alexa, Play The Crusing Debt Podcast”) for more free information about these topics.

Shawn M. Yesner, Esq., is the host of the Crushing Debt Podcast and founder of Yesner Law, P.L., a Tampa-based boutique real estate and consumer law firm that helps clients eliminate the financial bullies in their lives. We assist clients with asset protection, the sale and purchase of real property, Chapter 7 liquidation, Chapter 13 reorganization, bankruptcy, foreclosure defense, debt settlement, landlord/tenant issues, short sales, and loan modifications in Tampa, Westchase, Odessa, Oldsmar, Palm Harbor, Clearwater, Pinellas Park, Largo, St. Petersburg, and throughout the greater Tampa Bay area.