What happens if you need to file a Chapter 13, you have not yet filed your tax return for last year, but you know that a refund will be coming your way.  The simple answer is that unless you are paying back your creditors at 100%, your Chapter 13 will demand that you turn over your tax refund check, and will use that money to pay your creditors.  If you know that a refund is headed your way, make sure to tell your lawyer before you file – there are some steps you can take to preserve some or all of your tax refund money.

Your Chapter 13 trustee will also want future refunds paid to the trustee.  This situation is easier to handle – you will want to adjust your payroll withholdings so that you do not have any refund coming.  As far as the Chapter 13 trustee is concerned, your tax refund is kind of like a savings account that artificially reduces your net pay amount.

All of the Chapter 13 trustees in the Northern District of Georgia require debtors who are paying less than 100% to creditors to include in their Chapter 13 plans a provision that authorizes the IRS to intercept any refund payable during the years that your plan is in effect and send this money to the Chapter 13 trustee.  And until now, the IRS has cooperated with the Chapter 13 trustees in redirecting refund money.

In January, 2010, however, a federal district court in Michigan has rules that the Chapter 13 trustee does not have the power to compel the IRS to serve as its collection agent.  In the case of United States v. Carroll, a judge in the Eastern District of Michigan ruled that there is no legal basis for the IRS to withhold money and deliver it to the trustee because Congress has not waived the IRS’ “sovereign immunity” that would otherwise leave the IRS vulnerable to contempt actions and other enforcement actions by the trustee (in other words, if the IRS failed to withhold a debtor’s refund, the trustee would not have the right to sue the IRS for damages or for remedial action).  The Michigan judge issued an order forbidding the bankruptcy courts there from confirming any Chapter 13 plan that has the income tax refund seizure language.

I would not be surprised if bankruptcy courts elsewhere in the nation begin to follow the path set by the Michigan judge.  We’ll know soon enough, but I suspect that the trustees in the Northern District may discontinue their demand for an income tax provision involving the IRS in Chapter 13 plans.

I do not expect, however that Chapter 13 trustees here or elsewhere in the country will permit Chapter 13 debtors from keeping large tax refunds.  I suspect that trustees will still demand provisions that obligate debtors to tender their tax refunds but they will expect the debtors to send in the money, rather than having it withheld by the IRS.  I will continue to advise my clients to minimize their refunds to avoid the problem entirely.

Needless to say, losing this automatic tax refund payment mechanism will make enforcement of tax refund plan provisions much more difficult.  It will be interesting to what if anything Chapter 13 trustees do to address this potential administrative nightmare.

I might need to file chapter 13 in the future.  I filed a Chapter 7 in 2003 and now have a lot of credit card debt.  I have a house but I do not want to keep it. When the house goes into foreclosure the only property I will have in my name is 3 cars valued from $6000 to $8000 each.  I only own one of them.  The other two belong to my parents.  I got loans in my name for the cars because I got the best rates, but when they were paid off I never signed the titles over to my parents.  In a ch. 13 will all the cars be considered mine, or is there a way to prove that they belong to my parents?  My name is the only name on the titles.

It appears to me that Lou and his parents made a common sense decision at a time when bankruptcy was not a consideration.  Lou most likely qualified for better rates because he was working so he made a decision to help out his parents by applying for car loans in his name.   His parents have made all the payments so as far as they and Lou are concerned the cars belong to the parents.

Unfortunately this is not how the bankruptcy court will look at things.   If the title to the vehicle shows Lou’s name only, all three cars belong to him.   If he files a Chapter 13 in Georgia, he can exempt up to $3,500 in vehicle equity but that is it.   Lou’s Chapter 13 will have to account for any non-exempt equity, as follows:

Let’s assume that all three vehicles are paid for and that each are worth $7,000.  That would be $21,000 of equity in vehicles.   In Georgia, Lou could exempt $3,500 of equity, leaving $17,500 of non-exempt equity.  Lou can also use half of his real estate exemption to shelter the vehicles.   In Georgia, the real estate exemption is $10,000, which means that Lou can use $5,000 of exemption and apply to the vehicles.  $17,500 – $5,000 = $12,500.  Georgia law also provides for a wild card exemption of $400 that applies to any property – I typically use that for cash and checking accounts so let’s leave that out of the mix.  For our example, Lou has $12,500 of “non-exempt” equity.

If Lou was able to qualify for Chapter 7, the trustee would have the right to sell the vehicles to liquidate $12,500, which would be used to pay claims of the Chapter 7 estate.   $12,500 is 25% of $50,000.  In a Chapter 13, therefore, Lou would have to pay back at least 25% of his unsecured debt.

Note that for purposes of this analysis, I did not address any means test problems which might arise from Lou’s household income.  Additionally, I think that Lou could face an objection from the Chapter 13 trustee regarding his need for three vehicles.  If Lou’s parents are not dependent upon him, the trustee might take the position that three vehicles are not essential for Lou’s financial rehabilitation.   As far as the trustee is concerned, the rights of Lou’s creditors may trump the needs of Lou’s parents.   In other words, should Lou’s creditors have to deal with the risk inherent in Lou being on the hook for two vehicles he does not drive?   In my experience, the Chapter 13 trustee would object to Lou keeping all three vehicles – his solution would be to pay a higher dividend (i.e. more than 25%) to the unsecured creditors.

As you can see, a simple question arising from a non-bankruptcy decision can have all kinds of bankruptcy implications.