For over 25 years, I represented debtors in over 4,000 Chapter 7 and Chapter 13 bankruptcy cases. Now, I exclusively represent creditors, helping them recover what they are owed from Texas debtors. My extensive experience provides valuable insight into the strategies debtors use to minimize payments and how creditors can assert their rights effectively.
One area creditors must pay close attention to in Chapter 13 bankruptcy is tax refunds and how they factor into a debtor’s disposable income. Understanding this process ensures that creditors can maximize their recovery during the repayment period.
Disposable Income and Its Role in Chapter 13
Disposable income is the portion of a debtor’s total income left after covering reasonable and necessary expenses such as food, transportation, and housing. This is the amount used to pay non-priority unsecured creditors through the Chapter 13 repayment plan.
Debtors disclose their disposable income using Form 22C, which calculates income and expenses based on national and local standards. In some cases, actual amounts are used for specific expenses.
- If a debtor’s average income (based on the six months before filing) is below the state median for their household size, the court generally assumes little to no disposable income exists. This often results in minimal or no payments to non-priority unsecured creditors.
- If the debtor’s income is above the state median, their disposable income calculation determines the total amount they must pay creditors over a 60-month plan.
Tax Refunds: A Hidden Asset in Disposable Income
Tax refunds are an often-overlooked component of disposable income in Chapter 13 cases. Trustees closely monitor tax refunds throughout the repayment period.
If a debtor pays less than the total amount owed to non-priority unsecured creditors, the Chapter 13 trustee may claim tax refunds as part of the repayment plan. The rationale is simple: since tax refunds were not included in the original disposable income calculation, they are considered excess funds that can be used to pay creditors.
Challenges for Debtors Seeking to Retain Tax Refunds
Debtors have limited options to retain their tax refunds during a Chapter 13 repayment plan. Courts and trustees scrutinize any attempts to exclude tax refunds from creditor payments.
Common methods debtors use to avoid surrendering tax refunds include:
- Claiming Unexpected Expenses
Debtors may argue that tax refunds are needed for unforeseen, necessary expenses, such as:- Emergency medical bills
- Funeral costs
- Replacing a vehicle damaged beyond repair
Routine expenses like food, utility bills, or car payments are typically not acceptable reasons.
- Adjusting Tax Withholding
Some debtors reduce their refund amount by adjusting tax withholding, thereby incorporating the funds into their regular income. - Plan Language Modifications
Debtors may attempt to include plan language that excludes future tax refunds, though this is often met with creditor opposition. Courts are likely to question a debtor’s eligibility for Chapter 13 if tax refunds are excluded. - Filing After Using the Refund
Filing bankruptcy after spending the tax refund is another tactic, but it is not always feasible or legally advantageous.
What Creditors Should Do
As a creditor, understanding how tax refunds fit into a debtor’s disposable income calculation is critical to maximizing recovery. Trustees often require debtors to surrender tax refunds, and creditors must ensure these funds are applied to the repayment plan.
I help creditors:
- Monitor and challenge repayment plans to ensure tax refunds are included as disposable income.
- Object to plan language that excludes refunds without compelling justification.
- Hold debtors accountable for accurate financial disclosures and proper distribution of funds.
