May Chapter 13 Debtors Be Compelled to Turn Over Income Tax Refunds?

by Gary on January 29, 2013

In 2012, the Chapter 13 trustees of the Northern District of Texas implemented procedures to capture tax refunds sent directly to debtors. In prior years, the IRS had sent refund checks directly to the Trustees. Northern District General Order 2010-01 authorized Trustees to apply the refunds to delinquent plans, to disburse $2,000 to debtors, and to distribute the balance to unsecured creditors. However, the IRS decided in 2011 to no longer send refunds to Trustees, but instead to issue refunds directly to debtors.

The Trustee’s response was to establish a procedure requiring debtors to provide copies of their income tax returns to the Trustee and turn over any refund amount, to the extent it exceeded $2,000. If debtors failed to voluntarily forward the refunds to the trustee, the trustee would move the bankruptcy court to compel turnover.

In a new decision out of Fort Worth, Judge Nelms was faced with the question of whether the Chapter 13 Trustee had authority to compel turnover of income tax refunds.

The debtors argued that the Northern District’s General Order 2010-01 authorizes the trustee to receive tax refunds, but does not compel the debtors to turnover the refunds to the trustees. Further, Chapter 13 Trustees do not have power to compel turnover.

The court first decided whether the post-petition refunds are property of the bankruptcy estate. Adopting the so called “estate reconciliation” approach to resolve the apparent conflict between the sections 1306(a) and 1327 regarding property of the estate, the court held that income tax refunds are property of the estate. This decision was consistent with previous decisions in the Northern District of Texas.

But, finding the refunds are property of the estate does not automatically require they be turned over. The Court looked to Section 542(a) of the Bankruptcy Code for turnover authority.  Section 542(a) requires parties to deliver to the trustee “property that the trustee may use, sell, or lease under section 363.”  But, section 1303 of the Bankruptcy Code assigns to the Chapter 13 debtor the rights and powers of the trustee under § 363. Therefore, the debtors’ argued, the Trustee lacks power to compel turnover. The Court found the debtors’ argument more persuasive and denied the motions to compel turnover.

The Court acknowledged that the trustee may request a modification of Chapter 13 plans in order to capture tax refunds based on changed circumstances. But the Court was careful to note that whether a tax refund is enough of a changed circumstance to justify plan modification may hinge on a debtor’s disclosures concerning tax refunds before plan confirmation.

The Court did not discuss whether the tax returns and pay slips provided by debtors at the outset of a case might be sufficient “disclosure” of a history of tax refunds, even if the debtor files a case before he has a right to a refund. The Court declined to address other tax refund issues until the matters are before the Court on motions to modify plans.

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