Are Income Tax Refunds Forfeited in Chapter 13 Bankruptcies

In most Chapter 13 Bankruptcies a debtor makes monthly payments for either 36 or 60 months based on the debtor’s income, and at the end of the term the debtor receives a discharge. Some Chapter 13 plans however also order the debtor to turn over his annual tax refunds to the plan during the term, which seems like a questionable practice under the law.

In most Chapter 13 plans the payments are based on the means test.  The means test is a mechanical formula which subtracts the allowable expenses from the debtor’s average monthly income to determine the payments that the debtor must make under the plan.  One of the expenses allowed in the means test is taxes, and according to the law the debtor should use  her actual tax expense rather than the withholding from one’s paychecks.  Thus the monthly payment should already be adjusted to reflect an annual tax refund or a balance due on one’s tax return.

The problem is that projecting what a future tax expense will be is always an estimate, which can vary in accuracy depending on the tax expertise level of the lawyers, the trustees, and the judges involved in the case.  Some bankruptcy judges have thus decided that as a practical matter the estimate will be made more accurate, if the debtor is required to pay his or her annual tax refund into the plan in addition to the monthly payments, and in fairness to the judges this is probably correct at least some of the time.

Unfortunately, this practice is not uniform and an individual filing a Chapter 13 Bankruptcy will often not know whether they will be required to make this extra payment until the plan is confirmed.  About the best they can do is ask their bankruptcy attorney for an opinion, who will probably make a better guess, since he or she is normally familiar with the local judges and trustees, but this too is only an estimate.