Usually you must turn over your tax refund to the Chapter 13 trustee. But there's a way you might be able to keep it.
If you receive a tax refund during a Chapter 13 bankruptcy case, the Chapter 13 trustee will require you to turn that money over for payment to your creditors. Fortunately, bankruptcy law allows you to modify your Chapter 13 plan to excuse payment of tax refunds in certain circumstances.
(To learn more about how Chapter 13 works, visit our Chapter 13 Bankruptcy topic area.)
Tax Refund Is Disposable Income in Chapter 13
Those who file Chapter 13 bankruptcy are required to pay all their disposable income into the Chapter 13 plan -- that is, any income they do not use to pay their reasonable and necessary expenses, such as food, transportation and shelter. (Learn more about the Chapter 13 Repayment Plan .)
When you receive tax refunds during a Chapter 13 bankruptcy, the trustee will consider those funds disposable income, because it is not income you used when you listed your income and expenses to show you could afford your Chapter 13 plan. The trustee's rationale is that since you can afford to pay all your necessary expenses and make your plan payment on your regular income alone, the tax refund is a surplus and is disposable income that you must pay into the plan.
To avoid paying your refund to the trustee, you can file a plan modification to excuse the tax refund (or include language in the plan the excuses them each year), provided that you need to use the refund for something necessary that is not in your current budget.
Annie files Chapter 13. For her Chapter 13 plan to work, she must pay $1,000 per month to the trustee. Her income from work is just enough to cover her reasonable and necessary expenses plus the plan payment. She ends up falling behind after making some poor decisions, and she needs her tax refund to catch up on her electrical bill. The court is unlikely to excuse the tax refund for that purpose, because Annie's failure to stick to her budget will be seen as an insufficient reason for excusing the refund.
How to Excuse a Tax Refund
There are two ways to excuse a tax refund: Modify your plan to excuse a particular refund, or include language in your plan that you won't commit any tax refunds to the plan because you need them in order to make your plan work.
Modifying Your Plan to Excuse a Tax Refund
You can request that the court excuse your obligation to pay your tax refund by filing a plan modification. You must file a separate plan modification every year for each tax refund you want to excuse. The modification should:
- specify which tax refund you need to excuse
- the amount of the refund, and
- why you need to keep the money.
Keep any documentation showing how you spent the money or how you will spend it.
The court will only excuse a tax refund if you need to use it for something necessary and unexpected. You cannot excuse your tax refund to buy food, make your car payment, pay your utilities or anything else your regular income normally covers. This is because the income and expense schedules you filed with your case show that you can afford the Chapter 13 plan on your regular income and still support yourself and your dependents - if you need your tax refunds to make ends meet, the Chapter 13 plan is not feasible.
Examples of situations in which you may excuse a tax refund:
- car repair
- appliance repair
- replacing a broken appliance, or
- unexpected medical or dental expenses for yourself or your children.
Judges may allow a tax refund to be excused for other things as well, such as funeral expenses or a down payment on a replacement vehicle if your vehicle is beyond repair.
Including Language in the Plan the Excuses All Tax Refunds
Another method of excusing tax refunds is to propose in the language of the plan itself that you will not commit any tax refunds into the plan. Again, will need a compelling reason.
The trustee and your creditors will likely object to such language in the plan. You'll have to show the court that you will need your refunds every year by incorporating the anticipated refunds into your income and expense schedules.
This is a risky proposition, however, because the court may be reluctant to allow you to rely on your tax refunds as income -- you will have no concrete idea whether you will get one at all and how much it will be. As a result, the court may conclude that if you cannot afford the Chapter 13 on your regular income, you should not be in Chater 13 at all. However, it is possible to excuse tax refunds in this manner.