This frequently asked question opens one of the largest cans of worms in a Chapter 13 bankruptcy. It involves various complicated issues, mostly the nature of the bankruptcy estate and the aggressiveness and diligence of the trustee (person who oversees the bankruptcy for the judge). Keep reading to learn about the interplay between bankruptcy and your tax refund.

Back taxes are a related issue. The IRS normally withholds tax refunds if the taxpayer owes money, even if the refund exceeds the amount of the tax owed. If you’re entitled to a $1,000 refund and owe $500, the IRS doesn’t send you a check for $500. It withholds the entire refund until the back taxes are paid.

An effective Georgia bankruptcy lawyer helps families take full advantage of all these benefits. An attorney prevents creditors from using obscure loopholes and continuing to harass debtors. Furthermore, a lawyer helps a debtor come up with the best possible repayment plan, which addresses your needs and satisfies both creditors and the trustee.

Chapter 13 & Automatic Stay in Georgia

As soon as debtors file their voluntary petitions, Section 362 of the Bankruptcy Code, more typically known as the Automatic Stay, usually takes full effect. This provision immediately stops adverse actions, like:

• Payment intercept,
• Wage garnishment,
• Foreclosure,
• Repossession,
• Eviction, and
• Collection lawsuits.

If back taxes or a pending tax refund are an issue, the first two bullet points on this list are probably the two which impact your finances the most.

Public creditors often utilize payment intercept. For example, if you owe child support or alimony, the Georgia Attorney General might seize windfall payments, like a tax refund, and apply it to the unpaid balance. 

Taxing authorities have broad powers to garnish wages. Frequently, they do not need court orders to take up to half a worker’s wages.

What the Automatic Stay Doesn’t Do

The Automatic Stay does not eliminate past-due child support or income taxes. But it does block aggressive collection efforts, so you can repay these obligations on your own terms. We’ll discuss the protected repayment period in a Chapter 13 below.

If you have filed bankruptcy within the previous six months, the Automatic Stay might have a more limited effect. A Georgia bankruptcy lawyer can usually file a motion to extend the Stay in these situations. Judges often sign these orders without requiring hearings.

Most people qualify for Chapter 13 and the Automatic Stay. There are some formal and informal qualifications.

Debt Ceiling and the Automatic Stay

Debt ceilings apply in Chapter 13. Debtors cannot owe more than $1.4 million in secured debts or $400,000 in unsecured obligations. These amounts include both current and past-due bills. Furthermore, all debtors must complete a pre-filing credit counseling course and a post-filing budgeting course. These brief, inexpensive classes are usually available online. The trustee also periodically sponsors free seminars which satisfy the budgeting course requirement.

Informally, the debtor must have enough disposable income to fund a monthly debt consolidation payment. The trustee collects this payment and distributes it among allowed claims. “Allowed claims” usually include secured debt arrears, certain unsecured priority debt arerats, like back taxes, and administrative costs.

Payment After the Automatic Stay in Chapter 13

The payment amount varies significantly in different cases. But it is usually about the size of a rent or mortgage payment.

If the monthly payment becomes a problem, a Georgia bankruptcy lawyer offers solutions. Options include a hardship discharge, motion to reduce the payment’s size, and conversion to Chapter 7.

Is a Tax Return Part of the Bankruptcy Estate in Chapter 13?

This part of the Chapter 13 bankruptcy/tax return question involves some complex legal principles. So, strap yourselves in.

Technically, when people file bankruptcy, their nonexempt property becomes part of the bankruptcy estate, which is managed by the trustee. Nonexempt property usually includes things like vacation homes, yachts, and financial windfalls, such as inheritances and tax refunds. So, if we ended the discussion here, a Chapter 13 trustee has an absolute right to seize your tax refund.

Fortunately, the discussion doesn’t end here. A number of legal doctrines, some of which are unique to bankruptcy, often come into play. Only an experienced Georgia bankruptcy attorney is aware of these legal loopholes which could greatly benefit your family.

Adverse Possession

Practical use or property, as opposed to legal possession rights, often determines legal ownership.

Assume Thelma and Louise are neighboring cattle ranchers. Thelma’s cattle drink from a lake on Louise’s property. Depending on the additional facts, at some point, Thelma owns the lake on her neighbor’s land. The only way for Louise to protect her property rights is to post a “Keep Out” sign near the lake or take other similar action.

In the tax refund context, the IRS sends the money to the debtor. So, unless the trustee takes immediate action to claim the refund, that money could become property of the debtor. In this area, he who hesitates is lost.

A question in the Statement of Financial Affairs asks if the debtor expects any financial windfalls, such as a tax refund. Technically, debtors have a responsibility to update the SOFA, and other bankruptcy documents, throughout a Chapter 13. That time period could be up to five years. However, many trustees do not scrutinize these updates. The documents just go straight into a file folder.

Mootness

Another legal principle is mootness. Bankruptcy judges, and other judges, usually only have the power to resolve actual disputes. They typically cannot settle theoretical questions.

Assume Bill and Ted each claim ownership of a house. Their dispute goes to court. Immediately prior to the hearing, the house burns down. Now, it does not matter who owned the house, because it is gone. Therefore, the judge cannot intervene.

Most people immediately spend their tax refunds. So, by the time the trustee files a motion for turnover, the money is probably gone. At that point, it does not matter if the debtor or the trustee legally owned the tax return. The litigants are quite literally fighting over nothing.

Here’s the bottom line. If you file Chapter 13 and the trustee tries to seize your tax return, an Georgia bankruptcy lawyer can stop that seizure, at least in many cases.

Best Interests of Creditors

Trustees do not have an unlimited right to liquidate nonexempt property, such as a tax refund. They may only take this action if it’s in the best interests of the creditors. That usually translates to the best financial interests of the creditors.

Assume Lisa has a dozen creditors. She owes each of them at least $5,000. She expects a $1,000 tax refund.

A Georgia bankruptcy lawyer could probably block a trustee’s efforts to seize the return. Lisa’s creditors would receive less than $100 each, which is a drop in the bucket compared to the amount owed. Additionally, creditors would probably pay more than $100 processing the payment, when considering employee time and resource use. Therefore, tax refund liquidation would not be in the creditors’ best interests.

Some Practical Tax Refund Issues

Adverse possession and mootness are formal rules which often control this process. There are a number of informal rules as well. These rules vary significantly in different jurisdictions. Once again, the bottom line is that an Athens bankruptcy lawyer can use these rules to protect your tax refund.

This informal rule is rather straightforward. In most cases, if the tax refund is less than about $2,000, the trustee does not bother with a motion for turnover. Individual creditors receive almost nothing once the refund is divided among them.

If the tax refund is over $2,000, the trustee might consider filing a motion for turnover. However, because of the mootness and adverse possession doctrines, this motion might or might not succeed. As a result, a Georgia bankruptcy lawyer can often convince a trustee to not file such a motion or at least allow the debtor to keep most of the return.

Alternatively, an attorney can often engineer an out-of-court settlement. For example, the debtor could give up a large tax refund if the trustee applies it to a debt consolidation payment or two. Once again, these deals are easier to arrange if a defense arguably applies.

A strategic approach could avoid these problems altogether. Many people intentionally over-withhold so they get large refunds in the spring. Adjusting one’s withholding could lower the amount of an anticipated return. That way, a Georgia bankruptcy lawyer does not have to go to court over a tax refund.

Back Tax Elimination 

Past due taxes are often an issue as well. In fact, many people file bankruptcy exclusively to retire this debt. 

The IRS offers a number of payment plans and partial forgiveness programs. These programs expanded slightly under the 2011 Fresh Start program. Yet despite this expansion, only a limited number of people qualify for these programs. As mentioned, pretty much everyone qualifies for Chapter 13 bankruptcy. This program offers two ways to eliminate tax debt.

Although the Automatic Stay doesn’t eliminate back taxes, the discharge provision often applies. Unsecured debts, a category which includes income taxes, are usually dischargeable in bankruptcy. But past-due income taxes are priority unsecured debts. As such, they are only dischargeable in some situations. The discharge rules are:

• No Fraud: This rule applies to all unsecured debt, but past-due taxes are a special case, because an IRS lawyer is usually involved. Omitted income streams are the biggest fraud badge. Other fraud badges include errors that are too large to be accidental and significant lifestyle discrepancies (e.g. reporting income of $40,000 a year and driving a new Mercedes).
• Waiting Period: The income taxes must be at least three years old, and the returns must have been on file for at least two years. As for the age, the IRS has been known to object to discharge if the taxes are a day or two shy of three years old. The returns must be taxpayer-filed returns. One of the fundamental rules of tax law is always file on time, even if you cannot afford to pay the tax.
• Assessment: If the income tax debt has been assessed in the last 240 days, it is not dischargeable. Assessment is an internal accounting device. A Georgia bankruptcy lawyer must request and review a tax transcript to determine if the IRS has assessed the debt. Generally, however, if the taxpayer hasn’t received a letter which includes the total amount due in the past eight months, the debt probably has not been assessed.

“Discharge” means the judge eliminates the legal obligation to repay the debt. But the debt itself remains, as do its collateral consequences. So, if the IRS filed a lien before the taxpayer filed bankruptcy, a Georgia bankruptcy lawyer must address the lien separately. However, the IRS can no longer intercept payments, levy bank accounts, or garnish wages. There’s no longer a financial obligation.

The non-assessment requirement derails many discharge efforts. Fortunately, discharging taxes and retaining your refund is only Plan A. There’s always Plan B. which involves the protected repayment period and the monthly debt consolidation payment. Taxpayers can include past-due taxes with their Chapter 13 payments. 

More Notes on Taxes Chapter 13 Repayment

Chapter 13 repayment has some key advantages over IRS repayment. Initially, as mentioned, pretty much everyone qualifies for Chapter 13. Additionally, the IRS may continue to harass and threaten people during a non-bankruptcy repayment period. Furthermore, the IRS may unilaterally cancel the payment plan over something as minor as one payment which is one day late. Finally, a Georgia bankruptcy lawyer might be able to stop penalties and interests from accruing during Chapter 13 repayment. The law is a bit uncertain on this point.

As a footnote, although a Georgia bankruptcy lawyer is not an accountant, an attorney can connect former debtors with accountants and other professionals. These individuals help debtors set up effective prepayment and withholding plans which don’t result in a big refund or a big tax bill.

Contact an Athens Georgia Bankruptcy Lawyer About Your Taxes and Chapter 13

Does Chapter 13 affect tax returns in Georgia? Filing bankruptcy could mean eliminating tax debt and retaining your refund. For a free consultation with an experienced Georgia bankruptcy lawyer, contact Morgan & Morgan, Attorneys at Law, P.C. Convenient payment plans are available.

 

The original article was published February 26th, 2021. This article was updated June 4, 2021.