Can I Keep My Tax Refund in Chapter 13 Bankruptcy?

If you receive a tax refund during your Chapter 13 bankruptcy, the trustee assigned to administer the case could 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.

(Learn more about what to expect in Chapter 13 Bankruptcy.)

Is Your Tax Refund Disposable Income?

People who file for Chapter 13 bankruptcy must pay all of their disposable income into the Chapter 13 plan—that is, any income not used for reasonable and necessary expenses, such as food, transportation, and shelter. (Learn more about the Chapter 13 Repayment Plan.)

When you receive a tax refund during a Chapter 13 bankruptcy, the trustee might consider those funds disposable income if they represent funds that weren’t included in the income and expense calculations used to support your Chapter 13 plan. Also, the Chapter 13 trustee might argue that since you can afford to pay all your necessary expenses and make your plan payment on your monthly income alone, the tax refund is a surplus and is disposable income that you must pay into the plan.

If you can show that the trustee’s analysis is incorrect, the court might find that the return isn’t disposable income and let you keep the money (more below under the “How to Excuse a Tax Refund” heading).

Example. For Ashley’s 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 and needs her tax refund to catch up on her electrical bill. The court might excuse the tax bill if she shows that she fell behind because she didn’t claim enough deductions and the money slated to pay her electric bill was withheld for unnecessary taxes. By contrast, it’s unlikely that the court will excuse the tax refund if Ashley received a raise and the tax refund represents money not accounted for in her plan.

(Find out more about the bankruptcy process in Bankruptcy Procedures.)

How to Excuse a Tax Refund

The easiest way to excuse a tax refund is to show that you’ll need to use the refund to make your plan work. However, most people can’t justify a “keep the return” provision in the plan.

That doesn’t mean you can’t seek relief. If you later run into a problem during the plan, you can modify it by asking the court to excuse a particular refund because your reasonable expenses have increased. However, this won’t work if the trustee can show that the refund isn’t needed to cover expenses.

Here are the specifics for each approach.

Modifying a 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.

The court will only excuse a tax refund if you need to use it for something necessary and unexpected. Because the bankruptcy income and expense schedules you filed with your case showed that you can afford the Chapter 13 plan on your regular income and still support yourself and your dependents, you can’t excuse your tax refund to buy food, make your car payment, pay your utilities or anything else your regular income normally covers.

The court might agree to excuse a tax refund for the following:

• car repairs or a down payment on a replacement vehicle
• appliance repair or replacement
• funeral expenses, or
• unexpected medical or dental expenses for yourself or your children.

It’s a good idea to keep documentation showing how you spent the money after receiving court permission to keep the refund.

Drafting a Plan That Excuses Future Tax Refunds

Another method of excusing tax refunds is to propose not committing any tax refunds in the plan itself. The trustee and your creditors will likely object to such plan language unless you:

• provide a compelling reason for the provision (perhaps you have a large yearly expense), and
• you limit the dollar amount to ensure you don’t receive more money than what’s specified in the plan.

Several problems could arise if the court approved (confirmed) a plan without limiting language. It could allow you to get more money than what you’re entitled to receive under the plan (if you receive a raise or bonus, for instance, and funnel the additional income into the return). Also, as discussed above, receiving a tax return suggests that you don’t need as much to pay your reasonable expenses.

Consulting With a Bankruptcy Lawyer

Preparing a confirmable Chapter 13 plan—and completing that plan—isn’t easy, and most people need the assistance of an attorney. In this, and any other Chapter 13 situation, you’ll be well served to seek knowledgeable bankruptcy counsel.

For information about what you’ll pay in attorneys’ fees, read Chapter 13 Bankruptcy: How Much Does It Cost?