Chapter 13 Bankruptcy Plans and Tax Refunds

Chapter 13 Bankruptcy Plans and Tax Refunds

Historically when a debtor files a Chapter 13 case they are required to commit all “disposable” income to the repayment of the plan throughout the duration of the plan.  Their disposable income is generally the income they have left over after they pay all their monthly expenses but many courts have expanded this definition to include any federal tax refunds received during the life of the plan as well.

Recently the Fifth Circuit Court of Appeals published a ruling related to the practice of requiring all debtors to commit their tax refund to the repayment of their unsecured creditors through their Chapter 13 Plan.  The case – Diaz v. Viegelahn, No. 19-50982 (5th Cir. 2020) – came out of the bankruptcy court in the Western District of Texas.  Here, there is a permanent form plan provision that requires payment of all tax refunds in excess of $2,000 to the trustee.  Diaz sought to have this provision stricken from her plan and the court denied her confirmation.  The appeals court reversed the decision of the Bankruptcy Court and remanded the matter to reconsider the confirmation with the stricken language.  The scope of the decision is limited to Chapter 13 debtors who are “below median” filers.

The “Means Test” is a test that is utilized to determine if a debtor can qualify to file a Chapter 7 case.  Part of the test calculates the household income of the debtor(s) and if they are at or below the median income for their state and number of persons in the household.  For example, the current median in Texas for a family of two is $66,900.  If the calculated income falls below this threshold, the debtor can file a Chapter 7 case, however, specific circumstances in the Debtor’s situation may dictate the filing of a Chapter 13 case, such as delinquent mortgage or car payments. These debtors would be considered “below median” Chapter 13 debtors and would be subject to the Diaz ruling.

The Diaz Court has considered the “disposable income” rules and the calculation of the Means Test to determine if a debtor is below the median.  In doing so, it was determined that a below median debtor would likely utilize their tax refunds to pay for expenses that would be reasonably necessary for her family’s “maintenance and support.”  As such, requiring a below median debtor to pay their tax refund into the plan, would contradict the intent and purpose of the “Means Test” that would provide a below median debtor the opportunity to file Chapter 7.  If they filed a Chapter 13 case, that same debtor should not be held to the same disposable income standards as a debtor that was required to file a Chapter 13 case because they were over median.

The interplay between Chapter 7 and Chapter 13 of the Bankruptcy Code is a complicated one. This case demonstrates that those complexities could cost a misinformed debtor thousands of dollars during their bankruptcy case. Hiring an experienced Bankruptcy Attorney is critical to ensuring that debtors will capitalize on the maximum benefits that the “fresh start” intended to provide. Contact LoBue Law, PLLC today for a free consultation and case evaluation by calling (972) 694-6400.