Chapter 13 is not as cut-and-dried in protecting your refund. But generally you can use it for an urgent expense or for an urgent creditor.
Previously Received and Spent Tax Refunds
From the start you can avoid questions about what happens to your pending tax refund in bankruptcy by simply not having any refunds owed to you at the time your case is filed. Just wait to file bankruptcy until after receiving and appropriately spending the refund.
The last three blog posts were about protecting pending tax refunds under Chapter 7 “straight bankruptcy.” In the second of that three-part series we wrote about waiting to file bankruptcy until after you’ve received and appropriately spent the refund money. That applies when you file a Chapter 13 “adjustment of debts” as well. The same warning we gave then applies to Chapter 13 cases, too:
We emphasize spending the money appropriately because the bankruptcy system looks very carefully (and suspiciously) at certain financial transactions done at the brink of filing bankruptcy. Talk with your attorney about your particular situation, but you will usually want to avoid situations in which you pay that money to a creditor, give it to somebody as a gift, use it to increase the value of something so that is already close to the exempt amount, or try to keep and hide it.
But what if you can’t wait to file a Chapter 13 case until after you’ve gotten and spent any tax refunds? How can your refund money still be protected?
Both Better and Worse Than Chapter 7, But Mostly Better
Under Chapter 7, if you have a refund that is owed to you at the time when your case is filed, you either get to keep it because it fits within an available property “exemption” or you don’t. Or sometimes, if the amount of the refund is larger than the available “exemption” amount, you get to keep the exempt amount and have to turn over the remaining non-exempt amount to the trustee.
Chapter 13 is better in that you can usually protect a tax refund that is not exempt (or the portion that isn’t exempt).
But Chapter 13 is worse than Chapter 7 in that the exempt refund amount is not necessarily yours to do with whatever you want.
Overall, you usually have a fair amount of flexibility about what happens to the pending tax refund, whether exempt or not.
Let us explain.
Better Protection of Non-Exempt Tax Refunds
A tax refund which would simply be taken by a Chapter 7 trustee because it isn’t protected by an “exemption” can be protected under Chapter 13 in the way that any of your unprotected assets could be. You just have to tweak your Chapter 13 payment plan to ensure that your creditors are no worse off than they would have been in a Chapter 7 case.
That may well not sound all that great for you—what’s the benefit of filing a Chapter 13 case if the creditors are going to get out of you what they would have gotten if you would have just filed the simpler Chapter 7 case?
There are two benefits.
First, Chapter 13 buys you time. It would likely allow you to use the tax refund for what you need now, even if it means paying a little more to your creditors over the course of the 3-to-5-year Chapter 13 payment plan. You pay later for the benefit of keeping the refund now, but sometimes that’s worthwhile.
Second, you often actually don’t have to pay anything more to your creditors to keep the current pending refund. This happens when you have “priority” debts, usually back child or spousal support or recent income taxes, in amounts that are larger than the amount of tax refunds that you are protecting. Why does that work to your benefit? Because had you filed a Chapter 7 case, the trustee would have had to pay all the money from the tax refunds to those “priority” debt, leaving nothing left over for the other debts. In this situation you are usually allowed to do the same under Chapter 13—pay off the priority debts and pay little or nothing to the other creditors—all while protecting your pending tax refund.
Worse Protection of Exempt Tax Refunds
While under Chapter 7 you are free to take an exempt refund (or the exempt portion) and to do with it whatever you want, it’s not that easy under Chapter 13. That’s because Chapter 7 fixates on your assets and debts as of the moment your case is filed, while Chapter 13 looks at your “disposable income” throughout the life of your case. The refund is a chunk of money usually not covered by your monthly budget, so arguably it should all go to the trustee to distribute to your creditors. A tax return is arguably just “disposable income” over and beyond your monthly expenses—regardless whether it is exempt or not for asset purposes.
More Control Overall Under Chapter 13
However, practically speaking, Chapter 13 can in many situations undo the above disadvantage.
First, if you have a legitimate urgent expense—such as a pressing vehicle repair you’ve had to put off until you got your tax refund—that can turn your refund from a form of “disposable income” into money unavailable for the creditors because of this legitimate expense. The money would go to the repair and not into your Chapter 13 plan to pay creditors.
The second way you can in effect protect the tax refund money is to go ahead and pay it into your plan but have it effectively earmarked to pay a special debt or debts. While you cannot do that on just any debt, there is often enough flexibility under Chapter 13 so that you can do so with a debt or two that are important to you. For example, if you are behind on your vehicle loan or home mortgage, you may well be able to have all or most of the current tax refund be paid towards those arrearages. Same thing with “priority” income taxes or back child support. These kinds of debts are ones that the law generally favors, and if you happen to want to favor them yourself you can often do so through money from your tax refund.
Chapter 13 does not protect pending tax refunds that would be exempt in a Chapter 7 case as straightforwardly as Chapter 7 does, but often has the same practical benefit. As for any tax refunds that would not be exempt in a Chapter 7 case, Chapter 13 protects them much better. Overall, Chapter 13 has flexible and creative ways of having refund money go to where you need and/or want it to go.