Tag Archives: trustee

Tax Refunds and the Bankruptcy Estate

Tax refunds present a couple of interesting points in a Bankruptcy filing.  This post is concerned with Chapter 7 filings.  Chapter 13 is a little bit different for a couple of reasons.  This is also rooted in Oklahoma law, and although the theory remains the same, the results can be very different in other States. 

When talking about tax refunds with my clients, the first thing I have to do is figure out exactly what we are talking about.  I long ago stopped asking my clients and just started looking at their most recent returns.  Clients tend to refer to that check they receive from the IRS (or electronic credit) as their tax refund, although in many cases, it is all kinds of other things.  A tax refund is literally the refund of money that the tax payer overpaid to the IRS during the course of the year.  Various tax credits are paid along with the refund, but they are money given, or credited, to the tax payer by the Government.  Some common tax credits are Earned Income Credit, Child Care Credit and recently the Making Work Pay Credit.  Those are not a tax refund, those are tax credits.  At this point my clients are generally rolling their eyes and muttering, “Whatever” under their breath thinking I can’t hear them.  Then, I get their attention.

You see, tax refunds are not exempt in Oklahoma.  That means that any tax refund that has accrued to a debtor at the time he files for bankruptcy becomes property of his bankruptcy estate — meaning his Bankruptcy Trustee gets the money, and the debtor doesn’t.  Earned Income Credit, however, is exempt; and the Debtor gets to keep that money.  It is about this point that eyes stop rolling and clients’ posture visibly improves. 

Let me explain.  A Chapter 7 Bankruptcy is a deal.  The Debtor agrees that if he has any non-exempt property that the Trustee wants to administer for the benefit of his creditors, the Debtor will put it on the front porch with a red bow on it for the Trustee to come get — and BE HAPPY ABOUT IT.  In exchange, the Debtor gets a discharge — meaning he gets out of the debt that brought him to my office in the first place.  If that deal isn’t worth doing, then don’t file a Chapter 7 Bankruptcy.  Now, in most cases my clients lose no property, because the list of property that you get to keep in Oklahoma (exempt property) is really very generous.  Most people who file in Oklahoma lose nothing but a whole bunch of ugly debt they didn’t want in the first place, but the most commonly lost asset in Oklahoma is a tax refund — because tax refunds are not exempt.  Earned Income Credit, however, is exempt; and so the Debtor gets to keep that.  Ah, yes, focused attention. 

Now, I am posting this in April — tax time; but this is a relevant topic all year.  Here’s why.  Any time a bankruptcy is filed, the Debtor creates what is called a Bankruptcy Estate, and he gives to that Estate everything he owns and everything he owes.  Then, the Debtor takes back all property that he is claiming as exempt.  The goal is to leave as much debt as possible trapped in the Bankruptcy Estate and as little property as possible.  The Debtor can take back his Earned Income Credit.  He cannot take back his overpaid taxes, those are trapped in his estate and belong to his Trustee to pay to his Creditors. 

Notice, that last sentence refers to overpaid taxes, not specifically to a tax refund.  That is why this is an issue that is relevant all year.  Let’s assume that a client is expecting a $4,800 tax refund.  That means he has overpaid his taxes at the rate of $400 a month ($400 x 12 = $4,800).  If he files for Bankruptcy on January 1, he will have overpaid to the IRS the whole $4,800.  Now, he probably can’t file his taxes and claim it for at least another month or two; but he is owed that money even though he doesn’t have it yet.  His right to that money passes into his estate the instant he files his Bankruptcy.  That means when he does file his tax return, that entire refund will belong to his Trustee for the benefit of his creditors — all $4,800 of it.  Ouch. 

Now, let’s assume that this same person files on July 1 rather than January 1.  At that point he will have overpaid his taxes by $2,400 (January – June = 6 months x $400 = $2,400).  Even though he can’t claim that money for another seven or eight months, he is entitled to it.  Think of this as a savings account that you could only withdraw from after the first of the year.  You still are entitled to the money you deposit, you just might have to wait a while to get it.  Well, your Trustee can wait a while too.  So, in this set of facts, if the Debtor files for Bankruptcy July 1 and gets a $4,800 tax refund the following February or March, he will be entitled to keep the excess, or refund, that he paid in after he filed his Bankruptcy on July 1.  The Trustee will be entitled to the excess paid in before July 1. However, to the extent that refund is Earned Income Credit rather than tax refund, the Debtor gets to keep it all, regardless of when he filed.

This illustrates several significant concepts central to the Bankruptcy system:  1.The nature of the Bankruptcy Estate; 2. The inclusion in the Estate of accrued interests in property; 3. The difference between exempt and non-exempt property, and how technical that distinction can appear to be; and 4. The role of the Trustee.

Of course, the moral of this story is don’t file a Bankruptcy shortly after the first of the year until your tax refund is back and spent.  Do, however, talk to an attorney in advance, however.  There are ways you can spend a tax refund right before you file that can cause bigger problems.  As this post should have pointed out, Bankruptcy is a complex and technical area of law, and there can be significant ramifications to deceptively routine transactions. 


First Meetings of Creditors — the Stories

If you have a 341 hearing coming up, talk to your lawyer.  If your lawyer tells you that you have nothing to worry about, then take a book.  Otherwise, you will leave shaking your head over stories like this one:

Some time ago the first debtor on the docket (not my client THANK GOD) testified under oath that he owed mid 3 digits ($30,000 or MORE) in child support to each of three women (yep, that actually did add up to a total of 6 digits).  The Trustee, of course, needed the Mother’s names and addresses to send a kind of special notice to that goes to child support creditors.  The debtor didn’t know any of the Mothers’ addresses.  He wasn’t sure which city any of the three women lived in (with his children).  Although, he did know which Counties they each lived in, because DHS was collecting child support, or trying to, and they are organized into County offices.  Oh, did I mention that he wasn’t sure about one child’s name?  The really scary part was that his current girlfriend was there with him.

He didn’t have a good time.  My clients were in and out in about 3 minutes.  Well, three minutes after we sat through an hour plus long docket.  We were dead last.


First Meetings of Creditors — the Questions

The First Meeting of Creditors, or 341 hearing, exists so that the Trustee assigned to administer the case  can make sure he understands the schedules, identify any non-exempt assets he needs to administer and ask the Debtor any questions he needs answered.  Also, any creditors who need to know something (like car lenders who want to know if the Debtor is going to keep a car and verify that it is insured) or someone who believes he has been defrauded and needs a chance to ask a few questions to decide whether or not to pursue an objection to discharge have the right to ask questions as well.  These are the people for whom this hearing exists, but for most clients, it is a non-event.

Once you have been sworn in, you will take a seat to the Trustee’s left, and your lawyer will stand opposite you behind a podium.  Your lawyer will then begin asking you incredibly difficult questions — like your Name.  (You might want to study.)  Your lawyer should go over with you exactly what he will ask before the hearing, but the questions don’t generally get much harder than that first one.

Then, the Trustee has the right to ask you questions if he wants to.   He may ask some basic questions to make sure that he understands everything.  Again, not really much harder than that, “Please state your full name for the record” bit; and your lawyer should give you a pretty good idea of what kinds of things about your case will catch the Trustee’s eye.

After that, any creditors present have the right to ask you questions and so does the U.S. Trustee’s office if they want to.  The U.S. Trustee’s office is generally interested in asking questions about the Means Test, any budget entries that look excessive or anything that might smell like fraud or abuse.

It is that whole idea that their creditors are going to ask them questions that I think really scares my clients.  Look at it this way.   No one is going to pay a representative to drive to the Courthouse and cool his heels through the first part of the docket without a good reason.   Car lenders may want to know if you are going to keep the car and if it is insured.  That makes sense.  They need to know that.

For most of my clients from the time their case is called by the Trustee until they are heading out the door is less than five minutes.

Now, there are exceptions.  Business cases or other cases with significant assets and large  dollar figures involved will take more time.  For one thing, they are more complicated and there is more to understand.  For another, the bigger the dollar figures and the more things going on the greater the opportunity to conceal funds or otherwise commit fraud.

Of course, people who kind of, sort of, forgot to tell their lawyers about the rent house they own in another County or oil and gas rights in Texas  are generally in for an unpleasant surprise.  People who filed Bankruptcy leaving a number of people feeling like they were defrauded or just a ticked off ex-spouse will frequently prefer a root canal without anesthesia.  Clients whose lawyers either didn’t do their jobs or didn’t know their jobs are generally not in for a brief or pleasant time.  Anyone who thought that not mentioning something to his lawyer was a good idea is in for an eduction.  These are generally people for whom the 341 is not pleasant.

That last paragraph was a little smug and isn’t completely true.  There can be plenty of good, honest people who are well represented whose 341’s aren’t fun.  Construction contractors who left a bunch of houses unfinished and bills unpaid will frequently find homeowners showing up to either lay the groundwork for an objection to discharge or just to regain a pound of flesh.  Ex-spouses can be unpleasant additions to a 341 room.

Ask your lawyer if anyone is likely to show up on your case.  Basically, non-institutional creditors (normal people instead of Capital One) are likely to show up just because they got something in the mail and don’t know that they don’t have to.

If your lawyer tells you that you have nothing to worry about, then take a book.  Otherwise, you will leave shaking your head over some poor sod who went before you and didn’t have a good day.  I will post a few of those stories another time.