Child Tax Credits Not Exempt from Missouri Bankruptcy Estate.
(Parker's Federal Tax Bulletin: June 7, 2013)

A couple in Chapter 13 bankruptcy could not claim an exemption under Missouri law for a portion of their tax refunds relating to certain child tax credits and additional child tax credits. In re Hardy, 2013 PTC 110 (Bankr. W.D. Mo 5/16/13).

In 2012, Pepper Hardy filed a Chapter 13 bankruptcy petition. On her Schedule B, she listed as other liquidated debt an income tax refund valued at $4,950. She noted that $2,000 of the refund was due to the child tax credit. On her Schedule C, Pepper claimed $4,895 of the $4,950 was exempt: $595 under the Missouri wild card exemption, $2,300 under the head of household exemption, and $2,000 as a public assistance benefit.

On her subsequently filed 2012 federal and state tax returns, Pepper's total federal tax liability was zero. Her $6,311 federal refund was comprised of: $926 from withholdings, a $2,661 earned income tax credit, a $2,000 in additional child tax credit, and a $724 American opportunity tax credit.

Larry and Tara Lovelace also filed a Chapter 13 bankruptcy petition in 2012. They included on their Schedule B, a 2012 anticipated income tax refund of $2,576 and an unknown amount of an anticipated child tax credit that they claimed as exempt. On their Schedule C, the Lovelaces claimed the entire $2,576 of the anticipated income tax refund as exempt under the Missouri wild card and head of household exemptions and claimed 100 percent of the 2012 anticipated child tax credit exempt as a public assistance benefit.

On their subsequently filed 2012 federal and state tax returns, the Lovelaces' total federal tax liability was $3,259, and that was reduced by a $3,000 child tax credit to $259. They paid $4,653 in withholdings, which resulted in a federal tax refund of $4,391.

The bankruptcy trustee timely objected in both cases to the Debtors' claim of exemptions in the child tax credit portion of their respective refunds. The Debtors claimed that the child tax credits constituted a public assistance benefit exempt from their bankruptcy estates under Missouri law.

The child tax credit was enacted in 1997 as Code Sec. 24 with the purpose to reduce the tax burden on working parents. The child tax credit is generally treated as a nonrefundable personal credit and can be used to reduce the taxpayer's regular tax liability and alternative minimum tax liability. Taxpayers with an adjusted gross income below the threshold amount may claim a $1,000 tax credit for each qualifying child under the age of 17. The child tax credit is phased out for taxpayers with modified adjusted gross income in excess of the threshold amount.

OBSERVATION: The applicable threshold amount is based on a taxpayer's filing status as follows: $110,000 for married taxpayers filing jointly; $75,000 for taxpayers filing as single, head of household, qualifying widow(er); and $55,000 for married taxpayers filing separately.

However, a portion of the child tax credit may be refundable for certain taxpayers. The refundable portion of the child tax credit, called the additional child tax credit, is based on an earned income formula.

The filing of a bankruptcy case created an estate consisting of all of the debtor's legal and equitable interests in property at the beginning of the case. Debtors may exempt certain property from the estate; however, only the debtor's interests that are property of the bankruptcy estate may be exempt. Missouri had opted out of the federal bankruptcy exemption scheme, thereby restricting its residents to the exemptions available under state law. There was no specific state statute that allowed for the exemption of tax refunds or tax credits. Thus, the only way a Missouri debtor in bankruptcy could claim an exemption in income tax refunds was to fit within a specific exemption statute. The exemption statute entitled Property exempt from attachment provides: The following property shall be exempt from attachment and execution to the extent of any person's interest therein: Such person's right to receivepublic assistance benefit.

The bankruptcy court held that the state legislature did not intend the child tax credit to be a public assistance benefit and thus concluded it was not exempt from a debtor's bankruptcy estate.

The court first addressed the trustee's objection in the Lovelace case. The court reasoned that the Lovelaces claimed $3,000 child tax credit reduced their federal tax liability from $3,262 to $262, but the child tax credit was not the basis of their federal refund. Rather, their refund was attributable to their $4,653 federal income tax withholdings.

The court agreed with the conclusion of the Eighth Circuit B.A.P. in In re Law, 336 B.R. 780 (2006) that the refundable portion of the child tax credit was a contingent interest in a future payment and constituted property of the bankruptcy estate, a prerequisite for exempting the credit from the estate. The court also relied on the plain language of the state exemption statute which exempted a taxpayer's right to receive a public assistance benefit. Since the Lovelaces refund was what they overpaid in taxes, the court concluded that they had no right to receive and did not receive the $3,000 nonrefundable CTC credit. In following In re Wallerstedt, 930 F2d. 630 (8th Cir. 1991), the court rejected the Lovelaces' claim of exemption of the refund since it was attributable to their overwithholdings. Because the Lovelaces had no property interest in and did not receive an additional child tax credit , the trustee's objection to their claim of a 100 percent exemption in the 2012 anticipated child tax credit was sustained.

Pepper Hardy did receive a $2,000 additional child tax credit. The court nonetheless concluded that Pepper was unable to claim the additional child tax credit as a public assistance benefit. Since the state statute did not define the phrase public assistance benefit, the court looked to other state statutes that used to term to refer to food, housing, unemployment, and similar benefits to low-income, elderly, or disabled citizens and dependent children. The $1,000 additional child tax credit is available to joint taxpayers of up to $110,000 in adjusted gross income and other taxpayers with higher incomes in reduced amounts. The court noted that the threshold for a single taxpayer such as Pepper is $75,000 of adjusted gross income; a level of income that is generally not considered as needy compared to low-income, elderly, and disabled citizens. Because the child tax credit is not limited to low-income taxpayers, the court determined that the state legislature did not intend the child tax credit to be a public assistance benefit.

Staff Editor Parker Tax Publishing

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