Debtor Must Pay Over Tax Refund Under Almost-Complete Bankruptcy Plan

(Parker Tax Publishing November 2021)

A bankruptcy court held that a debtor was required under his Chapter 13 bankruptcy plan to turn over one half of his tax return refund, equaling $1,518, to the trustee even though a plan shortening provision stated that the plan would be complete when unsecured creditors received one percent of their claims and only $108 remained to be paid before that requirement was met. The court rejected the debtor's argument that he should be allowed to keep his refund and pay the $108 to the trustee, reasoning that the plan was still in effect and the plan shortening provision did not conflict with the provision requiring the payment of tax refunds to the trustee. In re Harrington, 2021 PTC 312 (Bankr. E.D. Wis. 2021).

Cedric Harrington was near the completion of his Chapter 13 bankruptcy plan. Section 1(B) of the plan required Harrington to turn over to the trustee half of all net federal and state income tax refunds received during the term of the plan. Section 2 of the plan identified the plan term as 60 months. Under the plan, Harrington was required to make bi-weekly payments of $268 to the trustee. However, Section 10 of the plan, which allowed for the inclusion of special provisions that overrode any contrary terms contained in preceding sections of the plan, contained a "plan shortening" provision which stated that (1) general unsecured non-priority claims were entitled to be paid "not less than" one percent of their respective total claims, and (2) the plan would be complete once unsecured creditors received one percent of their claims. When he filed for bankruptcy, Harrington used a model plan form which contained a standard provision that allowed him to choose whether he wished to keep his tax refunds or surrender one-half of the refunds received during the plan to the trustee. Harrington opted for the latter.

The trustee filed a motion to dismiss Harrington's Chapter 13 case based on Harrington's failure to make plan payments - specifically, his failure to pay into the plan one-half of his tax refund for the 2020 tax year. Harrington argued that because he needed to pay only $108 into the plan for the unsecured creditors to receive a one percent distribution, and one-half of his 2020 tax refund was $1,581, the plan would be complete on its own terms as of the date he paid $108. Therefore, according to Harrington, it would be a waste of time to pay in the refund only to have his tax refund, minus the $108, returned to him. The trustee responded that submission of the tax refund was a required plan term and was supplemental to the percentage owed to unsecured creditors. The trustee referred to two previous rulings where the court ruled in favor of the trustee on a challenge to payment of late-in-plan tax refunds: In re Win, Case No. 16-31085 (oral ruling issued on Sept. 8, 2020); and In re Nasino, Case No. 16-30555 (oral ruling issued on Aug. 11, 2020). In both of these cases, the debtor's confirmed Chapter 13 plan included the requirement that the debtor pay in half of any tax refunds received during the term of the plan, as well as the same plan "shortening" language at issue in this case.

In In re Win, the trustee had moved to dismiss the debtor's case based on his failure to pay the trustee half of his 2019 tax refunds. The debtor responded that he was not required to do so because the plan had been completed at 36 months due to the plan-shortening language - even though the debtor was still making plan payments to the trustee to pay in (belatedly) half of his 2016, 2017, and 2018 tax refunds. The court rejected the debtor's argument and required the debtor to pay one-half of his 2019 tax refund to the trustee for distribution to creditors because the debtor had not yet completed his plan. The court relied in part on its holding in In re Nasino. In that case, the debtor had objected to the trustee's final report and account, arguing that the trustee had erred in using a portion of the debtor's 2019 tax refunds to distribute more than a one percent dividend to unsecured creditors (approximately 22 percent) because, according to the special provisions, the plan should have been completed once the 36-month mark was reached and general unsecured creditors were paid one percent on their claims. The debtor asked the court to order the trustee to refund the extra 21 percent paid to general unsecured creditors. The trustee responded that nothing in the plan's special provision expressly contradicted the requirement to pay to the trustee half of all net tax refunds received during the plan term. The court acknowledged that the provision addressing tax refunds and the plan shortening provision may have conflicted and reasoned that any ambiguity should be resolved against the debtor as the drafter of the plan. The court therefore held in favor of the trustee and denied the debtor's request.

In Harrington's case, the bankruptcy court found that the trustee's reading of the plan was the correct one. The court reasoned that, since Harrington still had to pay $108 into the plan before the unsecured creditors would receive one percent of their claims, the plan was therefore not yet complete. Therefore, Harrington's 2020 tax refunds fell within the scope of Section 1(B) of the plan as tax refunds received "during the term of the plan." The court further noted that the plan called for a distribution to unsecured creditors of "not less than" one percent. In the court's view, the "not less" requirement imposed a floor as opposed to a ceiling, and therefore the plan shortening provision did not conflict with the provision requiring the payment of tax refunds to the trustee. The court followed the approach taken in In re Win and denied the trustee's motion to dismiss, subject to the condition that Harrington comply with the plan term that required him to turn over half of his 2020 tax refund to the trustee.

For a discussion of Chapter 13 bankruptcy, see Parker Tax ¶16,125.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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