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Bankruptcy Court Allows Debtors to Retain Their Tax Refund for Necessary Expenses

(Parker Tax Publishing March 2021)

A bankruptcy court held that debtors in a chapter 13 bankruptcy, who received a tax refund and used it to pay for various needs relating to the wife's debilitating disease before filing a motion to retain the funds, were permitted to retain the entire amount of the tax refund, even though a local rule allowed the trustee the option of using part of the refund to pay the debtor's unsecured creditors. The court found that the debtors did not act in bad faith and needed the extra funds to pay for unexpected but necessary costs associated with the wife's multiple sclerosis. In re Young, 2021 PTC 38 (Bankr. N.D. Tex. 2021).


Charles Young and Cindy Wells-Young (the Youngs) filed a chapter 13 bankruptcy petition on December 6, 2019, in the northern district of Texas. Mrs. Young was diagnosed with primary progressive multiple sclerosis two and half years earlier. Her sister quit her job and moved in with the Youngs to provide 24-hour care to Mrs. Young. While the Youngs are above-median income debtors, Mrs. Young's medical and other expenses related to her care take everything Mr. Young makes and more.

The Youngs own three cars: a 2012 Nissan Titan, a 2014 Chevy Camaro, and a 2013 Dodge Journey. The Dodge Journey is the only car that can accommodate Mrs. Young's wheelchair and is low enough to the ground that Mrs. Young does not have to be lifted up to get into the car, thus making it an ideal car for transporting Mrs. Young. The Youngs still owe money on the car but the lender did not secure its lien on the car and was thus an unsecured creditor. The Youngs filed a motion to retain their 2019 tax refund, totaling $4,415, for repairs to the car so that they could use it for taking Mrs. Young to her various appointments. The motion was filed after the refund was spent. According to the Youngs, the money was spent on a myriad of things, including home modifications and a wheelchair ramp to accommodate Mrs. Young. Although their motion stated only that the refund was needed to repair the Dodge Journey, the Youngs said that they only mentioned the car repairs because their attorney believed that would be sufficient. Because the tax refund had already been spent, the Youngs still had to come up with the funds to repair the car used to take Mrs. Young to doctor appointments. Mr. Young came to an arrangement with the body shop working on the car whereby the Youngs would pay what they could each montha "pay-as-you-go" type of arrangement. The payments were between $250-500 a month for the repairs.

Under a local rule (i.e., the standing order) for the Northern District of Texas Bankruptcy Court, a chapter 13 debtor is allowed to retain the first $2,000 of a tax refund. Any amount in excess of $2,000 is deemed an "excess tax refund." The trustee may file a plan modification to increase the base amount by the excess tax refund for the benefit of the allowed general unsecured creditors. The debtor may object to the plan modification in order to retain the refund above $2,000, without having to add it to the plan's base amount, through a detailed written narrative explaining the debtor's need for the excess tax refund. In most cases, the bankruptcy court hears requests to retain a tax refund only after the chapter 13 trustee has moved for the debtor to turn over the tax refund or has filed a motion to modify the chapter 13 plan to add the tax refund amount to the required base for the plan. Thus, the main issue in this case was whether the Youngs were permitted to retain their entire tax refund.

In In re Diaz, 2020 PTC 270 (5th Cir. 2020), the Fifth Circuit held that a provision in a local chapter 13 bankruptcy plan, which requires that debtors in the Western District of Texas turn over to the bankruptcy trustee any tax refund received in excess of $2,000 is invalid because it abridges debtors' substantive rights and conflicts with Supreme Court's guidance. The Western District of Texas Court's form chapter 13 plan had a provision, like the Northern District's standing order, that allowed every chapter 13 debtor to keep the first $2,000 of their tax refund. However, the form plan required the debtor to turn over any excess to the trustee unless (1) the debtor filed a motion to retain the tax refund, (2) the debtor's plan paid unsecured creditors in full, and (3) the trustee did not object. The Fifth Circuit determined that this local rule, which automatically designated debtors' excess tax refund amounts as "projected disposable income" to which the trustee was entitled, was invalid because of the effect the rule had (or could have) on below-median income debtors. The Fifth Circuit noted the Supreme Court's decision in Hamilton v. Lanning, 560 U.S. 505 (2010), which discusses how to calculate projected disposable income and emphasizes that courts must treat above- and below-median income debtors' disposable income differently. The Fifth Circuit also emphasized that local rules must be only procedural and may not abridge, enlarge, or modify any substantive right. The Fifth Circuit concluded that the provision that required all chapter 13 debtors to turn over to the trustee all tax refunds in excess of $2,000 as "projected disposable income" abridged below-median income debtors' substantive rights to use their excess refund income to finance reasonably necessary expenses for their maintenance and support.

In this case, the Youngs proactively requested that they be allowed to retain their refund amount to help pay for their expenses related to Mrs. Young's illness. Their motion specifically asked for the funds in order to repair a car that Mrs. Young needed for her travel to and from medical appointments. The chapter 13 trustee asked the court to both deny the Youngs' motion and then require that their attorney turn over to him the $400 they paid in fees and expenses for bringing the motion. The trustee did not formally object to the motion but expressed his dissatisfaction with the fact that (1) the Youngs had already spent the excess refund rather than having it turned over to the trustee, (2) their attorney was paid the $400 without prior approval, and (3) the Youngs took on additional debt (by entering into the pay-as-you go agreement with the body shop) without notice.


The court granted the Youngs' motion to retain their entire 2019 tax refund. The court found that the refund was reasonably necessary for the Youngs' maintenance or support. The court noted that Mrs. Young has a disease that impacts her ability to function, and that the Youngs needed a car that would not only fit Mrs. Young, her wheelchair, and a driver, but also one that is conducive to transferring Mrs. Young from her wheelchair to the car. The court found that the Youngs were asking to use their excess refund to repair a car that they already own and would meet their special transportation needs. Further, although the Youngs spent the refund before the hearing, the court found that there was no indication, given their circumstances, of bad faith on their part.

The court also found that the Northern District Bankruptcy Court's standing order was not invalid under the Fifth Circuit's holding in Diaz. The court noted that the Youngs, unlike the debtor in Diaz, are above-median income debtors. However, the court found that more importantly, the standing order does not mandate the turnover of any portion of a tax refund, but only defines what constitutes an excess tax refund and sets forth the procedure for addressing the refund. In the court's view, the rule does not limit or interfere with chapter 13 debtors' substantive rights as did the Western District's form plan.

In addition, the court agreed with the trustee that the Youngs' attorney was required to request approval from the court for payment for his preparing of their motion. However, the court found that the Youngs did not need permission for the arrangement they made with the repair shop since Mr. Young did not take out a loan to pay for the repairs but rather agreed to make the payments directly to the body shop, and the body shop did not want to file a claim in the bankruptcy.

For a discussion the rules for individuals in a chapter 13 bankruptcy, see Parker Tax ¶16,120.

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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