During our initial bankruptcy consultation we go out of our way to advise potential clients that they will likely be required to turnover income tax refunds to their bankruptcy trustee. Many potential clients choose to delay the filing of their bankruptcy until they have filed tax returns, and received and spent tax refunds. Clients who retain our firm are again reminded of the requirement to turnover tax refunds to the Trustee.
However, sometimes the case is filed and the client collects and spends the tax refunds without consulting counsel. The usual explanation is “I am bankrupt, I needed the money for… insert a compelling, important reason.” When the requirement is again brought to the client’s attention we sometimes hear “So what? What can the trustee do about it?” This is an important question, and the answer is of critical importance.
CHAPTER 7 TRUSTEE:
If a debtor refuses or fails to turnover a required tax refund (or required portion thereof) to the chapter 7 Trustee, the Trustee can file a motion with the court seeking to prevent the discharge of the debtor’s debts. If a discharge of debts has already been ordered, the chapter 7 Trustee may seek to have the discharge order revoked (set-aside). If the discharge order is revoked, the debtor can then be pursued by her/his creditors as if no bankruptcy had been filed.
CHAPTER 13 TRUSTEE:
If a debtor refuses or fails to turnover tax refunds in a chapter 13 case, the chapter 13 Trustee may prevent the entry of a discharge order or seek to have the discharge order revoked. If the debtor has not completed the regular monthly plan payments, the debtor may seek, through counsel, to have the turnover of the refunds waived. It is very important to acknowledge that there must be a very compelling, documented reason for the waiver. The Trustee and/ or the Judge will consider the circumstances and make a decision. The debtor will then have to comply or the chapter 13 case may be dismissed.
Potential bankruptcy filers should be aware of the requirement to turn over tax refunds to the trustee and prepare their affairs accordingly.