Chapter 7 bankruptcy trustees will target debtor’s income tax refunds. Tax refunds provide immediate cash available for distribution to creditors as opposed to other assets, such as cars, which have to be stored, noticed for sale, and liquidated at auction with commissions due.One of my bankruptcy clients is expecting a significant tax refund. He stated that all his income in the past year was in the form of distributions from a qualified pension plan and social security. Proceed from pensions and social security distributions are exempt under Florida law after they money has been distributed to the recipient debtor. My client wants to know if his tax refund representing taxes withheld from pension and social security distributions is exempt in Chapter 7 bankruptcy.
I have never seen a case on this issue, and the issue has not come up before in any of my previous bankruptcy cases. In my opinion, the tax refund would not be exempt. Money from pensions and social security in a debtor’s financial account is exempt only if the debtor can trace the funds in his financial account to pension or social security distributions.
It is difficult for a debtor to trace pension and social security funds after the money has been commingled with money received from non-exempt sources. The debtor’s tax refund has been commingled with other money in the U.S. treasury. The IRS does not keep each taxpayer’s tax withholding in a segregated account such that the withheld funds could be traced to their source, and therefore the money the debtor receives as a tax refund is not the same money withheld from his pension and social security. Because the tax refund money cannot be traced to this debtor’s social security and pension distributions the refund should be part of the non-exempt bankruptcy estate.
I am learning reading your post which I am sometimes naive about. This is quite interesting though and I couldn’t imagine if tax refund will be taken as it should be.
Interesting post – I would have to agree with you. I have had this situation arise in several bankruptcy cases. However, we were able to time them so the debtor could collect their refund prior to filing. I imagine it is one of those things that varies based on trustee, but I would not want to try it. Can you follow up on the outcome?
wow this is really great information! thanks to inform about this..great content!!
I do not believe the funds are comingled by the nature of them being held by the treasury. If that were true, then the nature of depositing your wages into a bank would “comingle” the funds with everybody elses money, and that is certainly not the case.
The 2010 Florida Statutes(including Special Session A)
222.25 Other individual property of natural persons exempt from legal process.–The following property is exempt from attachment, garnishment, or other legal process:
(1) A debtor’s interest, not to exceed $1,000 in value, in a single motor vehicle as defined in s. 320.01.
(2) A debtor’s interest in any professionally prescribed health aids for the debtor or a dependent of the debtor.
(3) A debtor’s interest in a refund or a credit received or to be received, or the traceable deposits in a financial institution of a debtor’s interest in a refund or credit, pursuant to s. 32 of the Internal Revenue Code of 1986, as amended. This exemption does not apply to a debt owed for child support or spousal support.
(4) A debtor’s interest in personal property, not to exceed $4,000, if the debtor does not claim or receive the benefits of a homestead exemption under s. 4, Art. X of the State Constitution. This exemption does not apply to a debt owed for child support or spousal support.
Does #3 not apply?
If the only source of withholding for income tax purposes was the distributions from the pension and social security accounts, I think that this would undeniably prove that the refund is exempt.
Example: Gross distributions $20,000
Federal Tax Withheld 5,000
Net amount received $15,000
If the debtor then receives this $5,000 back in the form of a refund, regardless of its “commingling” with other treasury funds, it’s source is most definitely a distribution from his/her pension or social security – there is no where else from which it could have come.
Is there income tax on the amt. of money discharged in chapter 7. Thank you