Bankruptcy

Chapter 7 Bankruptcy Treatment Of Tax Refund From Exempt Income Sources

By Jonathan Alper

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.

Full post as published by Florida Bankruptcy Law on December 22, 2010 (boomark / email).