Debtors Defeat Bankruptcy Trustee in Battle Over Tax Refunds

Kansas debtors defeated the bankruptcy trustee in a battle over their income tax refund recently.

“It was creative bankruptcy planning by debtors and their counsel to assign their income tax refund pre-petition to pay their attorney’s flat fee retainer,” the U.S. Bankruptcy Appellate Panel of the 10th Circuit ruled last week in In Re Miller, Case No. 06-132. “Doing so was within the bounds of applicable law.”

Kansas has no law to exempt tax refunds in bankruptcy. Debtors forfeit to the trustee a pro-rated share of the tax refund for the year in which their bankruptcy case is filed. For example, when a Kansas debtor files a bankruptcy petition on September 1, he has to turnover to the trustee three-fourths of the 2007 tax refund when it arrives the following spring.

Debtors have been assigning their tax refunds to their attorneys for many years in Kansas, a tactic that has come under attack by bankruptcy trustees in recent years. The assignment makes it possible for a debtor to retain an attorney and get a bankruptcy case filed without having to pay all of the attorneys fees in advance The attorney is paid out of funds the debtor otherwise would lose to the trustee. Often, the assignment results in no funds being paid to the trustee and the trustee closing his file with a report of no assets.