In United States v. Carroll, No. 2:09-cv-13505 (E.D.Mich. Jan. 20, 2010), a U.S. district court ruled that the chapter 13 trustees of the Eastern District of Michigan may no longer seek to intercept the federal income tax refunds of chapter 13 debtors. The IRS had soveriegn immunity from bankruptcy court orders requiring the IRS to intercept tax refunds, the court held.
This ruling ought to assist chapter 13 debtors in keeping all or a portion of their tax refunds, because the IRS will no longer be paying tax refunds directly to the chapter 13 trustee in this federal court district. Trustees seeking additional “back door” chapter 13 payments will have to rely on traditional methods, such as turnover motions or motions to enforce chapter 13 tax refund provisions against the debtors themselves. Debtors may have defenses to such motions, which they can now assert in their individual chapter 13 cases.
The court’s ruling points out that the standard Michigan chapter 13 plan form required the IRS to intercept tax refunds, and then to pay the refund over to the chapter 13 trustee for payment to creditors at the expense of the debtor. However, the IRS was not made a formal party to every chapter 13 proceeding involving tax refunds; consequently it had been given no opportunity to object to the chapter 13 plans.
Additionally, the court found that Congress had not waived the IRS’s soveriegn immunity in lawsuits of this nature. It therefore forbade the chapter 13 trustees from enforcing any orders entered in the past involving interception of tax refunds. The court also issued a writ of mandamus against the bankruptcy court judges of the Eastern District of Michigan, forbidding them from confirming any more chapter 13 plans containing tax refund interception provisions.
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