For debtors with incomes below the median, the Fifth Circuit invalidated a local rule requiring all chapter 13 debtors to turn over income tax refunds in excess of $2,000 for distribution to creditors as additional disposable income.
The appeals court said that the local rule was invalid because it conflicted with Section 1325(b) as explicated by the Supreme Court in Hamilton v. Lanning, 560 U.S. 505 (2010).
The District’s Chapter 13 Plan
Debtors must use the Official Form for chapter 13 plans unless the district has adopted its own local form. See Bankruptcy Rule 3015.1. The Western District of Texas adopted its own form plan with a provision requiring all chapter 13 debtors to turn over income tax refunds in excess of $2,000 for distribution by the chapter 13 trustee as additional disposable income. Debtors were allowed to retain excess refunds only if the plan called for paying unsecured creditors 100%.
The chapter 13 trustee said that many districts around the country have similar provisions in their local plans.
In the case that went to the Fifth Circuit, the debtor anticipated receiving a refund of about $3,200. She filed a plan that deleted (that is, struck out) the local form provision calling for turnover of refunds of more than $2,000. She claimed that the refund would be offset by her expenses.
When the bankruptcy court denied confirmation, the debtor filed an amended plan that included the local provision. To ameliorate the effect of the turnover, the confirmation order said that the debtor could pay the $1,200 excess refund to the trustee at the rate of $25 per month for the remaining life of the plan.
The debtor appealed, but the district court affirmed. The debtor appealed again, this time overturning the local plan provision in an opinion on August 26, by Circuit Judge Edith Brown Clement.
Lanning Precludes Mandatory Turnover
Citing Fifth Circuit authority, Judge Clement said that local rules adopted by districts must be procedural only and may not abridge substantive rights.
Did the requirement for turning over tax refunds of more than $2,000 abridge the debtor’s substantive rights? Judge Clement found the answer in Section 1325(b)(1)(B) and Lanning.
When there has been an objection to the plan, Lanning explained how Section 1325(b)(1)(B) requires that all of the debtor’s “projected disposable income” be applied toward the claims of unsecured creditors. Although “projected disposable income” is not defined, “disposable income” means “current monthly income” less “amounts reasonably necessary” for the debtor’s maintenance and support. “Current monthly income” refers to the six months before filing.
For Judge Clement, the question was whether the excess tax refund represented “projected disposable income.”
Judge Clement explained that Lanning made a distinction between debtors with income above the median and those below median.
For debtors below the median like the debtor on appeal, the high court said that all amounts reasonably necessary for maintenance and support are not part of disposable income. For an above median income debtor, only specified expenses are deducted.
Judge Clement therefore held that “Section 1325(b)(2) of the Code, as clarified in Lanning, plainly allows below-median income debtors to retain any income that is reasonably necessary for their maintenance and support.”
Judge Clement rejected the trustee’s argument that a uniform rule for all chapter 13 debtors promoted efficiency. She said that efficiency “is not grounds for abridging below-median income debtors’ substantive rights to use their ‘excess’ refund income to finance reasonably necessary expenses for their maintenance and support.”
Looking at the debtor’s income and expenses, Judge Clement said it was “entirely plausible that [the] Debtor will use her ‘excess’ tax refund of [about $1,200] for expenses that are reasonably necessary for her family’s maintenance and support.” Leaving the question open, she invalidated the provision in the local plan mandating the turnover of excess tax refunds, vacated the confirmation order, and remanded the case for the debtor to file a plan consisted with the circuit’s decision.
Observations
The language of the opinion appears to invalidate the local plan provision entirely. However, the analysis by Judge Clement showed defects only with regard to below median income debtors.
Could the district adopt a local rule requiring turnover of excess tax refunds by above median debtors?
The opinion does not seem to mean that below median income debtors can always retain tax refunds. The opinion puts the onus on chapter 13 trustees. After a debtor discloses his or her tax return, trustee can pursue a plan modification if the trustee believes that some of the refund is not necessary for maintenance and support.
In other words, the opinion ends the presumption that excess tax refunds belong to creditors and helps debtors who could not afford to pay counsel fees required for proving an entitlement to retain tax refunds. The opinion should mean that debtors will not end up paying too much just simply because they couldn’t afford counsel fees.
For debtors with incomes below the median, the Fifth Circuit invalidated a local rule requiring all chapter 13 debtors to turn over income tax refunds in excess of $2,000 for distribution to creditors as additional disposable income.
The appeals court said that the local rule was invalid because it conflicted with Section 1325(b) as explicated by the Supreme Court in Hamilton v. Lanning, 560 U.S. 505 (2010).
The District’s Chapter 13 Plan
Debtors must use the Official Form for chapter 13 plans unless the district has adopted its own local form. See Bankruptcy Rule 3015.1. The Western District of Texas adopted its own form plan with a provision requiring all chapter 13 debtors to turn over income tax refunds in excess of $2,000 for distribution by the chapter 13 trustee as additional disposable income. Debtors were allowed to retain excess refunds only if the plan called for paying unsecured creditors 100%.
The chapter 13 trustee said that many districts around the country have similar provisions in their local plans.
In the case that went to the Fifth Circuit, the debtor anticipated receiving a refund of about $3,200. She filed a plan that deleted (that is, struck out) the local form provision calling for turnover of refunds of more than $2,000. She claimed that the refund would be offset by her expenses.