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Federal Tax

Trustee Nabs Joint Income Tax Refund in Spouse’s Bankruptcy

· 5 minute read

· 5 minute read

By David J. Light

An Ohio couple must pay their entire federal income tax refund, minus applicable exemptions, to the trustee administering the husband’s bankruptcy because withholdings from his income were the refund’s sole source, a bankruptcy judge has ruled. (In re Walton, (Bktcy Ct Ohio) 132 AFTR 2d ¶2023-5078)

U.S. Bankruptcy Judge Mary Ann Whipple of the Northern District of Ohio on July 25 rejected Thomas Walton’s arguments that the bankruptcy trustee’s claim should be limited to half of the refund. The judge determined that using divorce law to divide the refund between the spouses is inappropriate in bankruptcy, and treating the spouses as if they had filed separate returns instead of a joint return ignored the law.

Tax refund.

Thomas Walton and his wife filed a joint federal income tax return for 2022, Judge Whipple’s opinion said. Thomas filed for Chapter 7 relief in February 2023.

After learning that he and his wife were entitled to a $5,695 refund, Walton amended his bankruptcy schedules to disclose that he was entitled to receive a refund of half that amount. The Chapter 7 trustee moved for turnover of the entire amount minus any applicable exemptions.

A hearing revealed that although Walton’s wife worked part time during 2022, the entire refund was attributable to withholding from Thomas’s wages.

Federal and state law.

Bankruptcy Code Section 541(a), 11 USC § 541(a), says a debtor’s bankruptcy estate includes “all legal or equitable interests of the debtor in property as of the commencement of the case.” Ohio Rev. Code Ann. § 3103.04 says neither spouse “has any interest in the property of the other.” Thus, “[f]ederal law defines what is property of the bankruptcy estate, but state law creates and defines property interests,” Judge Whipple said.

Because the refund came from excess withholding from Walton’s wages, his wife could not claim an interest in it, the judge said. That the Waltons filed a joint income tax return did not affect ownership of the refund, she added, citing In re Taylor22 B.R. 888 (Bankr. N.D. Ohio 1982).

Walton cited In re Aldrich250 B.R. 907 (Bankr. W.D. Tenn. 2000), In re Innis331 B.R. 784 (Bankr. C.D. Ill. 2005), and In re Crowson, 431 B.R. 484 (B.A.P. 10th Cir. 2010), in support of his argument that his wife owned half of the refund.

However, these courts arrived at their conclusions by drawing primarily from divorce law, Judge Whipple said. While divorce law provides a framework for dividing assets between spouses, adopting that framework in bankruptcy cases is not fair to creditors and does not further the goals of bankruptcy, the judge said.

She also rejected the “separate filings” rule for allocating interests in the joint tax return. This method calculates the amount of each spouse’s “married, filing separately” tax liability, which is then divided by the total of the spouses’ combined liabilities to determine the percentage of the joint tax liability attributable to each spouse, the judge said.

According to Judge Whipple, “[t]he separate-filings rule is arduous and inefficient.” “While filing jointly, as opposed to separately, may result in tax benefits, like a larger refund, that fact alone does not transform the property of one spouse into the property of the other,” she concluded.

Jennifer Donahue of Rauser & Associates LP in Canton, Ohio, represented Walton.

This article previously appeared in Westlaw Today. 


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