A few tips about Tax Refunds in Chapter 13 Plans

It’s tax time – again.  For many, including myself, it can be a time of fear and loathing.  Given a choice between having a colonoscopy or going to see my accountant to prepare my annual taxes, I would probably choose the former.  I’m relieved to be able to say that mine are done and filed.  So glad to have that over with.  Since I’m self employed, I almost always have to pay in.

For my Chapter 13 clients tax time has another layer of complexity, trickiness might be a better word.  Most Chapter 13 plans in Minnesota are required to have a provision that says the Debtors are to provide copies of all annual state and federal income tax returns to the Trustee’s office as soon as the returns are filed.  If they are to receive a refund, the provision usually allows married debtors filing jointly to keep the first $2,000 of the refunds, and allows individual filers to keep the first $1,200 of the refunds.  After those allowances, the balance of the refunds is to be paid into the Chapter 13 Plan as an additional contribution.  This contribution benefits the creditors, but usually has no particular effect on the monthly payment plan for the Debtors.  After making this extra contribution, in most cases the monthly payments under the Plan continue unchanged and on the same schedule.

The preferred method of sending the tax returns to the Trustee is now to make the return into a PDF and email it to an email address that the Trustee’s office has designated for that purpose.  After that the Debtors should wait for a letter from the Trustee’s office which will tell them how much of the refund should be mailed in.  The letter is usually sent promptly, although it comes by snail mail.  Since I tend to be copied with both the emails and the snail mail, I have had quite of bit of this correspondence arriving on my desk over the past few days.  So far this year there has been only one case where I disagreed with the way the Trustee’s office was calculating how much my clients were to send in.  When that happens, I have always been able to straighten things out with a of series of email exchanges with the staff person who did the calculations.

Here’s a few important things to know about how they calculate exactly how much the extra contribution from the tax refunds is supposed to be.  First of all, if you get a refund from one level of government – for example the feds – and have to pay in to the other level of government – for example the state, usually you can expect the amount you had to pay in to be deducted from the amount of the refund.  If you paid to have an accountant or other preparer to do your returns, be sure to send the bill for the tax preparation in to the Trustee’s office along with the tax returns.  At least this year I have been seeing the Trustee’s office allow a credit for the cost of tax preparation.  In one letter that just arrived on my desk, they allowed a credit for a $96 processing fee from TurboTax.  

If you find your refund to be a whole lot more than the part you are allowed to keep, I’ve never seen anybody get in trouble for adjusting their wage withholding so that next time the refund won’t be so large.  Such adjustments can involve a lot of trial and error, however, and you might find it pretty hard to get it just right.  It’s easy to overshoot the goal and wind up having to pay in to the IRS and Department of Revenue.  Like Garrison Keillor says, be careful.

Keep in mind that everything I say here only applies to Minnesota cases.  I would expect that practices vary quite a bit around the country concerning this topic.  And as I always say, this post is for general information purposes only.  It is not legal advice and does not create an attorney-client relationship.  Please consult the attorney of your choice concerning the details of your case.

 

What NOT to do while going Over the Fiscal Cliff

 

Cliff near Pike's Peak

Watch out for the temptation to under withhold .

Most people I talk to have not heard of the “fiscal cliff.”  Those who have believe it will not affect them.  This includes a husband and wife I met with yesterday.  But when I ran the numbers for them, based on a November 1st article in Forbes, I found that between the two of them their paycheck withholding should go up by about $438 per month.  That is, the net take home pay for the two of them together will be $438 less per month starting January 2, 2012.  That is just a few days from now.  When I tried to warn them and suggested that they should be thinking about how they would deal with this, they blew me off.  They are absolutely in denial about the prospect that this could ever happen.  If we go over the fiscal cliff as scheduled,  this should come as a heck of a shock.

My calculations assume, of course, that no steps will be taken to reduce the impact of the fiscal cliff.

From where I sit it looks like a majority of people are living right on the edge.  For them a drop in take home pay like this will mean they no longer have the funds to pay their credit card debt.  Often when people are in such a situation, they go to their employer and increase the number of exemptions they are claiming for withholding purposes on their paychecks.  They claim more withholding exemptions than they should.  Some increase the number of exemptions to the point that no taxes are being withheld at all, and for them all that is withheld is social security and medicare.  This increases their take home pay, but it is at the cost of not having enough taken out to cover state and federal tax liability.  The income which should have been withheld for taxes is then used to make payments on credit card debt.  Often this is still not enough to get that credit card debt under control.

When it comes time to file their tax return, they find that they owe a tax debt which is too large for them to pay.   Now on top of the credit card debt there is a substantial tax debt.  Eventually they wind up in my office.  I can help get rid of the credit card debt.  But as long as the tax debt is less than three years old, there’s nothing I can do to help with the tax debt.

The worst creditors you can have are the IRS and the Minnesota Department of Revenue.  In almost all circumstances, it is better to stop paying other debts before you stop or reduce the withholding of taxes from your pay check.  Don’t fall for the temptation to unreasonably increase the exemptions you claim for withholding from your paycheck.  That will work for a short time, and then you’ll really wish you hadn’t done that.

This post is for general information purposes only and should not be considered legal advice.  You should consult the attorney of your choice concerning the details of our case.  Reading or responding to this post does not create an attorney-client relationship.  I am a debt relief agency helping people to file for relief under the federal bankruptcy code.

 

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