Summary:
The Bankruptcy Court for the Middle District of North Carolina sustained the objection filed by the Chapter 7 trustee against the debtor's claimed exemptions for their 2023 federal and state tax refunds—$10,035 federal and $1,490 state—based on North Carolina’s statutory exemptions for at N.C.G.S. § 1C-1601(a)(12) for “support payments” and with the Female Debtor's wildcard exemption.
The trustee objected, arguing that the tax refunds, specifically the Earned Income Tax Credit (EITC) and Additional Child Tax Credit (ACTC), do not qualify as “support payments” under N.C. Gen. Stat. § 1C-1601(a)(12), which protects "funds that have been received or to which the debtor is entitled, to the extent the payments or funds are reasonably necessary for the support of the debtor or any dependent of the debtor." The court agreed, interpreting the statute as applying only to alimony, support, and child support payments within a family law context, not tax credits. The court rejected the debtors' interpretation, which would make nearly any financial support eligible for exemption, as overly broad.
Additionally, the trustee argued that Bellido could not claim ownership of the refunds through the wildcard exemption since she had no taxable income or withholdings for 2023. In that regard, the court ruled that the correct method for allocating joint tax refunds in bankruptcy cases should be based on the “separate filings rule,” which calculates each spouse’s share as if they filed individually. This approach, consistent with IRS guidelines, more accurately reflects individual ownership in joint refunds than the 50/50 division suggested by the debtors. As a result, the trustee’s objection was sustained, disallowing the claimed exemptions.
The court ordered the ruling to be followed in contested cases, advising that trustees and debtors negotiate to avoid unnecessary litigation.
Commentary:
As usual when ruling on exemptions, the court began with the presumption that "exemption laws are to be liberally construed in favor of the debtor and allowance of the exemption." That presumption, however, seems to always be little more than a feather on the scales and which, even when other IRS Guidance describes the purpose of the EITC being to "[help] low- to moderate-income workers and families get a tax break" , is outweighed by trustee demands and hard-hearted courts concerned that protection the EITC as "funds reasonably necessary for the support of the debtor or any dependent of the debtor" would be an over-extension that would render the other sections of N.C.G.S. § 1C-1601(a)(12) superfluous.
Research from the Center on Budget and Policy Priorities report Policy Basics: The Earned Income Tax Credit has shown that "that families mostly use the EITC to pay for necessities such as food and housing, and in some cases, for education or training to boost their job prospects and earning potential." Recognition of this purpose and usage of EITC funds, together with a full application of the "reasonable" limitation in N.C.G.S. § 1C-1601(a)(12, would have allowed both a liberal construction that still conservatively examined the need for the EITC funds.
Certainly this is another example of how North Carolina's exemptions need to be reformed or even the federal bankruptcy exemptions more uniformly provide for the protection of these funds, regardless of how stingy an opt-out state might be.
In choosing the "separate filings rule" for determining how much of a tax refund belongs to each spouse, the bankruptcy court selected the most complicated resolution. This will encourage consumer debtors attorney to prepare these sort of hypothetical tax returns, increasing the costs of filing bankruptcy for low- to moderate-income workers and families (but heck- they've got EITC funds and would certainly prefer to pay their own lawyer than hand those over to some Chapter 7 trustee), delaying the filing of their bankruptcy so the EITC funds can be reasonably used for the support of their family, or diverting those debtors into Chapter 13 cases, where the trustees generally have a greater willingness to adopt a negotiated resolution (because unlike with Chapter 7 Trustees, their personal pecuniary interests are not meaningfully impacted by seizing funds.)
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