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Bankruptcy Trustee's Objection to Exemption of Tax Refund Was Incorrect, Panel Rules - Sanchez and Gonzalez v. Oliveras

October 29, 2012

In order to get the benefits of bankruptcy--discharge of your debts and a clean slate at the end--you have to give up control over your own financial life to a trustee. Vincent Howard and our Norco consumer bankruptcy attorneys emphasize to clients that the trustee is not representing their interests, although he or she might seem to be; rather, the trustee's job is to get the most money possible for creditors. Sometimes, however, trustees make mistakes with the law, and that was the allegation in Sanchez and Gonzalez v. Oliveras, a First Circuit Bankruptcy Appellate Panel case involving tax refunds. Luis Roberto Sanchez Santiago and Carmen Margarita Gonzalez Morales filed for Chapter 13 bankruptcy and listed an expected tax refund as exempt, but their trustee, objected and the court disallowed it. The BAP of the First U.S. Circuit Court of Appeals reversed, finding the trustee failed to carry his burden of proof.

Sanchez and Gonzalez, of Puerto Rico, filed for bankruptcy in March of 2011. Anticipating that they would receive a refund from their 2010 taxes due the next month, they claimed that refund as exempt. The trustee's objection argued that they were attempting to remove projected disposable income from the plan. The couple responded that they were entitled to exempt the property because the mere fact that something is income is not a reason to deny an exemption. They also argued that the trustee hadn't proven they weren't entitled to the exemption. The bankruptcy court ruled for the trustee, finding that a tax refund is not part of the property of the estate and therefore cannot be exempt. In so doing, it applied the reasoning in another case that moved through the BAP at the same time, Garcia v. Oliveras.

On appeal, the couple argued that the bankruptcy court made errors of law when it found that they couldn't exempt a tax refund attributable entirely to pre-petition earnings, and relied of the wrong section of law. The BAP agreed. The U.S. Supreme Court has ruled that tax refunds arising entirely from pre-petition earnings are property of the estate under section 541 of the bankruptcy code, not under section 1306, as the bankruptcy court ruled. That section says certain property is in the estate the moment the bankruptcy is filed--including tax refunds. The trustee also argued that the refund was post-petition income that must be included, but the debtors argued that this objection could only be made as an objection to their bankruptcy plan, and none was filed at the time it was raised. The panel agreed, saying the bankruptcy court had confirmed an unopposed plan before ruling on this objection, and thus the trustee missed his chance to object. Thus, it concluded that the trustee failed to prove the claimed exemption was in error.

Vincent Howard and our Westminster personal bankruptcy lawyers rarely see an error of law reversing a bankruptcy ruling. However, we're pleased to see a case reinforcing the well-established rule that bankruptcy filers may exempt tax returns paid out of income that was earned entirely before the bankruptcy was filed. This is effectively pre-petition income, even though it may arrive after the petition is filed; a tax refund, after all, comes from overpayment of taxes, so it's a bit like being repaid for a loan you gave the government. At Howard Law, P.C., our Redlands individual bankruptcy attorneys help clients keep this and all other assets they are entitled to exempt, to help them live the best life they can while they do the hard but rewarding work of bankruptcy.

If you're considering filing for bankruptcy in California, you should call Vincent Howard and the experienced attorneys at Howard Law to discuss your legal options and your rights. For a consultation, call us toll-free at 1-800-872-5925 or send us a message online.

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