Posts Tagged ‘Property of the Bankruptcy Estate’

Property of the Bankruptcy Estate | Bank accounts

Client: Are the funds in my bank account property of the estate?
Attorney: Well….that depends.

It depends on whether the funds are the clients.  It depends on whether the client’s children’s funds are in a “UTMA” account labeled as such.  It depends on whether the client shares a bank account with another individual or entity.  It depends on whether the client has deposited his funds into the account.  It just depends on the facts and circumstances of the client’s particular situation.

But simply put, if the debtor deposits his wages in his bank account, which is his and his alone, then chances are yes, the funds in the account are property of the bankruptcy estate.

It is important to note that it is the funds in the bank account as of the Petition date that are property of the estate, not the funds in the debtor’s check register after all outstanding checks clear.  This is a big distinction. Granted it is not likely as much an issue nowadays with POS and ACH transactions so prevalent in our spending, but it certainly something the debtor must know when filing.

In fact, I bet Mr. And Mrs. Wolfe were not so aware of this little distinction when they filed their bankruptcy Petition.  In their case, they had timely filed their 2011 Federal income tax return on October 15, 2012.  They included with their tax return a check for $8,360, the amount of their 2011 tax liability; they had borrowed the funds from their acquaintance, Larry.  The IRS received the returns and deposited the check on October 19, 2012.  The Wolfe’s then filed their chapter 7 bankruptcy petition on October 22, 2012.  Then, on October 23, 2012, the IRS check cleared their bank account, debiting $8,360 from the account.

The Trustee subsequently sought from the debtors, the $8,360 they had in their bank account as of the Petition date.  (It should be noted that due to the source of the funds, a loan, there appears to be no applicable exemption for the debtors to claim to protect the funds from administration by the estate.)  The Debtors protested.  And Judge Pappas issued a written decision on the matter.

The Court held that the funds in the bank account became property of the bankruptcy estate the moment the Wolfe’s filed their bankruptcy petition.  That at that moment, they were still in control of the $8,360 in their bank account because they could have withdrawn all the funds in cash, transferred the funds to a different account, issued a stop-payment on the check, or close the account.  And that because they had control of the funds during the pendency of the case, they had a duty to preserve those funds and turn them over to the trustee if and when so demanded.

The last thing any debtor wants after declaring bankruptcy is the bankruptcy court issuing a $8,000 money judgment against the debtor.  So when attorneys and clients discuss the timing of a bankruptcy petition, the attorney needs to ask, and the client needs to advise, as to the status of any outstanding checks.  Though the check this case involved over $8,000, which may appear unusual; it is not uncommon for debtors to have mortgage payments upwards of $1,500 – $2,000 that may be outstanding.  It might just be better to wait until those checks clear before filing.  If waiting is not an option, then it is advised take out cashier’s check or money orders and mail those out prior to filing.


EDIT (1/10/2014):

The 9th Circuit filed an Opinion yesterday that affirms Judge Pappas’s reasoning in the Wolfe case.  In facts very similar to the Wolfe’s the issue was not whether the funds in bank account were property of the estate, but whether the defendant must have possession of property of the estate at the time the Trustee brings his motion for the turnover of said property.  In a rather short 13 page decision the 9th Circuit held that possession of property of the estate at the time the Trustee’s motion is filed is not necessary for the Trustee to succeed on the matter.  The Court opined that to hold otherwise would allow any defendant of such an action to simply transfer the property to avoid liability to the estate.

Property of the Bankruptcy Estate

**This article should be considered an incomplete article until further notice. The intent with this article is to establish a general article about property of the bankruptcy to which subsequent articles discussing the different specifics of property of the estate may refer. **

By definition, property of the bankruptcy estate includes: All legal and equitable interests of the Debtor in property as of the commencement of the case. 11 U.S.C. § 541(a)(1). When explaining this definition to a prospective client, I typically start with the paraphrase: Anything you can point to, whether you can see it or not, and say, “that is mine,” or “that should be mine,” or “that will be mine” is property of the bankruptcy estate.

The bankruptcy code broadly defines property of the estate with a few narrow exceptions. For instance one exception to property of the estate, found in § 541(b)(1), is any power the debtor may exercise solely for the benefit of an entity other than the debtor, i.e., a debtor’s fiduciary power under an express trust, or his managerial powers pursuant to his employment.

Whether an interest is property of the estate, at the moment the Petition is filed, is not left to the discretion of the debtor, trustee, or even the court. It is an objective determination based upon whether the asset falls within the definition in § 541(a).

There is often the question of whether a certain asset is property of the bankruptcy estate. While Federal law (i.e., Bankruptcy law) determines whether such asset of the debtor is property of the estate, state law determines whether the asset is property of the debtor.  So if state law recognizes the property being of the debtor, then Federal law will determine whether such property of the debtor is property of the estate.  Conversely, if state law does not recognize an asset as being property of the debtor, then there is no property of the debtor for Federal law to determine as property of the estate.

There is much to be discussed with regards to property of the estate.  And Debtors need to understand what constitutes property of the estate as their ignorance could put their discharge at risk.  When the debtor understands how broad the definition actually is, the debtor is better prepared for his bankruptcy.

Tax REFUNDS in a Chapter 7

I’m talking about tax refunds, not returns.  There is a difference.  A tax return is the paper that you send to the taxing authority.  The tax refund is the actual money you get back from the taxing authority.  Tax refunds are property of the estate….well, not entirely….but mostly….well, that is the subject of this post: when are tax refunds property of the estate?

To answer the question, you must understand, exactly what tax refunds are.  Like I said, they are the $$$ that is returned to you by the taxing authority.  But its a little more complicated than that.  First off, while the amount of your refund, if any, is determined when completing your tax return, your right to that refund  actually vests at the end of the tax year for which your refund pertains.  So if for tax year 2011, you paid in more than your actual tax obligation, then your right to a refund vests on January 1, 2012 (even though the actual amount may not be determined until October, 2012, if you filed an extension).  Thus on January 1, 2012, your 2011 tax refund may be considered an account receivable, albeit for an unknown amount.  And since accounts receivables are considered property of the estate,  the 2011 tax refund may be considered property of the estate.

The extent of the bankruptcy estate’s interest in  a tax refund depends on the date you filed for bankruptcy relief.  As in the example above, if a debtor were to file for relief on January 1, 2012, his entire 2011 tax refund would be property of the estate.  The Bankruptcy Code requires that debtors file their tax returns as required by law and therefore the bankruptcy trustee will request turnover of the entire 2011 tax refund upon the debtor’s receipt.  So, if the debtor has yet to file his 2011 tax return before filing bankruptcy, 100% of the 2011 tax refund is property of the estate and will likely need to be turned over to the Trustee

The same is true if the debtor files bankruptcy after filing his tax returns but before receiving the tax refund.  Also, if he has received his tax refund and is still in possession of the refund, or any portion of it, at the time he files bankruptcy then he’ll be asked to turn over to the Trustee the portion of the refund debtor had in his possession at the time of the bankruptcy filing.  At this point, the debtor’s interest in the tax refund is likely an interest in cash, or, more likely, an interest in a bank account in which the funds are deposited.  Regardless of its disposition, if the debtor is in possession of the refund at the time of filing bankruptcy, the debtor must turn those funds over to the Trustee.

The scenario may be different if the debtor files bankruptcy after receiving his tax refund and spending the funds on reasonable and necessary goods (such as car repairs, bk atty fees, necessary food/clothing/maintenance items, housing repairs, etc.).  In this scenario, the 2011 tax refund was already received prior to the bankruptcy filing, thus it transformed from an account receivable to an asset – a diminishing asset.  If diminished prior to the filing of the bankruptcy, then, well, it is diminished and any residual is considered property of the bankruptcy estate (see previous paragraph); if fully diminished, however, then there is nothing for the bankruptcy estate.  (See below for comments regarding use of a tax refund prior to the filing of a bankruptcy.)

But what happens when a debtor files bankruptcy much later in the year….like October, 2012.  At that point it is very likely the debtor received his 2011 tax refund and spent it (assuming a tax return was filed in or before April).  However, it is also likely that the debtor will be filing another tax return in the next 6 months….so Bankruptcy Trustees, the sly devils they are, will seek the bankruptcy estate’s pro-rata share of the debtor’s 2012 tax refund, if there is one.  Basically, the Trustee calculates the bankruptcy estate’s percentage of the tax refund based upon the Petition date (the day the debtor filed bankruptcy).  So if the Debtor filed October 1, 2012, the Trustee will divide  275 (numbers of days lapsed prior to the Petition date + the Petition date) by 366 (total days in the year).  So in this instance the Trustee would get 275/366 (75.14%) of the debtor’s 2012 tax refund.

Sometimes tax refunds are the only asset a Trustee administers.  Thus, Trustee’s will hold cases open until they get a copy of the tax return – if it shows little to no refund, then they’ll likely file a no-asset report and allow the case to close.  However, if there is a sufficient refund, then the Trustee will likely elect to administer such funds and the  case will remain open until the Trustee is finished.

Notes Regarding Tax Refunds:

1.  The debtor cannot exempt his interest in his tax refund.  In fact the tax refund may be the only non-exempt asset a debtor has – which means that Trustee’s are keen on what happens to them.

2. A debtor’s liquidation of the tax refund will be scrutinized.  Thus, if you wish to spend your tax refund prior to filing bankruptcy, then understand that you will be asked how you spent such funds and why such an expense would be considered reasonable and necessary in your circumstances.  That means a debtor  should not spend his tax refund on a vacation, novelty or frivolous items, or other things not necessary for his welfare.  Some accepted expenses include groceries, car/house repairs or maintenance, bankruptcy attorney, catch up arrears on secured debt, medical expenses, and the like.  It is advised though that debtors consults with their attorney prior to the spending of tax refunds.

3. Due to the scrutiny that tax refunds get, which is rightly deserved, the better the debtor can show how those funds were used, the better it is FOR EVERYONE.  It is recommended that debtors deposit their tax refund into its own separate bank account; the account should start with a $0.00 balance, and should only reflect the deposit of the debtor’s tax refunds….nothing else.  Funds should be withdrawn from the account only by way of checks or POS transactions…that is it (i.e., no cash withdrawals or transfers to other accounts).  This way the bank, not the debtor, will generate a statement as to how those funds were used or disposed.  Also, the debtor should  not transfer funds from the “refund” account to some other “regular checking” account in order to use the funds; otherwise the Trustee will then need to review 2 checking account statements to determine how the funds were used.

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