EITC Exemption Update

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We have two updates for you in the ongoing fight in Kansas for the right to keep one year’s worth of earned income tax credit in bankruptcy.

Kansas Bankruptcy Trustee Appeals

Earlier this month, the Bankruptcy Appellate Panel affirmed the Topeka bankruptcy judge’s ruling that the debtors could keep their EITC.  On February 13, 2013, the bankruptcy trustee appealed that decision to the 10th Circuit Court of Appeals in Denver. Williamson v. Westby (In re Westby), BAP No. KS 12-027 (10th Cir. BAP, Feb. 4, 2013). The trustee claims the new Kansas statute protecting the EITC is unconstitutional because it applies only in bankruptcy and not to debtors outside of bankruptcy. She seeks turnover of the money to pay trustee fees and creditors claims.

U.S. Supreme Court Rejects Similar Theory

An important legal development occurred this week that affects the Westby case.  The Supreme Court of the United States declined to hear an appeal of a lower court ruling that Michigan’s bankruptcy specific exemption is constitutional. Richardson v. Schafer (In re Shafer), 689 F.3d 601 (6th Cir. 2012), petition for cert. denied (U.S. Feb. 19, 2013) (No. 12-643).

The Michigan homestead allowance for bankruptcy debtors ($30,000 or $45,000 if over 65 or disabled) is substantially higher than the Michigan general homestead exemption ($3,500). Compare Mich. Comp. Laws § 600.5451(1)(n) with Mich. Comp. Laws § 600.6023(1)(h) (West 2012). The Sixth Circuit Court of Appeals rejected the argument that having different exemptions in bankruptcy that outside of bankruptcy is unconstitutional. It said Michigan’s higher homestead exemption for debtors in bankruptcy “actually furthers, rather than frustrates, [the] national bankruptcy policy” of providing debtors with a fresh start.

The Kansas bankruptcy trustee is making the same argument that Richardson made against Schafer and lost. A West Virginia trustee lost a similar argument against Peveich in bankruptcy court and appeals in Sheehan v. Peveich, 574 F.3d 248 (4th Cir. 2009). Debtors Westby will urge the 10th Circuit to adopt the precedent of the 4th and 6th Circuits so they may keep their much-needed earned income tax credit. It will probably be months before a decision is announced. We’ll keep you posted.

Kansas EIC Bankruptcy Exemption Constitutional

A second  judge ruled Thursday that the new Kansas statute exempting one year of earned income tax credit from creditors  in bankruptcy proceedings  passes constitutional muster.

Hon.Robert Nugent, Chief Judge of the U.S. Bankruptcy Court for the District of Kansas, joined the previous ruling of his colleague, Hon. Janice Miller Karlin, in finding K.S.A. 60-2315 constitutional.  Chapter 7 bankruptcy trustees in  Topeka and Wichita have filed hundreds of objections to the use of the EITC exemption by debtors in bankruptcy. An appeal of the earlier ruling in the Topeka Division is pending before the Bankruptcy Appellate Panel for the  10th Circuit of the U.S. Court of Appeals in Denver.

Tax refunds and earned income tax credits have been collected from debtors to pay commissions to chapter 7 bankruptcy trustees and then pay a small dividend to creditors.  Under the new Kansas law, trustees will not be allowed to take the earned income tax credit portion of the tax refunds for the year of the bankruptcy case filing.  The law reduces substantially funds available for chapter 7 bankruptcy estates.

The exemption statute adopted by the 2011 Kansas Legislature “insures that a bankrupt Kansan’s earned income credit goes to pay the rent or buy her family food, not a prepetition creditor’s claim. All of this is consistent with the federal law and does not infringe upon the Constitution’s Supremacy Clause,” Judge Nugent wrote.

Both judges dismissed all the challenges to the exemption statute by the bankruptcy trustees and ordered the earned income tax credit refunds released to debtors. That is good news for hundreds of low income, working families in Kansas who desperately need the money to pay for their necessary living expenses.

Read Judge Nugent’s decision, In Re Lea, Case No. 11-11131. Read Judge Karlin’s decision, In Re Westby, Case No. 11-40986.

K.S.A. 60-2315  An individual debtor under the federal bankruptcy reform act of 1978 (11 U.S.C. § 101 et seq.), may exempt the debtor’s right to receive tax credits allowed pursuant to section 32 of the federal internal revenue code of 1986, as amended, and K.S.A. 2011 Supp. 79-32,205, and amendments thereto. An exemption pursuant to this section shall not exceed the maximum credit allowed to the debtor under section 32 of the federal internal revenue code of 1986, as amended, for one tax year. Nothing in this section shall be construed to limit the right of offset, attachment or other process with respect to the earned income tax credit for the payment of child support or spousal maintenance. History: L. 2011, ch. 25, § 1; Apr. 14.

Four chapter 7 bankruptcy trustees mounted an all-out attack on the newly enacted Kansas statute exempting the EITC  from creditors for debtors in bankruptcy, but failed to convince either  judge that the Kansas Legislature can’t make a law saying a citizen may keep earned income tax credits for one year away from her bankruptcy trustee and creditors. Jill Michaux filed a friend of the court brief in the Westby case for the National Association of Consumer Bankruptcy Attorneys (NACBA) and is c0-c0unsel with debtor attorney Bruce Barry of Manhattan in representing the Westbys in the appeal. The Kansas Attorney General, represented by Assistant Attorney General Derenda Mitchell, intervened in the cases to support the new law.

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Reaffirmation Requires More than Checking a Box

Much has been written on this blog about reaffirmation. BLN author Jed Berliner makes a compelling argument that reaffirmation in Chapter 7 is a bad idea – why should you assume personal liability for a debt and forgo up to 8 years of bankruptcy protection on the hope that time Full Article…
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Earned Income Tax Credits Now Exempt in Kansas Bankruptcy

Debtors will get to keep one year of earned income tax credits when filing bankruptcy in Kansas. A new law went into effect April 14, 2011, granting the exemption.  This change in the law will prevent bankruptcy trustees from taking the portion of income tax refunds that is EITC, a valuable benefit for low to moderate income, working people, most of whom have minor children at home.

SENATE BILL No. 12

AN ACT concerning civil procedure; relating to bankruptcy;

exempt property; earned income tax credit.

Be it enacted by the Legislature of the State of Kansas:

Section 1. An individual debtor under the federal bankruptcy

reform act of 1978 (11 U.S.C. §101 et seq.), may exempt the debtor’s

right to receive tax credits allowed pursuant to section 32 of the

federal internal revenue code of 1986, as amended, and K.S.A. 2010

Supp. 79-32,205, and amendments thereto. An exemption pursuant

to this section shall not exceed the maximum credit allowed to the

debtor under section 32 of the federal internal revenue code of

1986, as amended, for one tax year. Nothing in this section shall be

construed to limit the right of offset, attachment or other process

with respect to the earned income tax credit for the payment of

child support or spousal maintenance.

Sec. 2. This act shall take effect and be in force from and after

its publication in the Kansas register.

(Published in the Kansas Register April 14, 2011.)

Prior to the enactment of Senate Bill 12, bankruptcy trustees took earned income tax credits and tax refunds for their fees and for creditors’ claims.  Tax refunds are the most commonly seized assets in Kansas consumer bankruptcy cases.  The amount forfeited by individual debtors was substantial, but the amount distributed to creditors is relatively low, often 1 or 2% of their claims.

The law limits the bankruptcy exemption to the right to receive one year of earned income tax credits and does not prevent government offset of the credits for child support collection.  Bankruptcy trustees will still be able to take tax refunds not attributable to earned income tax creditors from debtors.

The Earned Income Tax Credit or the EITC is a refundable federal and Kansas income tax credit for low to moderate income working individuals and families. According to the Internal Revenue Service, Congress originally approved the tax credit legislation in 1975 in part to offset the burden of social security taxes and to provide an incentive to work. When EITC exceeds the amount of taxes owed, it results in a tax refund to those who claim and qualify for the credit. To qualify, taxpayers must meet certain requirements and file a tax return, even if they do not have a filing requirement.

Our thanks goes to Kansas Senator John Vratil, R-Leawood, for sponsoring SB12.  The bill passed unanimously in the Senate and nearly so (118 to 5) in the House of Representatives.  Testifying in favor of the bill were Marilyn M. Harp, executive director of Kansas Legal Services, and attorneys John Hooge of Lawrence, Paul Post of Topeka and Kansas Bankruptcy Information blogger Jill Michaux of Topeka.