Filing a Chapter 13 bankruptcy is a helpful tool to deal with overwhelming debt. A Chapter 13 bankruptcy allows a debtor to pay as much as they can afford in a three to five year repayment plan. After three to five years, a debtor will receive a bankruptcy discharge of their remaining debts. How much a debtor pays each month, is impacted by their monthly expenses and the deductions from their paystubs. A debtor must pay all of their disposable income each month as a payment to their creditors in a Chapter 13 bankruptcy. A debtor’s disposable income is calculated by taking their gross income and subtracting their deductions, including taxes, and all of their other monthly expenses. Disposable income is the amount that remains.
The more taxes that are withheld from a debtor’s paycheck, the lower the amount of disposable income that is available to pay creditors. The benefit of increasing or maximizing one’s tax withholdings, is that it makes a debtor’s monthly Chapter 13 payments lower and more affordable. However, the downside is that even though a debtor’s monthly payment may be lower, this could result in a large tax refund from the federal and state government at the end of the year. When a debtor receives a large tax refund, they may need to turnover a portion of the refund to the bankruptcy trustee, as an additional Chapter 13 plan payment. The bankruptcy trustee will use that portion of the refund to pay the debtor’s creditors. In Minnesota, the Chapter 13 trustee’s office allows a debtor to file jointly with their spouse, and keep $2,000 of their tax refund for themselves. If the debtor is a single tax filer, the Chapter 13 trustee’s office will allow the debtor to keep $1,200. In addition to this, the Chapter 13 trustee’s office will also allow the debtor to keep any portion of their tax refund that comes from Minnesota working family credit or earned income credit. Anything else will need to be turned over to the bankruptcy trustee.
Since some debtors would rather keep their tax refunds during a Chapter 13 bankruptcy, those debtors may opt to increase their tax withholdings from their paystubs, so that they do not end up with a large refund they will need to turnover to the bankruptcy trustee. In some cases, a debtor’s tax withholdings from their paystubs may be too low. This is a common issue, typically for high income earners, who have a large amount of tax debt prior to filing a Chapter 13 bankruptcy. For these individuals, a Chapter 13 bankruptcy can greatly help them by allowing them to pay their taxes over a three-five year plan. However, since a Chapter 13 bankruptcy only allows debtors to pay and discharge certain tax debt that was incurred before their bankruptcy case was filed, these individuals are best advised to increase their tax withholdings after they file their Chapter 13 case. This ensures that they do not continue to incur large debt at the end of each year while they are in the bankruptcy.
Tax withholdings have a large impact on a debtor’s monthly Chapter 13 payments and also has a large impact on how much will have to go to creditors. It will also impact the amount of tax refund a debtor receives and has to turnover to the bankruptcy trustee throughout the Chapter 13 bankruptcy. In order to ensure that a debtor’s tax withholdings are adjusted properly to maximize the benefit to the debtor in their Chapter 13 plan, one should consult with an experienced bankruptcy attorney.
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