To what extent are “child tax credits” from a debtor’s income tax refund considered exempt in a bankruptcy case as a “public assistance benefit”?  This was the question considered by the Eighth Circuit Bankruptcy Appellate Panel (B.A.P.) in the 2013 case of In Re Pepper Hardy (B.A.P. No. 13-6029).  The answer was:  not at all.  The appeal involved a Chapter 13 bankruptcy case coming from the Kansas City-based Chapter 13 Trustee, Richard V. Fink.

What happened was this.  The Debtor filed a Chapter 13 case. On her Schedule C (“Property Claimed as Exempt”), Debtor claimed exempt, as a “public assistance benefit” under RSMo. § 513.430.1(10)(a), the portion of her 2012  federal income tax refund that was attributable to a “Child Tax Credit” allowed under 26 U.S.C. § 24.  The Chapter 13 Trustee disagreed with this position, and objected to the Debtor’s exemptions.

The bankruptcy court agreed with the Chapter 13 Trustee, stating:  “The fact the additional [Child Tax Credit] is available as a refund for taxpayers whose income places them out of range for most public assistance benefits available to Missourians is a sufficient basis to conclude that the additional [Child Tax Credit] is not an exempt ‘public assistance benefit.”  The debtor then appealed.

The B.A.P. first noted that  “the federal child tax credit . . . has two distinct components–a non-refundable component, denominated on Form1040 as the ‘Child Tax Credit,’ and a refundable component, denominated on Form 1040 (under the ‘Payments’ section) as the ‘Additional Child Tax Credit.'”  In re Law, 336 B.R. 144, 146 (Bankr. W.D. Mo. 2005).”

The bankruptcy estate, the B.A.P. continued, includes contingent interests in future payments, such as tax refunds.  In re Law, 336 B.R. 780, 782 (B.A.P. 8th Cir. 2006).  The bankruptcy estate also includes the refundable portion of the child tax credit allowed under 26 U.S.C. § 24.  Id. at 783.  The debtor, however, can then claim certain property to be exempt, which has the effect of placing it outside the bankruptcy estate.  In re Benn, 491 F.3d 811, 813 (8th Cir. 2007).

In determining exemptions, the bankruptcy courts will normally look to state law.  In most situations in bankruptcy cases in Kansas and Missouri, the exemptions are created by state law.  Under the Missouri statutes, a debtor may claim exempt “[a] Social Security benefit,  unemployment compensation[,] or a public assistance benefit.” RSMo. §513.430.1(10)(a).

The debtor did not argue that the portion of her 2012 federal income tax refund that is attributable to the child tax credit is either a “Social Security benefit” or “unemployment compensation.”  Thus, the issue turned on whether that portion of her refund is a “public assistance benefit” within the meaning of  RSMo. §513.430.1(10)(a).  This was the question.

But what is the definition of a “public assistance benefit?”  The statutes are unfortunately silent on the term.  The debtor attempted to make the definition a benefit that “assists the public,” but the B.A.P. rejected this definition as overly vague and “not supported by any authority.”

Instead, the B.A.P. turned to the dictionary to find the plain-language meaning of the term:

Merriam-Webster defines “public assistance” as “government aid to needy, aged, or disabled persons and to dependent children.”  Merriam-Webster’s Collegiate Dictionary 1005 (11th ed. 2012).  Random House defines it as “government aid to the poor, disabled, or aged or to dependent children, as financial assistance or food stamps.” The Random House Dictionary of the English Language 1563 (2nd ed. 1987).  Oxford Press defines it as “government benefits provided to the needy, usually in the form of cash or vouchers.” New Oxford American Dictionary 1411 (3rd ed. 2010).

The B.A.P. concluded that none of these definitions supported the debtor’s interpretation of RSMo. §513.430.1(10)(a).  “Public assistance” is more of an aid to the needy, impoverished, or the disabled.  The debtor was none of these.

Furthermore, the reported cases supported the B.A.P.’s position.  In the case of In re Steinmetz, 261 B.R. 32, 35 (Bankr. D. Idaho 2001), the court stated:  “[T]he high income threshold adopted by Congress before the [child tax] credit starts to phase out clearly indicates the credit was not intended as a form of public assistance legislation.”

In the case of In re Jackson, Bankr. No. 12- 9635-RLM-7A, 2013 WL 3155595, at *2 (Bankr. S.D. Ind. June 20, 2013), the court stated:   “Even if [Indiana’s exemption statute] remotely could be interpreted as a ‘public assistance’ exemption which is not limited to the [earned income credit], the refund attributable to the [child support credit] here would not qualify as it was not enacted solely to assist lower income families, but applies to middle income families.”

In other words, the debtor’s position was not supported by any current authorities.

It is worth noting that the state of Kansas, unlike Missouri, has specifically exempted a debtor’s  EIC (earned income tax credit).  This exemption became effective in 2011.  It has been upheld by the bankruptcy courts in Kansas, despite a strenuous attack the some bankruptcy trustees.  In a recent case decided by Robert Nugent, U.S. Chief Bankruptcy Judge for Kansas, on February 13, 2014,  (In Re: Myers, et al, Case No. 11-12155), Judge Nugent upheld the exemption.

The exemption of tax refunds, or portions of refunds, is a complicated issue and depends on what state you live in, and what part of the refund is being considered.

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