Tax Refund Not Property of the Bankruptcy Estate, Income Attributable To the Tax Refund Was Derived From the Employment of the Non-Debtor Spouse

December 13, 2021, Eastern District of Texas – The case revolves around a 2018 tax refund that a trustee maintains is a property of the debtor’s bankruptcy estate. The trustee also argues that any additional refund that the debtor and his spouse receive in the future on account of the pre-bankruptcy capital loss carryforward would be the bankruptcy estate’s property. Additionally, the trustee asserts that a real estate property, Clearwater House, owned by the debtor, is the property of the bankruptcy estate. The trustee further seeks to recover the value of a Honda car and the monthly payments made to the debtor’s parents as constructively fraudulent transfers.

The Court found that the 2018 tax refund was not the property of the bankruptcy estate under § 541(a)(2) and was not subject to turnover to the trustee because the sole source of income attributable to the 2018 tax refund was derived from the employment of the non-debtor spouse. The Court agrees that the debtor and his spouse did not have the authority to use the net operating losses in their 2018 tax return. They were the debtor’s pre-bankruptcy tax attributes, and those attributes belonged to the debtor’s bankruptcy estate. The Court further concluded that the down payment for the house was a gift to the debtor’s parents and because the debtor held only a legal interest in the house as a co-owner subject to a resulting trust for his parents, it was not the property of his bankruptcy estate. Accordingly, the Court held that the trustee failed to establish grounds for turnover under § 542.

Next, the Court ruled that the purchase of the Honda was not a constructively fraudulent transfer because the acquisition of the Honda occurred before the debtor’s insolvency, and the debtor’s business was flourishing when he helped his mother acquire the Honda for her use. However, the Court concluded that the trustee did establish that the debtor’s payments to his parents after May 2017 (when he became insolvent) and before October 2017 (when he stopped drawing a salary) were constructively fraudulent. Accordingly, the Court ruled that the trustee is entitled to a judgment against the debtor’s parents for the constructively fraudulent transfers.

Chow v. Lee (In re Lee), Nos. 18-42066 (Chapter 7), 20-4036, 2021 Bankr. LEXIS 3397 (Bankr. E.D. Tex. December 13, 2021)

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