Treatment of Income Tax Refunds in Bankruptcy After Lines v. Frederick

Under section 70a(5) of the Bankruptcy Act, the bankruptcy trustee is entitled to take the debtor’s interest in “property” that “prior to the filing of the petition [the debtor] could by any means have transferred or which might have been levied upon and sold under judicial process against him.” The Act does not, however, specifically define the term “property,” and, as a result, the Supreme Court has developed its own definition. No problem has been presented by money or assets held by the bankrupt at the time of filing; such items are uniformly considered to be property. Nor has a problem arisen with respect to property acquired after filing; with limited exceptions, such property does not pass to the trustee as part of the bankrupt’s estate. However, where a right to money has arisen prior to filing but the sum is not available until some time after filing, the Court has exercised its power to determine whether the money is “property” for the purposes of section 70a(5). The most recent case in which this last situation was presented was Lines v. Frederick, which held that vacation pay accrued but unpaid at the time of filing is not section 70a(5) property. Two circuit courts, however, have split on the question of whether the analysis in Lines should be interpreted to prevent a trustee in bankruptcy from reaching a tax refund received by the bankrupt after filing but attributable to withholding from wages earned prior to that time. In so far as a tax refund is held to be “property,” the applicability of the provisions of the Consumer Credit Protection Act (CCPA) that exempt a certain portion of earnings from garnishment must also be considered, since, if they are applicable, the trustee will be unable to reach the entire amount of the refund attributable to prefiling wages. The same two circuits have also split on this issue.

This Note will focus on the issue of whether, under Lines, tax refunds are to be considered section 70a(5) property; however, the applicability of the CCPA and the solutions to both issues suggested by the Proposed Bankruptcy Act of 1973 will also be discussed.