Tax Credits Exemptible as Public Assistance

Posted by NCBRC - July 13, 2021

Where the Additional Child Tax Credit and Earned Income Tax Credit were both intended to benefit low-income households and were not limited by taxes owed, they were properly deemed “public assistance” under state exemption laws. In re Moreno, — B.R. —-, 2021 WL 1904189 (Bankr. W.D. Wash. May 11, 2021) (case no. 3:20-bk-42855).

The debtor’s $10,631.00 tax refund for the year 2020 included $1,709 from the Additional Child Tax Credit (the “ACTC”), and $5,550 from the Earned Income Tax Credit (the “EITC”). She filed chapter 7 bankruptcy on December 30, 2020. Excluding certain exempt portions of the refund, the trustee sought to recover $5,169.11, representing the remaining portion attributable to the pre-petition tax period, including the pro-rated ACTC and EITC amounts. The debtor argued in opposition that the tax credits were either not part of her bankruptcy estate, or were exempt.

As an initial matter, the bankruptcy court declined the debtor’s request to certify to the Washington State Supreme Court the question of whether the tax credits qualified as “public assistance” under state law. The court found the issue to be one bankruptcy courts routinely address.

The court began with the question of whether the tax credits were property of the estate, rejecting the debtor’s argument that, because she filed her tax return post-petition, the refund did not enter the estate. Rather, citing Segal v. Rochelle, 382 U.S. 375, 379–80 (1966), the court found the tax credits were “sufficiently rooted in Debtor’s prepetition earnings to be considered property of the estate.”

Turning to whether the tax credits were exemptible as “child support” under Washington law, which exempts “[a]ny past due, current, or future child support paid or owed to the debtor, which can be traced,” the court found they were not. The court reasoned that the debtor’s proposed definition of child support to cover any funds allocated to the care of children, was so broad that it could include regular income. Instead, the court found that “child support” refers to a parent’s legal requirement to pay specifically for the support of a child. Finding that neither the ACTC nor the EITC fell under this definition, the court found the two tax credits were not exemptible as child support.

The court turned to whether the tax credits were exemptible under state law exempting assistance or grants that provide “public aid to persons in need thereof for any cause, including services, medical care, assistance grants, disbursing orders, work relief, benefits under RCW 74.62.030 and 43.185C.220, and federal aid assistance.” The court found the tax credits fell under the heading of “federal aid assistance.”

Washington law defines federal aid assistance as “the specific categories of assistance for which provision is made in any federal law existing or hereafter passed by which payments are made from the federal government to the state in aid or in respect to payment by the state for public assistance rendered to any category of needy persons for which provision for federal funds or aid may from time to time be made, or a federally administered needs-based program.”

With respect to the ACTC, the court cited In re Farnsworth, 558 B.R. 375, 377 (Bankr. D. Idaho 2016), which identified three considerations in its finding that ACTC was exemptible as a “federally administered needs-based program:” 1) The purpose of the tax credit, 2) whether the credit could exceed taxes owed, and 3) the income level at which the credit is no longer available. Like the Farnsworth court, the court here found the ACTC was enacted for the purpose of lifting low-income families out of poverty. The finding was supported by the fact that the amount of the tax credit could exceed taxes owed.

The court reached the identical conclusion with respect to the EITC. It found that tax credit was specifically aimed at assisting low-income heads-of-households, and the amount of the tax credit was not tied to taxes owed. The court noted that other courts have likewise found the EITC to be a needs-based tax credit that falls under the category of public assistance. Courts finding to the contrary typically found that the language of the state exemption statute precluded inclusion of the EITC in its scope. That was not the case here. The Washington exemption statute was sufficiently broad as to include the EITC as “public assistance.”

The court concluded, therefore, that both the ACTC and the EITC were exempt under state law.

The trustee has appealed to the Bankruptcy Appellate Panel for the Ninth Circuit, case No. 21-1124.

Moreno Bankr WD Wash May 2021

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