How should an income tax refund from a joint tax return be divided between a husband and wife in a Virginia bankruptcy case?
In the case of In re: Lyall, 191 B.R. 78 (E.D. Va., 1996), the U.S. District Court for the Eastern District of Virginia ruled that the tax refund had to be divided in proportion to each spouse’s withholding rather than divided equally or divided in proportion to each spouse’s percentage of the total income. The husband had filed a chapter 7 bankruptcy case in the Eastern District of Virginia Bankruptcy Court without his wife. In the bankruptcy case, the Debtor husband listed on his Schedule B, as part of the property of the estate under Section 541 of Title 11, the Bankruptcy Code, a tax refund, which the husband claimed as exempt on Schedule C under the Virginia Homestead Exemption found in Section 34-4 of the Code of Virginia. A creditor objected the husband’s claimed exemption of the tax refund. Although most of the couple’s income had been derived from the husband’s withholdings, the bankruptcy court judge ruled that the husband and wife were each entitled to 50% of the tax refund, based on the case of Bass v. Hall, 79 B.R. 653 (Bankr., W.D. Va., 1987).
On appeal, the United States District Court for the Eastern District of Virginia disagreed. The court recognized that there were three positions across the county: a majority position which held that the tax refund should be allocated proportionally according to each spouse withholding in the relevant year, a position that the tax refund should be allocated equally without regard to income or withholding, and a position that the refund should be allocated in proportion to each spouse’s income produced. The court agreed with the majority position on the grounds that the income withheld would have been the husband’s property if the withholding amount were correct, and the husband could not have transferred that amount of income to the wife before filing because that transfer could be set aside as a fraudulent transfer. The court recognized the well-established law that the filing of a tax return does not alter the property rights between the spouses, citing In re: Wetteroff, 453 F.2d 554 (8th Cir, 1972) .
You should consult with your Virginia bankruptcy lawyer concerning your property rights in a tax refund from a joint tax return with your husband or wife.