8th Circuit Exempts Additional Child Tax Credit from Bankruptcy Estate in Missouri Cases

Today we welcome first time guest blogger Phil Rosenkranz. Phil is an attorney with the Legal Aid Society of Milwaukee who both directs the federal tax clinic there and represents individuals in bankruptcy.  At the outset, I express my apologies to Phil for the delay in posting this article.  As I transitioned over the summer this post got buried under other items and then left perpetually on the back burner.  The 8th Circuit case Phil discusses raises important bankruptcy issues concerning the ability to exempt certain tax benefits from a bankruptcy estate.  Earlier cases essentially established that in most states debtors can exempt refunds stemming from the earned income tax credit because those refunds provide a public assistance benefit and most states create an exemption for such benefits.  In Hardy, the 8th Circuit wrestles with the issue of whether the additional child tax credit provided by IRC 24 also qualifies as a public assistance benefit.  The answer to this question can determine whether a low income taxpayer gets to keep the refund generated by this credit to use it for current living expenses or it goes to pay creditors of their bankruptcy estate.  Keith

The bankruptcy code in the United States seeks to allow an individual to discharge most types of debts while simultaneously exempting (aka keeping) certain types of property. The most common type of bankruptcy in the United States is Chapter 7 otherwise known as liquidation.  Most Chapter 7 cases, almost 90%, are filed as no-asset cases.  This nomenclature does not mean that the debtor has no assets but rather that none of the debtor’s assets are available to pay unsecured creditors of the estate.  In very simple terms the individual debtor will not have to pay these unsecured creditors any money while simultaneously retaining most or all of their assets.  Retaining assets does not eliminate liens but it does eliminate the ability of unsecured creditors to collect from the debtor unless the debt is excepted from discharge.   What assets the debtor can keep depends upon the State in which the debtor resides and the elections the debtor makes concerning the exemptions. (Federal Exemptions or State exemptions or only the State exemptions if the state opts out of the federal scheme of exemption set forth in the Code)

Most States have exemptions for “public assistance”. Even the Federal Exemptions provided in section 522(d)(10)(A) of the bankruptcy code exempt “a local public benefit.”  (no Federal Court has yet ruled that this Federal Exemption covers the Earned Income Tax Credit (EITC)  or the Additional Child Tax Credit (ACTC)). Only a handful of States specifically exempt the EITC and fewer exempt the ACTC. The Child Tax Credit (CTC) is a federal tax credit worth up to $1,000 in 2015 for each qualifying child under age 17 claimed on the worker’s tax return.  Since 2001, the CTC has been available to millions of lower- and moderate-income working families. This ACTC is the refundable portion of the CTC, allowing individuals with less tax than the value of the CTC to receive a refundable credit of some or all of the credit that exceeds the tax liability.

Bankruptcy trustees seek to marshal the assets of debtors for the benefit of unsecured creditors. Trustees have learned to look for the tax refunds due to debtors as a source of funds they can use to pay the unsecured creditors.  In their pursuit of the tax refunds of debtors, a fight has arisen over the nature of the refund and whether it qualifies as an exempt asset.  As Congress, over the past two decades has begun using the tax code more and more as a delivery system for public assistance, payments that once might have been characterized as purely tax in nature and therefore subject to the reach of the trustee are now contested by debtors as exempt property because of their public assistance nature.  The Hardy case tees up this issue in the case of the ACTC.


When Pepper Hardy filed her Chapter 13 Bankruptcy in October of 2012, she was a resident of Missouri. Because Missouri had opted out of the Federal Exemptions, Ms. Hardy used the Missouri exemptions.

In her bankruptcy schedules, Ms. Hardy stated she would receive a federal tax refund. She sought to exempt that portion of her federal tax refund attributable to her ACTC ($2,000) under Missouri’s exemption for “public assistance benefit.”  The trustee objected and the bankruptcy court sustained his objection, holding that CTC (and therefore ACTC) was not a form of public assistance as it went to more taxpayers than just the needy.  The CTC is available to individuals with the Head of Household filing status who have a modified adjusted gross income of up to $75,000 and to couples with married filing joint filing status of up to $110,000.  In many ways the debate on this issue in bankruptcy court mirrors the larger social issue being debated in the current presidential campaign about who is middle class and where should tax breaks occur.

Hardy appealed to the Bankruptcy Appellate Panel (BAP) and they affirmed. They stated public benefits are benefits the government provides to the needy.  Because the CTC/ACTC could benefit non-needy people this was not a public benefit.  Hardy argued that while the CTC benefited families with income outside the socially accepted range of needy those families would have a tax liability of sufficient size that the entire amount of the CTC would be used to satisfy the tax.  As a consequence of the amount of tax at certain income levels and the amount of the CTC, the ACTC only benefited the needy because only the needy would have a tax liability low enough to qualify for the ACTC.  The Court found that no evidence was presented establishing this point.  The BAP also expressed concern that the  ACTC requires a  minimum earned income level and the most needy (those with incomes less than $10,350 in 2002) would not be eligible.

The 8th Circuit first looked to Missouri’s method of statutory construction.  The exemption schedule did not define “public assistance benefit”.  The court also found other definitions in Missouri’s code for “public assistance benefit”   to be unhelpful,  however it did find that the legislature for Missouri intended that it mean those benefits provided to the needy.  The court was aided by an amicus brief filed by the National Association of Consumer Bankruptcy Attorneys.

The Court looked at amendments to CTC/ACTC since its inception from 1997 to 2009. This analysis provided the difference between the approach of the circuit court and the lower courts. With each amendment Congress made a point to increase the ACTC permitting low-income recipients to benefit in a greater amount and shift the bulk of the benefit to those with lower income. The Court also made note of the commentary by several senators to the 2001 amendments. One of those comments by Senator Baucus stated “We increase the amount of the (child tax) credit that is partly refundable so lower income families can benefit from the credit as well.”  These comments illustrated that the overwhelming intent was to benefit low-income families.

The 8th Circuit decided that the number of high income individuals that might possibly obtain the benefit of the ACTC in comparison to the substantial number of individuals of modest and low income levels that do benefit from the ACTC is sufficient to satisfy the public assistance standard.  Because it is the first circuit court to address this issue, the influence of the case has added importance.  Lower courts looking at this issue have split but most holding against exempting the refund have not analyzed the history of the statute in the way the 8th Circuit did.