Opinion
18-12218 PROC. 20-1073
11-02-2021
IN RE GALEN SCOTT PITNER Debtor v. U.S. DEPARTMENT OF EDUCATION INTERNAL REVENUE SERVICE Defendants MARTIN E. SEIFERT, TRUSTEE Plaintiff
DECISION
Robert E. Grant, Chief Judge, United States Bankruptcy Court
On November 02, 2021
This case arises out of the proposition that the portion of a debtor's post-petition tax refund attributable to pre-petition withholdings constitutes property of the bankruptcy estate when the debtor files bankruptcy before the end of the tax year. In re Meyers, 616 F.3d 626 (7th Cir. 2010). See also, Segal v. Rochelle, 382 U.S. 375, 86 S.Ct. 511 (1966). Debtor filed a petition for relief under Chapter 7 of the United States Bankruptcy Code on November 16, 2018. Among his creditors was the United States Department of Education. When he subsequently filed his federal income taxes for 2018 he had overpaid those taxes by $5,861. Instead of paying this amount to either the trustee or the debtor, the Treasury Department applied it to the debtor's pre-petition debt to the Department of Education, which was in excess of $15,000. By this adversary proceeding the trustee seeks to recover that part of the overpayment which is attributable to the debtor's pre-petition withholdings. The parties agree that amount is $5,138.41. The matter has been submitted to the court for a decision on stipulations of fact and the briefs of counsel.
Based on Meyers, the trustee contends he is entitled to turnover of the tax overpayment attributable to the debtor's pre-petition withholdings, and by setting it off against the debt to the Department of Education the United States violated the automatic stay, so that its actions can be avoided. See, 11 U.S.C. §§ 542, 362(a)(7), 549. The defendant argues that the overpayment never became property of the bankruptcy estate, because it could not be determined until the end of the debtor's tax year, so there is no right to turnover and no violation of the stay. It also argues that the government's right of setoff, 26 U.S.C. § 6402(d), 11 U.S.C 553(a), has priority over the trustee's right to seek turnover.
The parties advance rather esoteric arguments regarding interactions between the Bankruptcy Code and Internal Revenue Code and metaphysical arguments about the type of claims or interests that can be the subject of a turnover action, what is or is not a transfer for the purposes of § 549 and when, how, or whether a tax overpayment is transformed from a post-petition event to a pre-petition asset of the estate depending on whether it is viewed through the lens of the Bankruptcy Code or the Internal Revenue Code and IRS procedures. Despite all that complexity, this a situation that calls for the application of Occam's razor - the simplest answer is probably the right one. See e.g., Merriam-Webster's Dictionary, found at https://www.merriam-webster.com/dictionary/Occam's% 20razor (last visited Oct. 14, 2021).
Given the Seventh Circuit's decision in Meyers, 616 F.3d 626, we must begin by recognizing that where, as here, a debtor files bankruptcy partway through the tax year, even though the closing out of the tax year is a post petition event, any credit or overpayment on account of pre-petition withholdings constitutes property of the estate. At the same time, we must also recognize that, outside of bankruptcy, the United States has the right to setoff any tax overpayments against the taxpayer's debts to the United States, 26 U.S.C. § 6402(a), (d), and the Bankruptcy Code preserves a creditor's right of setoff. 11 U.S.C. § 553(a). See also, In re Wood, 993 F.3d 245, 250-51.
Section 553 preserves a creditor's right "to offset a mutual debt owing by such creditor to the debtor that arose before the commencement of the case . . . against a claim of such creditor against the debtor that arose before the commencement of the case ..." 11 U.S.C. § 553(a)(emphasis added). The statute requires both the debt being offset and the claim against which the offset is being made to arise before the case is filed. See e.g., In re Roberts, 2020 WL 5531508 (Bankr. D. N.M. 2020). This is where things begin to get complicated. The debtor's tax year and the event which allowed the IRS to determine the amount of any overpayment - and therefore to determine the amount of the debt available to offset against the government's claim - closed after the case was filed. This prompts the trustee to argue that the debt owed by the government - the tax overpayment - is really a post-petition debt and so cannot be offset against its pre-petition claim against the debtor. In other words, even though part of the overpayment constitutes a pre-petition asset for the purpose of being property of the estate under §541, the overpayment itself constitutes a post-petition obligation for the purposes of setoff under § 553(a). This is reason for the parties' esoteric and metaphysical arguments about when the overpayment comes into existence and from whose point of view that determination should be made. For the government it is entirely a post-petition event. For the trustee it is both: pre-petition for the purpose of determining what is property of the estate (§ 541) and post-petition for the purposes of set off (§ 553).
This is where Occam's razor comes into play. Esoteric and metaphysical arguments aside, the court finds it difficult to conceive how part of the credit or overpayment can constitute a pre-petition interest in property and become property of the bankruptcy estate, but, for the purposes of the creditor's right of setoff, that same credit must be considered a post-petition debt. It should be one or the other. Since the credit is "sufficiently rooted in the pre-bankruptcy past" so as to constitute property of the estate, Meyers, 616 F.2d at 628, those same pre-petition roots should make the credit a pre-petition debt for the purposes of a creditor's right of setoff. Accord, In re Wilson, 29 B.R. 54, 57, 58 (Bankr. W.D. Ark. 1982). That seems to be the best method for analyzing the situation and "if it happens to looks like an involuntary [short year election under 26 U.S.C. § 1398(d)(2)] so be it." Meyers, 616 F.3d at 631.
In the same fashion, the court cannot accept the defendant's argument that the taxpayer has no right in the overpayment until the IRS decides to pay it, so that it is property of the estate in the hands of the debtor but not until then. Either the taxpayer has an interest in the overpayment, which somehow inures to its benefit, whether through the duty to refund it or credit it toward some other debt to the government, or it does not.
The trustee's only argument against recognizing the defendant's right of setoff was that the credit from the debtor's overpayment constituted a post-petition debt owed by the United States. See, Wood, 993 F.3d at 250-51; Copley v U.S., 959 F.3d 118, 122-126 (4th Cir. 2020) (discussing the right of setoff). While allowing setoff is a discretionary call, that discretion is limited and, particularly in Chapter 7 cases, should be denied only when the validity of the right can be questioned under non-bankruptcy law. Copley, 959 F.3d at 125-26. Here, that is not the case.
The only issue before the court is turnover and whether the United States should pay the trustee a portion of the debtor's 2018 income tax overpayment. In light of the government's right
of setoff the answer to that question is no. Judgment will be entered accordingly.
The same result would follow if the court concluded that the setoff could be avoided, under § 549, as an unauthorized post-petition transaction. 11 U.S.C. § 549. Doing so would return the parties to their pre-setoff positions, but the defendant would be in possession of the overpayment and could retain that possession in order to preserve its right of setoff. See, In re Rush-Hampton Industries, Inc., 98 F.3d 614 (11th Cir. 1996) (right to payment not lost through harmless violation of the automatic stay). See also, Citizens Bank of Maryland v. Strumpf, 516 U.S. 16, 21, 116 S.Ct. 286, 290 (1995) (party may retain property in order to preserve right of setoff); City of Chicago, Illinois v. Fulton, __U.S.__, 141 S.Ct. 585, 590 (2021) (mere retention of property does not violate the automatic stay).