Porter v. Internal Revenue Service (In re Porter)Porter v. Internal Revenue Service (In re Porter)
AMENDED MEMORANDUM OPINION AND ORDER DENYING DEBTOR’S MOTION TO RECOVER INVOLUNTARY PREFERENCE
This matter is before the Court on the Debtor’s Motion to Recover an Involuntary Preference against the' Internal Revenue Service. Docket No. 17. The IRS has filed an Answer. Docket No, 21. The IRS filed a Brief in support of its position, as did the Debtor. Docket Nos. 22, 24. The Court heard the parties’ arguments on November 8, 2016. For the reasons stated below, the Court will deny the Debtor’s Motion.
Undisputed Facts
The facts in this case are not disputed:
1. On April 4, 2016, the Debtor filed her individual tax return (Form 1040) for the tax year 2014, pursuant to which the Debt- or was entitled to an overpayment in the amount of $4,169.00.
2. On May 2, 2016, the IRS set off the Debtor’s overpayment for the year 2014 against her tax liability for the tax year ending December 31,2012.
3. The Debtor filed a voluntary petition under Chapter 7 with this Court on May 25, 2016. Docket No. 1.
4. In her Schedule C, the Debtor listed the tax refund as exempt pursuant to Va. Code § 34-4. Id., Schedule C.
5. The Debtor filed a Motion to Recover Involuntary Preference, arguing that the IRS’s setoff of her 2014 tax overpayment impaired her claim of exemption pursuant to 11 U.S.C. § 522(h).
Conclusions of Law
The Court has jurisdiction over this matter pursuant to 28 U.S.C. § 1334 and the Order of Reference of the U.S. District Court for this District entered August 15, 1984. This is a core proceeding under 28
Bankruptcy Code Section 553(a) provides as follows:
Except as otherwise provided in this section and in sections 362 and 363 of this title, this title does not affect any right of a creditor to offset a mutual debt owing by such creditor to the debt- or that arose before the commencement of the ease under this title against a claim of such creditor against the debtor that arose before the commencement of the case [with certain exceptions not relevant here].
11 U.S.C. § 553(a).
Section 553(a) does not create a federal right of setoff; rather, it preserves setoff to the extent that setoff may be allowable under applicable non-bankruptcy law. In re Camellia Food Stores, Inc.,
Section 6401(b)(1) of Title 26 of the U.S. Code defines an “overpayment” as any amount of allowable credits that exceed the tax imposed by the Internal Revenue Code. Section 6402(d) of Title 26 indisputably provides for a right of setoff in favor of the IRS.
The IRS asserts two legal positions in opposition to the Debtor’s Motion for Turnover. First, the IRS argues that the Debtor has no legal right to a refund until after the IRS applies the overpayment to any deficiency. Second, the IRS argues that there was no improvement in position as required for a recovery under Bankruptcy Code Section 553(b). The Court will address each of these issues, in turn.
I. Did the Debtor Have any Rights in Her 2014 Overpayment?
The IRS argues first that Section 553 applies only to property of the estate and the Debtor as the taxpayer never had any right to her refund until after the Service applied any overpayment to her tax liability in accordance with IRC 6402(d). Here, the IRS relies heavily on the distinction between an “overpayment” and a “refund,” arguing that the Debtor has no rights in an overpayment until after the government has made a determination to apply the overpayment pursuant to Section 6402(d). The IRS’s position is undercut by recent authorities from both the Western District of Virginia and this. District. In In re Sexton,
The Sexton holding was adopted by the U.S. District Court for the Western Dis
Absent the IRS effectuating a § 6402 offset, the overpaid funds belong to the taxpayer. See Sexton,508 B.R. at 662 (holding that the debtor’s right to recover her tax overpayment arose at midnight on the last day of the year when her overpaid taxes were due). The overpaid funds do not belong to the government until a federal agency has provided notice, and an offset has taken place. Therefore, if a bankruptcy stay is instituted prior to the actual offset, then the overpaid funds are protected by the stay, and the government must be treated like any other creditor of the debtor.
Id., at *3 (citations omitted).
Similarly, Judge Phillips of this Court recently followed Sexton, holding that the debtor was entitled to exempt and recover an overpayment of taxes, notwithstanding the government’s setoff rights under the Treasury Offset Program, or TOP (IRC § 6402). In re Copley,
The Court, following Sexton and its progeny, finds that the Debtor in this case retained a legal right in her overpayment sufficient to bring her Motion for Turnover. The Court rejects the IRS’s position that the Debtor has no legal right in the overpayment.
II. Did the IRS Improve Its Position Within the 90 Days?
Bankruptcy Code Section 553(a), as noted above, does not create an independent right to setoff; rather, Section 553(a) preserves setoff rights to the extent that those rights arise under non-bankruptcy law. Section 553(b) in effect prevents a party with setoff rights from improving its position within the 90 days preceding the filing of Debtor’s bankruptcy case. Specifically, Section 553(b) provides as follows:
(1) Except with respect to a setoff of a kind described in section 362(b)(6), 362(b)(7), 362(b)(17), 362(b)(27), 555, 556, 559, 560, 561, 365(h), 546(h), or 365(i)(2) of this title, if a creditor offsets a mutual debt owing to the debtor against a claim against the debtor on or within 90 days before the date of the filing of the petition, then the trustee may recover from such creditor the amount so offset to the extent that any insufficiency on the date of such setoff is less than the insufficiency on the later of—
(A) 90 days before the date of the filing of the petition; and
(B) the first date during the 90 days immediately preceding the date of the filing of the petition on which there is an insufficiency.
(2) In this subsection, “insufficiency” means amount, if any, by which a claim against the debtor exceeds a mutualdebt owing to the debtor by the holder of such claim.
11 U.S.C. § 553(b).
The IRS argues that, because of the timing in this case, it did not improve its position during the 90 days preceding the Debtor’s bankruptcy. The Court agrees. The overwhelming weight of authority holds that the debtor’s right to a refund arises at the end of the taxable year to which it relates, in this case, December 31, 2014. U.S. Dep’t. of Agric. Rural Hous. Serv. v. Riley (In re Riley),
In this case, the Debtor filed for bankruptcy protection on May 25, 2016. Ninety days prior to that was February 26, 2016 (2016 was a Leap Year, with 29 days in February). As of February 26th, the Debt- or owed the government taxes for the tax year ending December 31, 2012 (the amount of the Debtor’s 2012 tax liability is unknown to the Court, but she does not contest that it was equal to or greater than the 2014 overpayment of $4,169.00). As of that same date (February 26, 2016), the government owed the Debtor a refund of $4,169.00 on account of her 2014 tax overpayment which accrued on December 31, 2014. There was, therefore, no improvement in position during the 90 days preceding the bankruptcy case, from February 26,2016, to the petition date.
The Debtor argues that the government’s improvement in position occurred only when she actually filed her 2014 tax return on April 4, 2016, which was within the 90 days of the Debtor’s bankruptcy. The Court rejects this argument for two reasons. First, it is inconsistent with the authorities cited above to the effect that the Debtor’s right to a refund arises on December 31st of the tax year- at issue. Second, if the Debtor is correct in her position, then April 4, 2016, the date on which she claims that she was first entitled to her refund, was the first date on which there were mutual debts between her and the government. Therefore, April 4th would have been “the first date during the 90 days immediately preceding the date of the filing of the petition on which there [was] an insufficiency,” and there was no improvement in position from that date until the Debtor’s bankruptcy petition date. 11 U.S.C. § 553(b)(1)(B).
Conclusion
For the foregoing reasons, it is ORDERED:
1. The Debtor’s Motion for Turnover is denied.
2. The Clerk will mail copies of this Memorandum Opinion and Order to the-Debtor and will provide cm-ecf notice of its entry to counsel, below.
Notes
. In her Motion, the Debtor relied on both Sections 547(b) and 553(b) for support. Docket No. 17, p.2 ("The transfer constituted an avoidable involuntary preference as defined by 11 U.S.C. § 547(b)[;]” "[Requesting that the Court] "Grant debtor’s motion to avoid the transfer under 11 U.S.C. § 522(h) and § 553(b)....") The Debtor has acknowledged in her Brief and in oral argument that Sections 522(h) and 553(b) provide the exclusive means for recovery of the refund, and that the preference statute, 11 U.SC. § 547(b) is inapplicable. In re Dillard Ford, Inc.,
. Judge Connelly acknowledged that the IRS may set off a refund for tax obligations pursuant to Bankruptcy Code Section 362(b)(26).
. The issue of whether the Debtor can exempt her tax refund in derogation of the government’s setoff rights is an issue of some controversy in the case law. See In re Buttrill,
. The only arguable exception would be under Section 553(a)(3), which provides an exception to an otherwise allowable setoff where the debt owed by the debtor was incurred by such creditor (here, the IRS): (1) after the 90 days before the petition; (2) while the debtor was insolvent (which is presumed under subsection (c)); and (3) for the purpose of obtaining a right of setoff against the debt- or. There is no showing in this case, nor could there be, that the IRS had anything to do with the timing of filing of the Debtor’s 2014 tax