United States v. Jones (In Re Jones)United States v. Jones (In Re Jones)
MEMOBANDUM OPINION AND ORDER
This case is before the court on appeal from the United States Bankruptcy Court for the Middle District of Alabama (“the Bankruptcy Court”). The United States of America (“the Government”) appeals the Bankruptcy Court’s final judgment of August 1, 1997, in which the Bankruptcy Court concluded that the Internal Revenue Service (“the IRS”) improperly setoff the 1995 federal income tax refund of Debtor Kathy Lorraine Jones (“Debtor”) against her 1990 and 1991 federal income tax debts. Debtor cross-appeals the Bankruptcy Court’s refusal to determine whether the IRS wilfully violated the automatic stay. The court has jurisdiction over this appeal pursuant to 28 U.S.C. § 158(a). 1 For the reasons stated herein, the final judgment of the Bankruptcy Court is AFFIRMED.
I. STATEMENT OF THE CASE
On April 12, 1996, Debtor filed a petition under Chapter 7 of the Bankruptcy Code in the Bankruptcy Court. Br. of Appellant at 2. Debtor listed the IRS as a creditor in her matrix and on her Chapter 7 petition schedules. Br. of Appellee at 2. She specifically listed as unsecured debts her federal income tax debts for the years 1990, 1991, and 1992, which amounted to $1,244.16, $749.17, and $92.21, respectively. Br. of Appellee at 2. Debtor filed her 1995 federal income tax return on April 15, 1996, and claimed a refund of $2,425. Br. of Appellee at 2. She also claimed the $2,425 refund as exempt in Schedule C of her Chapter 7 petition. Br. of Appellee at 2.
Debtor received a refund check for $339.46 from the IRS on May 20, 1996. Br. of Appellee at 2-3. The $339.46 represented the difference between her claimed refund of $2,425 and her collective tax debt of $2085.54 for the years 1990, 1991, and 1992. Br. of Appellee at 2-3. The IRS withheld the $2085.54, claiming its right of setoff under 11 U.S.C. § 553(a). See Br. of Appellee at 3.
After the IRS and Debtor filed cross motions for summary judgment, on August 1, 1997, the Bankruptcy Court found that the IRS could not setoff Debtor’s 1995 federal income tax refund against her 1990 and 1991 tax debts because the 1995 refund was exempt property which could not be used to satisfy discharged liabilities. See Bankruptcy Ct.Op. at 5. The court ordered that the Government refund to Debtor $1,993.33 2 plus interest from the date of setoff. See Bankruptcy Ct.Op. at 6. While the Government did not dispute that the setoff violated the automatic stay, the court did not decide whether the IRS’s violation was willful because the only damages proven by Debtor were the amounts of the refund improperly offset. See Bankruptcy Ct.Op. at 5. Finally, on August 4, 1997, the Bankruptcy Court issued an order denying the IRS relief from the stay nunc pro tunc as to tax years 1990 and 1991, but granted it relief from the stay as to tax year 1992 because the tax debt for that year was not discharged. See Order on Mot. from Relief from Stay.
II.ISSUES ON APPEAL
1. Whether the Bankruptcy Court erred when it found that the IRS was not entitled to setoff Debtor’s 1990 and 1991 federal income tax debts against her exempt 1995 federal income tax refund.
II. Whether the Bankruptcy Court erred when it declined to order the IRS to remit the entire amount withheld from Debtor’s 1995 tax overpayment, if the IRS willfully violated the automatic stay.
III.STANDARD OF REVIEW
The district court reviews the bankruptcy court’s factual findings under a clearly erroneous standard. Fed.R.Bankr.P. 8013;
Club Assoc. v. Consolidated Capital Realty Investors (In re Club Assoc.), 951
F.2d 1223, 1228 (11th Cir.1992). A finding is clearly erroneous when although there is evidence to support it, the reviewing court on the entire evidence is left with the definite and firm conviction that a mistake has been committed.
Anderson v. City of Bessemer City, N.C.,
IV.DISCUSSION
A. Whether the IRS Was Entitled to Setoff Debtor’s 1990 and 1991 Federal Income Tax Debts Against Her Exempt 1995 Federal Income Tax Refund.
The Government argues that under § 553(a) of the Bankruptcy Code the IRS had a right to setoff Debtor’s 1990 and 1991 federal income tax debts against her 1995 federal income tax refund. Section 553(a) provides:
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 debtor that arose before the commencement of the case under this title against a claim of such a creditor against the debtor that arose before the commencement of the case....
11 U.S.C. § 553(a). While the Bankruptcy Code does not create a federal right of setoff, if a party possesses a right of setoff outside of bankruptcy, § 553(a) preserves that right when certain conditions are met.
Citizens Bank of Md. v. Strumpf,
The Government invokes § 6402(a) of the Internal Revenue Code as the basis of the IRS’s non-bankruptcy right of setoff which is preserved by § 553(a). Section 6402(a) states:
In the case of any overpayment, the Secretary, within the applicable period of limitations, may credit the amount of such overpayment, including any interest allowed thereon, against any liability in respect of an internal revenue tax on the part of the person who made the overpayment and shall, subject to subsections (c), (d) and (e), refund any balance to such person.
26 U.S.C. § 6402(a). Therefore, by way of § 6402(a), the IRS possesses a non-bankruptcy right of setoff which is preserved by § 553(a).
The four remaining prerequisites to setting-off a debt under § 553(a) are also present here. First, as the parties concede, no exception to § 553(a) is relevant in this matter. Second, the debt that the IRS owes to Debtor, represented by Debtor’s 1995 income tax overpayment, arose prior to Debtor filing for bankruptcy. Although Debtor filed for bankruptcy on April 12,1996, and she did not file her 1995 tax return until three days later, April 15, 1996, her 1995 overpayment of $2425, actually accrued on December 31, 1995, the end of the 1995 tax year.
See Okwukwu v. Internal Revenue Serv. (In re Okwukwu),
Although the IRS has satisfied the elements of § 553(a), the Bankruptcy Court found that § 553(a) is limited by 11 U.S.C. § 522(c), which sets forth federal exemptions permitted under the Bankruptcy Code.
See
Bankruptcy Ct.Op. at 5. The Bankruptcy Court relied on the fact that when Debtor filed her bankruptcy petition she scheduled her expected refund of $2425 as an asset and, pursuant to 11 U.S.C. § 522©, claimed the refund exempt.
See
Bankruptcy Ct.Op. at 2. Under § 522©, “[t]he debtor shall file a list of property that the debtor claims as exempt. ... Unless a party in interest objects, the property claimed as exempt on such list is exempt.” 11 U.S.C. § 522©. The IRS did not file an objection to Debtor’s listing of the $2425 as exempt. Bankruptcy Ct.Op. at
Section 522(c) provides:
Unless the case is dismissed, property exempted under this section is not liable during or after the case for any debt of the debtor that arose, or that is determined under section 502 of this title as if such debt had arisen, before the commencement of the ease, except—
(1) a debt of a kind specified in section 523(a)(1) or 523(a)(5) of this title;
(2) a debt secured by a lien that is—
(A)(1) not avoided under subsection (f)
of (g) of this section or under section 544, 545, 547, 548, 549, or 724(a) of this title; and (ii) not void under section 506(d) of this title; or
(B) a tax lien, notice of which is properly filed; or
(3) a debt of a kind specified in section 523(a)(4) of 523(a)(6) of this title owed by an institution-affiliated party of an insured depository institution to a Federal depository institutions regulatory agency acting in its capacity as conservator, receiver, or liquidating agent for such institution.
11 U.S.C. § 522(c). The parties agree that Debtor’s 1990 and 1991 tax liabilities are not any of the types of debts excepted in § 522(c)(1) through (3). Section 522(c)(1) and (3) except certain nondischargeable debts from § 522(c)’s application and § 522(e)(2) excepts debts secured by a lien. The IRS concedes that Debtor’s 1990 and 1991 tax liabilities are dischargeable. See Br. of Appellant at 2 n. 2. In addition, the IRS does not allege that Debtor’s 1990 and 1991 tax liabilities are secured by a lien. Therefore, the exceptions to § 522(c) do not apply.
Because the exceptions to § 522(c) are irrelevant here Debtor’s “[1995 tax refund] exempted under [§ 522©] is not liable ... for any debt of [hers] that arose ... before [April 12, 1996].”
See
11 U.S.C. § 522(c). However, that conclusion is contrary to the result prescribed by § 553(a), which, as discussed, allows the IRS to setoff Debtor’s 1990 and 1991 tax debts against her 1995 refund. There is, therefore, an apparent conflict between § 522(c) and § 553(a). As one court put it, “This analysis presents an appellate nightmare, for these provisions appear to be in direct conflict in regard to resolving the precise question presented here.”
Pieri v. Lysenko (In re Pieri),
The apparent conflict between § 522(c) and § 553(a) has never been addressed on appeal in this circuit. However, several courts have addressed the issue, each reaching one of two conflicting conclusions. Some courts have found that a creditor’s right of setoff under § 553(a) must yield to the debt- or’s right to exempt and protect assets under § 522(c).
See, e.g., Alexander,
In contrast, a minority of courts have allowed a creditor to exercise a right of setoff
The court believes that the majority rule is better reasoned. Therefore, the court finds that the IRS’s right to setoff under § 553(a) must yield to Debtor’s right to exempt and protect assets under § 522(c). Three factors warrant the court’s finding. First, if the court found that a creditor could exercise a right of setoff against exempt property, § 522(c) would be nullified.
Alexander,
Second, the chief policy behind the Bankruptcy Code — providing the debtor with a fresh start — is furthered under the majority rule.
See City Bank & Trust Co. v. Vann (In re Vann),
Third, the legislative history of § 522 supports the court’s conclusion. Senate Bill 2266 contained a version of § 522(c) that would have allowed the IRS to validly perform the setoff in question.
3
However, that version of § 522(c) was rejected by Congress, thereby “indicating that Congress ‘did not intend that exempt property be liable to the
The Government argues that the court should apply the minority rule. However, the cases upon which the Government relies — primarily
Wiegand, Eggemeyer,
and
Posey
— in support of the minority rule are not persuasive.
See
Br. of Appellant at 6-7. In
Wiegand,
the court allowed a credit union to setoff the balance due on a loan it made to a Chapter 7 debtor against the debtor’s exempt account.
Wiegand,
The court finds that the plain language of § 522(c) contradicts the rationale of Wie-gand. Section 522(c) does not make a distinction between the types of debts it protects. Instead, § 522(c) applies to “any debt of the debtor” that was pre-petition. 11 U.S.C. § 522(c) (emphasis added). Although, as in Wiegand, the parities’ debts in this matter are mutual, § 522(c)’s exemption of “any” debt includes Debtor’s. Therefore, the court finds Wiegand unpersuasive.
In
Eggemeyer,
a debtor who had previously filed a Chapter 7 petition filed suit to compel the IRS to turn over his 1985 federal income tax refund, which he had claimed as exempt.
Eggemeyer,
Although Eggemeyer did not address the conflict between § 522(c) and § 553(a), the court finds that its reliance on § 542(b) to allow a setoff is not helpful to the Government here. Section 542(b) provides:
Except as provided in subsection (c) or (d) of this section, an entity that owes a debt that is property of the estate and that is matured, payable on demand, or payable on order, shall pay such debt to, or on the order of, the trustee, except to the extent that such debt may be offset under section 553 of this title against a claim against the debtor.
11 U.S.C. § 542(b). The court that most recently discussed the conflict between § 522(c) and § 553(a) also analyzed § 542(b)’s applicability in determining the validity of a setoff under § 553(a).
See Alexander,
The facts in Alexander were materially identical to the facts in the case at bar. See id. at 146-47. The IRS argued, in part, that § 542(b) permits a creditor with a valid right of setoff to retain exempt property. Id. at 150. The Alexander court disagreed. Id. “[Section § 542(b)] applies only to debts which are property of the estate, and directs turnover of such property to the Trastee, except where the debt is the proper subject of a set-off. Section 542(b) does not, however, determine the validity of a set-off.” Id. Instead, the court found that the exception for setoff in § 542(b) only comes into play where the entity involved has a valid and proper right of setoff. Id. “In this case, the IRS simply does not have a valid right of set-off. Debtor has properly exempted his tax refund; consequently, the refund is no longer property of the estate. Rather, it is property belonging to Debtor.” Id. at 151 (internal citation omitted).
The court agrees with
Alexander.
Section 542(b) does not permit the IRS to exercise its right of setoff against Debtor’s exempt property. Here, as in
Alexander,
the IRS simply does not have a valid right of setoff under
In sum, the IRS’s right of setoff under § 553(a) must yield to Debtor’s right to exempt and protect assets under § 522(c). Therefore, the court finds that because Debt- or properly exempted her 1995 federal income tax refund and the 1990 and 1991 tax debts for which the IRS intercepted her refund were dischargeable debts, setoff against those debts was impermissible under § 522(c).
B. Whether Debtor is Entitled to a Refund of the Entire Amount of Her 1995 Tax Overpayment, if the IRS Willfully Violated the Automatic Stay.
On cross-appeal, Debtor seeks a return of the entire outstanding balance of her 1995 tax refund — $2,085.54—because by setting-off Debtor’s 1995 tax refund against her pre-petition income tax debt when it had not been granted relief from the automatic stay the IRS willfully violated the stay.
See
Br. of Appellee at 10. Because the court has already determined that the IRS improperly setoff Debtor’s 1995 refund against her 1990 and 1991 tax liabilities, the only amount relevant to Debtor’s cross-appeal is $92.21, her nondischargeable 1992 tax liability. The IRS does not contest that it violated the automatic stay provision of 11 U.S.C. § 362(a) when it setoff Debtor’s 1995 tax refund against her 1990, 1991, and 1992 tax liabilities. Br. of Appellant at 3 n. 3.
4
Therefore, the only issues in dispute are whether the IRS’s violation of the stay was willful and, if so, whether the violation warrants the Bankruptcy Court sanctioning the IRS by ordering it to refund to Debtor her nondischargeable 1992 tax liability — $92.21—to which by law the IRS is otherwise entitled. The Eleventh Circuit’s recent decision in
United States v. Ruff (In re Rush-Hampton Indus., Inc.),
In
Ruff,
the debtor filed a bankruptcy petition.
See Ruff,
The issue before the Eleventh Circuit was whether an otherwise harmless violation of the automatic stay was sufficient to deprive the IRS of the post-petition interest setoff to which by law undoubtedly it would have been entitled had it first sought a lifting of the stay.
Id.
at 617. Answering in the negative, the court reasoned that the trustee had not established that the estate was in any way
Similarly, by seeking a sanction against the IRS amounting to a permanent denial of a tax liability which, but for the breach of the automatic stay, Debtor concedes the IRS would otherwise be entitled, Debtor has asked the court to go too far under the circumstances of this case. Debtor concedes that, unlike her 1990 and 1991 tax debts, her 1992 tax debt is not dischargeable. Br. of Appellee at 5 n. 1. Therefore, as in Huff, were it not for the filing of the bankruptcy proceeding by Debtor, the IRS would clearly be entitled to setoff Debtor’s refund against her 1992 tax liability. Under these circumstances, the IRS’s violation of the stay, although not justifiable, was harmless. Furthermore, consistent with Huff, even if the IRS’s violation of the stay was willful, § 562(h) does not permit the bankruptcy court to deny the IRS its right to setoff Debtor’s 1992 tax liability. Therefore, Debt- or’s cross-appeal is without merit.
V. CONCLUSION
For the foregoing reasons, it is hereby ORDERED that the judgment of the Bankruptcy Court is AFFIRMED.
Notes
. 28 U.S.C. § 158(a) provides, in part, that district courts shall have jurisdiction to hear appeals from final judgments, orders, and decrees of bankruptcy judges.
. $1,993.33 is the amount the IRS withheld to cover Debtor's 1990 and 1991 tax debts. Debtor conceded to the Bankruptcy Court that her 1992 tax liability of $92.21 is not dischargeable under 11 U.S.C. § 523(a)(1). Bankruptcy Ct.Op. at 2 n. 5.
. In relevant part, the legislative history of Senate Bill 2266 states:
Subsection (c)(3) permits the collection of dis-chargeable taxes from exempt assets. Only assets exempted from levy under Section 6334 of the Internal Revenue Code or under applicable state of local tax law cannot be applied to satisfy these tax claims. This rule applies to prepetition tax claims against the debtor regardless of whether the claims do or do not receive priority and whether they are dis-chargeable or nondischargeable. Thus, even if a tax is dischargeable vis-a-vis the debtor's after-acquired assets, it may nevertheless be collectable from exempt property held by the estate.
S.R. No. 95-989, 95th Cong.2nd Sess. 76 (1978), U.S.Code Cong. & Admin.News 1978, pp. 5787, 5862.
. Except under limited circumstances, the filing of a bankruptcy petition under 11 U.S.C. § 301, § 302, or § 303 acts to automatically stay litigation, lien enforcement, and other actions which would affect or interfere with the debtor's property or the bankruptcy estate.
See
11 U.S.C. § 362(a);
Orix Credit Alliance, Inc. v. Delta Resources, Inc. (In re Delta Resources, Inc.),