By: Timothy Fox
St. John's Law Student
American Bankruptcy Institute Law Review Staff
In Nichols v. Birdsell,
the Ninth Circuit held that a taxpayer’s pre-bankruptcy irrevocable election to apply a tax refund as a credit for the following tax year was not a bar to the bankruptcy trustee’s turnover claim under section 542, i.e. the credit was property of the estate. In Nichols, the debtors filed their 2001 tax return two weeks before filing their Chapter 7 bankruptcy and, pursuant to sections 6402(b) and 6513(d) of the Tax Code, irrevocably elected to apply their anticipated refund to the 2002 tax year. The following year, the debtors used nearly the entirety of the 2001 credit to satisfy their 2002 income tax obligation. The trustee instituted the suit against the debtors to recover the 2001 overpayment, advancing theories under sections 542(a) and 548(a)(1) of the Bankruptcy Code.
[2]
Analogizing the present case to its previous decision in Feiler v. Sims (In re Feiler),
[3]
the Ninth Circuit rejected debtors’ argument that the irrevocable nature of the election and their resulting inability to access the funds was a bar to the assertion by the trustee that the tax credit was property of the estate.
[4]
The case implicates section 541 of the Bankruptcy Code, which defines what constitutes property of the estate and has been described by commentators as the heart of the Code.
[5]
Defining what property of the debtor will pass into the estate is critical to effectuating the dual purposes of the Bankruptcy Code: to grant the debtor a fresh start and to divide the assets of the estate equitably among creditors.
[6]
The reach of section 541 is broad: “all legal or equitable interests of the debtor.”
[7]
Even prior to the passage of the 1978 Code revisions,
[8]
the Supreme Court established that a tax refund can be property of the estate.
[9]
Thus, the issue presented in Nichols was not whether a tax refund could be property of the state, but instead whether this particular tax refund should be considered property of the estate given the irrevocability of the debtors’ decision to apply the tax refund forward to the following tax year. Although the debtors argued that the election had changed the character of the overpayment, the Court instead viewed it as merely delaying the liquidation of the asset or preventing its transfer, neither of which would prevent it from becoming property of the bankruptcy estate.
[10]
The novelty in this case is the interaction between section 541(c)(1)(A)
[11]
of the Bankruptcy Code and section 6513(d)
[12]
of the Tax Code. The tension highlights policy choices regarding the powers and duty of the trustee and purposes of the Code itself.
[13]
The purpose of the Code to secure assets of the debtor for distribution to creditors would be greatly frustrated if the debtor, through his choices and by operation of nonbankruptcy law, could place valuable property beyond the reach of the trustee.
[14]
In ruling that the Tax Code must yield to the Bankruptcy Code, the Ninth Circuit followed established jurisprudence that the scope of the trustee’s reach in constituting the estate is broad and should not be impaired by the actions of the debtor or operation of nonbankruptcy law.
[5]
See 11 U.S.C. § 541 (2006) (defining property of estate); 6 Collier on Bankruptcy, ¶ 541, at 541-8.1 (Alan N. Resnick et.al. eds., 15th ed. rev. 2006) (“Section 541 embodies the essence of the Bankruptcy Code.”); 4 Norton Bankruptcy Law and Practice § 61, at 61-2 (William L. Norton, Jr. ed., 3d ed. 2007) (“Central to bankruptcy’s collective debt-collection scheme is the creation of the bankruptcy estate under Code § 541.”).
[6]
See 6 Collier on Bankruptcy, ¶ 541, at 541-8.2 (Alan N. Resnick et.al. eds., 15th ed. rev. 2006) (discussing generally section 541).
[8]
See Barowsky v. Serelson (In re Barowsky), 946 F.2d 1516,1518 (10th Cir. 1991) (discussing how, despite differing language of applicable statutes, definition of property of estate has been and remains to be interpreted very broadly).
[11]
11 U.S.C. § 541(c)(1)(A) (2006) (“[A]n interest of the debtor in property becomes property of the estate . . . notwithstanding any provision in an agreement, transfer instrument, or applicable nonbankruptcy law– that restricts or conditions transfer of such interest by the debtor.”).
[12]
26 U.S.C. § 6513(d) (2006) (“If any overpayment of income tax is . . . claimed as a credit against estimated tax for the succeeding taxable year, such amount shall be considered as a payment of the income tax for the succeeding taxable year . . . and no claim for credit or refund of such overpayment shall be allowed for the taxable year in which the overpayment arises.”).
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