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Bankruptcy Taxation

IRS Setoff Rights Not Limited to Priority Taxes

By: Robert Griswold

St. John's Law Student

American Bankruptcy Institute Law Review Staff

 

In U.S. v. White,

[1]

a debtor owed $8,922.40 to the Internal Revenue Service (“IRS”), $1,780.52 of which was considered priority debt.

[2]

  The debtor filed for chapter 13 bankruptcy in February of 2004 and claimed as exempt a $3,148 tax overpayment for the 2003 tax year.

[3]

  The IRS moved to lift the automatic stay in order to allow it to setoff the entire 2003 overpayment against its pre-petition tax claim.

[4]

  In the decision appealed from, the Pennsylvania bankruptcy court allowed the IRS to setoff only to the extent of the priority debt, requiring the remainder of the overpayment to be returned to the debtor as a tax refund.

[5]

  The district court reversed, holding that the IRS could setoff the entire 2003 overpayment.

[6]

  The court acknowledged a split of authority regarding whether the IRS’ right to setoff non-priority debt is allowed against exempt assets of the debtor or whether its right to setoff is limited to priority claims,

[7]

but found the reasoning behind the cases allowing setoff of the overpayment against entire pre-petition claim more compelling.

[8]

Taxpayers Election to Apply Tax Credit Forward Not So Irrevocable

By: Timothy Fox

St. John's Law Student

American Bankruptcy Institute Law Review Staff

 

In Nichols v. Birdsell,

[1]

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]