Chief Bankruptcy Judge Frank W. Volk of Charleston, W.Va., was nominated this month to sit on the U.S. District Court for the Southern District of West Virginia. He served as editor-in-chief of the West Virginia Law Review and clerked on the district court, the Fourth Circuit, and the West Virginia Supreme Court.
Judge Volk’s qualifications for an Article III court are reflected in his March 31 opinion ruling in favor of the debtor on an issue where the courts are hopelessly divided.
The Government Tax Refund Setoff
Several years before bankruptcy, the debtor defaulted on a federally guaranteed home mortgage. Also before bankruptcy, the Department of Housing and Urban Development, or HUD, paid the $23,000 deficiency owing to the lender and served the debtor with a notice of intent to collect by a so-called treasury offset.
Also before bankruptcy, HUD recovered almost $10,000 of the deficiency by offsetting a federal tax overpayment for 2016.
The debtor filed a chapter 7 petition in early 2018 and claimed an exemption covering a scheduled 2017 federal tax overpayment of some $6,000. After bankruptcy, the U.S. Treasury used the 2017 overpayment to offset the remaining deficiency owing to HUD.
The debtor initiated an adversary proceeding to recover and exempt the overpayment that the Treasury had offset.
The IRS Statute
Section 6402 of the IRS Code, 26 U.S.C. § 6402, establishes the so-called Treasury Offset Program.
When the Treasury is notified by a federal agency that someone owes a past-due and legally enforceable debt, Section 6402(d)(1) provides that the Treasury Secretary “shall” reduce the taxpayer’s overpayment by the amount of the debt, pay the agency, and notify the taxpayer.
Judge Volk’s Decision
Deciding how to rule, Judge Volk confronted what he called a “decisional divide.” Some courts, he said, rule that a tax overpayment is estate property protected by the automatic stay and eligible for exemption. Two circuits hold otherwise, he said.
Ruling that the tax overpayment was protected by the automatic stay and represented an asset that the debtor could exempt, Judge Volk followed two decisions by bankruptcy courts in the Fourth Circuit: Addison v. U.S. Dept. of Agriculture (In re Addison), 533 B.R. 520, 528 (Bankr. W.D. Va. 2015); and Sexton v. Dept. of Treasury (In re Sexton), 508 B.R. 646, 525 (Bankr. W.D. Va. 2014). He praised the two decisions for their “resolute adherence to the statutory texts.”
Saying he was “unable to materially improve” on Addison and Sexton, Judge Volk added “a few general observations.”
Judge Volk said that the Bankruptcy Code establishes procedures, priorities and practices for recovering from the estate. “To allow the Treasury to supervene that reticulate structure via setoff,” he said, “would seem to require much more in the way of statutory guidance than has been provided by Congress.” Indeed, a result contrary to Addison and Sexton would pose “a considerable threat to settled bankruptcy principles and policies.”
Judge Volk concluded that the right to an overpayment “vested” in the debtor at midnight on December 31, 2017. The Treasury, he said, did not attempt to offset the overpayment until after the debtor had filed his chapter 7 petition. On filing, the overpayment became estate property protected by the automatic stay.
The debtor’s exemption claim, Judge Volk said, “trumps any right of HUD to offset.” Still, any nonexempt portion of the overpayment would “be available for offset should HUD wish to pursue a stay lift.”
In summary, Judge Volk ruled that the overpayment vested in the estate at filing, “so long as the Treasury had not acted to set off by that time. That contingent right is further protected by the automatic stay.”
Finally, Judge Volk held that Section 522(c) — providing that exempt property is generally not liable for a prepetition debt — “prevents a creditor from exercising a right of setoff against properly exempted tax overpayments.”
To read ABI coverage of other decisions restricting the use of Section 6402 in bankruptcy, click here and here.
Treasury Offset Program Can’t Be Used After Bankruptcy, Judge Volk Rules
Chief Bankruptcy Judge Frank W Volk of Charleston, West Virginia, was nominated this month to sit on the U S District Court for the Southern District of West Virginia. He served as editor-in-chief of the West Virginia Law Review and clerked on the district court, the Fourth Circuit, and the West Virginia Supreme Court. Judge Volk’s qualifications for an Article III court are reflected in his March 31 opinion ruling in favor of the debtor on an issue where the courts are hopelessly divided.