In one of his last rulings before ascending to the district court bench, then-Chief Bankruptcy Judge Frank W. Volk of Charleston, W.Va., navigated between several decisional splits and three statutes to hold that the government may not offset a tax refund without having effected the offset before the taxpayer files bankruptcy.
Judge Volk was upheld on December 19 by District Judge Irene C. Berger of Charleston. In October, the Senate unanimously confirmed Judge Volk for his seat on the district court.
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.
The Government Tax Refund Setoff
Several years before bankruptcy, the debtors 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 debtors with a notice of intent to collect by a so-called treasury offset.
Before bankruptcy, HUD had recovered almost $10,000 of the deficiency by offsetting a federal tax overpayment for 2016.
The debtors filed a chapter 7 petition in early 2018, before they filed their 2017 tax return. The couple nonetheless claimed an exemption covering the expected 2017 federal tax overpayment. After bankruptcy, the debtors filed a tax return seeking a $6,000 refund. Also after bankruptcy, the U.S. Treasury used the 2017 overpayment to offset the deficiency owing to HUD.
The debtors initiated an adversary proceeding to recover and exempt the 2017 refund that the Treasury had offset.
Judge Volk ruled that the 2017 refund was estate property and that the debtors’ right to claim an exemption took precedence over the government’s offset right. The government appealed, to no avail.
Judge Berger’s Affirmance
Judge Berger identified two issues on appeal: (1) Was the debtor’s potential tax refund estate property, and (2) did the debtors’ right to exempt an overpayment under Section 522 take precedence over the government’s right of offset under Section 553?
On the first question, Judge Berger followed courts holding that a tax overpayment becomes the taxpayer’s property at midnight on December 31 of the tax year. Because the government had not effected the setoff by December 31, he held that the right to a refund became estate property.
Judge Berger said that the majority of courts believe overpayments to be estate property. He cited the holding in Whiting Pools Inc., 462 U.S. 198, 205 (1983), for the notion that contingent property interests become estate property.
Judge Berger recognized, however, that the Fifth and Ninth Circuits hold otherwise. They believe that tax overpayments are contingent claims that do not become estate property.
On the question of the primacy of setoff rights versus the ability to exempt property, Judge Berger dealt with seemingly inconsistent provisions in the Bankruptcy and IRS Codes. Section 522(c) provides that exempt property “is not liable during or after the case for any debt of the debtor that arose . . . before the commencement of the case . . . .”
On the other hand, Section 553(a) preserves rights of setoff under nonbankruptcy law, while Section 6402 of the IRS Code gives the government setoff rights.
Judge Berger observed that the Fourth Circuit has not decided which section comes out on top. However, he cited lower court decisions in the Fourth Circuit holding that exemptions trump rights of setoff.
Judge Berger said that the more specific statute, Section 522(c), controls over the more general statute, Section 553(a). Giving primacy to Section 522(c), he said, would more often give meaning to both sections.
Finally, Judger Berger said that one of the “overarching goals of federal bankruptcy law” — the right to a fresh start — “trumps the offset provisions of Section 553 of the Bankruptcy Code and Section 6404.” He therefore found that Judge Volk “correctly concluded that the Debtors are entitled to recover” the $6,000 overpayment.
Judge Volk 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. Perhaps we shall eventually see Judge Volk on the Fourth Circuit. To read ABI’s report on his decision from March, click here.
In one of his last rulings before ascending to the district court bench, then-Chief Bankruptcy Judge Frank W. Volk of Charleston, W.Va., navigated between several decisional splits and three statutes to hold that the government may not offset a tax refund without having effected the offset before the taxpayer files bankruptcy.
Judge Volk was upheld on December 19 by District Judge Irene C. Berger of Charleston. In October, the Senate unanimously confirmed Judge Volk for his seat on the district court.
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.
The Government Tax Refund Setoff
Several years before bankruptcy, the debtors 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 debtors with a notice of intent to collect by a so-called treasury offset.
Before bankruptcy, HUD had recovered almost $10,000 of the deficiency by offsetting a federal tax overpayment for 2016.
The debtors filed a chapter 7 petition in early 2018, before they filed their 2017 tax return. The couple nonetheless claimed an exemption covering the expected 2017 federal tax overpayment. After bankruptcy, the debtors filed a tax return seeking a $6,000 refund. Also after bankruptcy, the U.S. Treasury used the 2017 overpayment to offset the deficiency owing to HUD.
The debtors initiated an adversary proceeding to recover and exempt the 2017 refund that the Treasury had offset.
Judge Volk ruled that the 2017 refund was estate property and that the debtors’ right to claim an exemption took precedence over the government’s offset right. The government appealed, to no avail.
Judge Berger’s Affirmance
Judge Berger identified two issues on appeal: (1) Was the debtor’s potential tax refund estate property, and (2) did the debtors’ right to exempt an overpayment under Section 522 take precedence over the government’s right of offset under Section 553?