Bankruptcy – IRS’s offset right trumps debtor’s right to receive tax overpayment

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The case of first impression held that despite a bankruptcy code section providing that exempt property cannot be used to satisfy a debtor’s prepetition debts, the tax code makes clear the government’s right to set-off a tax overpayment against a taxpayer’s preexisting tax liabilities extends to an overpayment due to a debtor.

Background

This case requires the court to resolve a conflict between the federal tax offset program and the bankruptcy code. Under the offset program, the Secretary of the Treasury has the discretion to set-off “any” tax overpayment against a taxpayer’s preexisting tax liabilities. And, with limited exceptions not applicable here, the bankruptcy code provides that exempt property cannot be used to satisfy “any” of the bankruptcy debtor’s prepetition debts.

The court must determine which of these statutory directives controls when a bankruptcy debtor claims, as exempt property, a tax overpayment that the government seeks to set-off under the offset program. This question is one of first impression in this circuit and has divided the bankruptcy courts.

In the present case, both the district court and the bankruptcy court resolved the statutory conflict in favor of the bankruptcy debtors, Matthew and Jolinda Copley, who filed for bankruptcy in 2014 and claimed their 2013 tax overpayment as exempt property. The court determined that the Copleys’ interest in their tax overpayment became part of the bankruptcy estate when they filed their petition, and that the Copleys’ right to exempt the overpayment under section 522(c) “supersedes the setoff rights of the United States [preserved] under § 553.” The bankruptcy court thus ordered the government to remit payment to the Copleys, and the district court affirmed.

Analysis

This court begins with the government’s contention that the Copleys’ 2013 tax overpayment never became part of the bankruptcy estate and, thus, could not have been exempted under the dual provisions of Virginia Code § 34-4 and 11 U.S.C. § 522(b)(1). According to the government, a taxpayer can only have a property interest in a tax refund, not a tax overpayment, and the taxpayer can only have an interest in a refund if the overpayment exceeds preexisting tax liabilities. Because the Copleys’ overpayment did not exceed their preexisting tax liabilities, the government asserts that their interest in a refund was valueless and, therefore, did not become part of the bankruptcy estate. This court disagrees.

The court next considers whether the IRS’s right to offset the Copleys’ overpayment under 26 U.S.C. § 6402 supersedes the Copleys’ right to exempt the overpayment under  11 U.S.C. § 522. Based on the plain language of the governing statutes, the court concludes that the government’s right to offset the Copleys’ overpayment prevails. Thus, we hold that the district court erred in affirming the bankruptcy court’s judgment requiring the IRS to remit the overpayment to the Copleys.

Vacated and remanded.

Copley v. United States (Lawyers Weekly No. 001-061-20, 15 pp.) (Barbara Milano Keenan, J.) Case No. 18-2347. May 12, 2020. From E.D. Va. (M. Hannah Lauck, J.) Richard E. Zuckerman, Bruce R. Ellisen, Bethany B. Hauser and G. Zachary Terwilliger for Appellant, Martin C. Conway for Appellees.