Bankruptcy – Tax offset violated automatic stay

AUTOMATIC STAY. The debtor filed for Chapter 7 in September 2014 and listed anticipated tax refunds for 2011 and 2012 as part of the bankruptcy estate, a portion of which was designated as exempt under Va. Code § 34-4 as a homestead exemption. The bankruptcy schedules also listed an amount owed to the USDA for a deficiency resulting from the foreclosure sale of the debtor’s residence. The debtor filed the returns for 2011 and 2012 after filing for bankruptcy claiming refunds but the IRS withheld the refund for application against the USDA loan deficiency. The debtor filed a motion charging the IRS with violating the automatic stay in retaining the refunds. The Bankruptcy Court held that the offset violated the automatic stay and ordered the payment of the refunds to the debtor. The trustee and USDA reached an agreement on the offset but the issue remained as to the portion of the refunds claimed as exempt property. The court noted a split of court authority as to whether the automatic stay prevents the IRS from offsetting tax refunds against non-tax government liabilities. However, the court noted that Section 362(b)(26) was amended to specifically provide that the automatic stay does not prevent “the setoff under applicable nonbankruptcy law of an income tax refund, by a governmental unit, with respect to a taxable period that ended before the date of the order for relief against an income tax liability… .” Because the amendment did not include the offset of non-income tax liability, the court reasoned that the amendment indicated that the Congress intended that the automatic stay prohibited the offsetting of tax refunds against non-income tax liabilities. The IRS argued that, under I.R.C. § 6402, the refunds were not bankruptcy estate property until the IRS approves the refunds; therefore, the automatic stay does not apply to a refund until the IRS allows the refund. The court held that I.R.C. § 6402 applies only in cases where the refund is applied to owed taxes and not to non-tax liabilities. The court affirmed the Bankruptcy Court decision that the IRS violated the automatic stay by offsetting the refunds against the USDA loan deficiency. In re Addison, 2016-1 U.S. Tax Cas. (CCH) ¶ 50,158 (W.D. Va. 2016).

The case summary is from Vol 27 No. 4 of the Agricultural Law DigestClick here for information on how to subscribe to the Digest.

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