Addison v. United States Department of Agriculture (In re Addison)
Docket: CASE NO. 14-71321; ADVERSARY PROCEEDING NO. 15-07002
Court: United States Bankruptcy Court, W.D. Virginia; July 13, 2015; Us Bankruptcy; United States Bankruptcy Court
The court is addressing whether the automatic stay under 11 U.S.C. § 362(a) applies to the federal Treasury Offset Program (T.O.P.), which permits the federal government to offset a non-tax debt owed by a debtor against a federal income tax refund owed to that debtor. Additionally, the court must determine if the debtor can claim an exemption in the tax refund that overrides the government's right to offset. Following the precedent set by Sexton v. Department of Treasury, the court answers both questions affirmatively, albeit with some hesitation due to conflicting case law.
The case involves Earl Douglas Addison (the "Debtor"), who filed for Chapter 7 bankruptcy on September 23, 2014, listing anticipated tax refunds for 2011 and 2012 as assets totaling $8,957.00 and claiming an exemption of $2,319.00 under Virginia law. The Debtor also listed a nonpriority unsecured debt of $80,989.00 owed to the United States Department of Agriculture (USDA) stemming from a foreclosure. After the bankruptcy filing, the Treasury applied the Debtor’s 2011 tax refund of $5,251.27 and 2012 tax refund of $2,834.00 to the non-tax debt without obtaining relief from the automatic stay. The Debtor's counsel notified the Treasury of the bankruptcy and requested that the withheld tax refunds be sent to the Chapter 7 trustee, but there was no response, and the funds were not released. Subsequently, the Debtor initiated an adversary proceeding against the government, alleging that the withholding of his tax refunds constituted a willful violation of the automatic stay.
The Debtor seeks a court order for the Defendants to reimburse the Chapter 7 trustee $5,766.27 with interest, for the government to reimburse the Debtor $2,319.00, and for the award of actual damages, costs, and attorney’s fees. The government, in its Answer, argues that the Treasury is not a proper defendant due to insufficient notice, as the Debtor did not serve the United States Attorney. Additionally, the government claims that it did not violate the automatic stay and that the Debtor's tax overpayment refunds were not part of the bankruptcy estate until the Treasury offset them against governmental debt under 26 U.S.C. § 6402(d). The government contends that its right to offset under 11 U.S.C. § 553 takes precedence over the Debtor's exemption rights under 11 U.S.C. § 522(c).
On March 4, 2015, the government filed a Motion for Summary Judgment. The Court conducted two pre-trial conferences and set deadlines for responses, with oral arguments scheduled for June 17, 2015. The Plaintiff responded on May 14, 2015, acknowledging that the Treasury is not a proper party defendant. The Defendants replied on June 2, 2015, and a hearing was held on June 17, 2015, after which the Court took the matter under advisement.
The Court confirms jurisdiction under 28 U.S.C. §§ 1334(a) and 157(a) and classifies the matter as a "core" bankruptcy proceeding. It concludes that the Treasury must be dismissed as an improper defendant, as 26 U.S.C. § 6402(g) permits suits against agency-claimants but prohibits actions against the Treasury for debt collection duties. The Plaintiff must pursue relief from the USDA, the agency claiming the debt. Under Federal Rule of Civil Procedure 56, summary judgment is warranted where there are no genuine disputes of material fact and the movant is entitled to judgment as a matter of law.
On a motion for summary judgment, courts must view evidence in the light most favorable to the nonmoving party, who is entitled to have their evidence believed and all reasonable inferences drawn in their favor. The nonmoving party cannot solely rely on pleadings and must present specific facts demonstrating a genuine issue for trial. Upon the filing of a bankruptcy petition, an automatic stay under 11 U.S.C. § 362(a) is triggered, offering protection to debtors and facilitating orderly distribution among creditors. This stay prevents legal actions against the debtor, enforcement of liens, or collection of assets within the debtor's estate and is crucial to the bankruptcy process. However, certain actions are exempt from the stay, as delineated in § 362(b), including the setoff of income tax refunds against tax liabilities under § 362(b)(26). The right of setoff allows mutual debts to be offset against each other to prevent unfair payments. The Supreme Court's ruling in Citizens Bank of Maryland v. Strumpf clarified that an administrative freeze on a debtor's account does not constitute a violation of the automatic stay. The Bankruptcy Code, specifically 11 U.S.C. § 553, preserves existing setoff rights under non-bankruptcy law, which in this instance involves the Treasury's authority to apply tax overpayments to outstanding debts as per 26 U.S.C. § 6402.
Section 6402(d) mandates that the Treasury must apply a taxpayer's income tax overpayment to any non-tax debt owed to another federal agency, excluding the IRS. Courts interpreting this provision distinguish between a tax "overpayment"—the excess payment beyond tax liability—and a tax "refund," which is the net amount returned to the taxpayer after satisfying tax obligations and other certified debts. The government argues that the Supreme Court's ruling in Sorenson establishes that only after applying Section 6402 to tax overpayments does any remainder constitute a refund, which then falls under the bankruptcy estate and is subject to an automatic stay. Although the government acknowledges Sorenson was not previously cited in the Sexton case, it maintains that Sorenson’s conclusions do not alter the current analysis. In Sorenson, the Supreme Court ruled that excess earned-income credits are classified as overpayments, permitting their interception under Section 6402(c) for delinquent child support. The Court emphasized that the intercept provisions of Section 6402 apply to excess earned-income credits, rejecting the argument that these credits were exempt from such offsets.
Sorenson is identified as a non-bankruptcy case decided before the enactment of Section 362(b)(26) by Congress, which is presumed to have knowledge of existing case law when legislating. It is established that Congress operates with awareness of legal interpretations tied to existing statutes. The USDA had a legal right under Section 6402 to offset the Debtor’s tax overpayment against debts owed to the government before issuing a refund. Upon the Debtor’s bankruptcy filing, the automatic stay under Section 362 was triggered. The key issue is whether the government's postpetition set-off of the Debtor's tax overpayment against a non-tax debt violates this automatic stay. The Debtor contends that his tax refund became property of the bankruptcy estate upon filing, arguing that Section 362(a)(7) prohibits setoffs and Section 362(b)(26) only allows for specific exceptions. He claims that the withholding of his tax refunds is a willful violation of the automatic stay. During the hearing, the Debtor's counsel acknowledged that the Debtor lacks standing to recover a portion of the withheld amount, seeking only $2,319.00 claimed as exempt. Conversely, the government argues that the Debtor only had a contingent interest in his tax refund until the Treasury fulfilled the requirements of the T.O.P. The government cites Sorenson, asserting that a tax overpayment must be applied to governmental debts before it qualifies as a refund. It contends that the Debtor owed more than his tax overpayment, meaning no refund existed to be included in the bankruptcy estate.
The Plaintiff's claim to his tax overpayment is contingent on the application of 26 U.S.C. § 6402(d), which the government argues does not entitle the Chapter 7 trustee to the overpayments, as both the Plaintiff and trustee hold only contingent interests. There is a noted split in case law regarding this issue, highlighted by contrasting rulings in *Sexton* and *Riley*. In *Sexton*, the court ruled that a debtor's interest in tax overpayments is considered property of the bankruptcy estate and thus exempt from set-off by the IRS. Conversely, *Riley* determined that debtors cannot claim a tax refund if their tax debts exceed their overpayments, as these do not become exempt property of the estate. The differing viewpoints are further illustrated by the Fifth Circuit's ruling in *I.R.S. v. Luongo*, where it was concluded that a debtor is only entitled to a refund if the overpayment exceeds unpaid tax liabilities, and that such refunds do not automatically become property of the estate. The court in *Sexton* emphasized that the right to recover tax overpayments is established at the close of the tax year, specifically pointing to December 31, 2011, and December 31, 2012, for the Plaintiff. It noted that while the government can intercept tax overpayments, if a bankruptcy case is filed before such action, the debtor's interest vests in the estate, requiring the government to seek relief from the automatic stay to utilize the overpayment for set-off.
Upon the Debtor's bankruptcy petition filing on September 23, 2014, all eligible property became part of the bankruptcy estate under 11 U.S.C. § 541(a). This section broadly defines estate property to encompass all the debtor’s interests, regardless of possession or location. Notably, § 541(b) lists certain exclusions from the estate, but does not mention tax overpayments or refund rights. Thus, the Debtor’s interest in his tax overpayment became part of the bankruptcy estate upon filing, protected by the automatic stay outlined in § 362(a)(7), which prevents setoff actions.
The Court emphasizes that previous cases suggesting the government’s right to setoff under § 6402 applies equally in bankruptcy fail to recognize that this right creates either a statutory lien on overpayments or an exclusion from the estate, which the Court rejects. The language in § 362(b)(26) supports this view by specifically allowing setoffs of income tax refunds against income tax liability without extending this exception to non-tax debts. This aligns with the principle of expressio unius est exclusio alterius, indicating that the inclusion of "income tax liability" excludes other liabilities from the exception.
The Court asserts that if Congress intended for a broader application of § 362(b)(26), it would have explicitly stated so in the statute. It distinguishes the case from Sorenson, as it was decided before the enactment of § 362(b)(26), which governs the current matter, and declines to adopt the Fifth Circuit’s reasoning in Luongo for similar reasons. The intention of Congress in crafting § 362(b)(26) suggests that property interests are part of the estate, subject to the stay, except for this specific setoff provision. Thus, the Court maintains that if the interpretation were otherwise, it would render the statute superfluous, emphasizing adherence to the statute's language as it stands.
Congress did not exempt governmental debts from the definition of ‘liability’ in the statute, leading the Court to uphold the explicit language of the law. The Debtor’s tax overpayment vested in the bankruptcy estate upon filing, thus gaining protections under the automatic stay. The Court must evaluate if the USDA's offset rights under Section 553 can override the Debtor’s exemption rights under Section 522(c). Section 522(c) generally protects exempt property from being liable for debts incurred during or after bankruptcy unless certain exceptions apply. Jurisprudence is divided on whether Section 522(c) supersedes a creditor's setoff rights under Section 553; however, a trend exists where more courts favor the protection of exempt property from setoff. In Virginia, it is well-established that exemptions take precedence over creditor rights to offset mutual prepetition debts. Therefore, the Debtor’s claimed exemption of $2,319.00 prevails against the USDA’s setoff rights without a challenge to the exemption or relief from the stay.
The Court also addressed the potential for awarding attorney’s fees to the Plaintiff's counsel under the Equal Access to Justice Act (EAJA), which is an exception to the American Rule that typically prevents a winning party from recovering fees from the losing party. The EAJA allows such recovery against the United States under specific conditions, unless the government can demonstrate that its position was substantially justified. The burden lies with the United States to prove this justification.
Courts determine the United States' position to be “substantially justified” if it has a reasonable legal and factual basis. Despite prior rejection of the government's stance in the Sexton case, this Court finds the government’s position justified due to prevailing case law splits and the lack of obligation to follow Sexton. The Court concludes that the Debtor’s tax overpayment is part of the bankruptcy estate, protected by the automatic stay, and that the Debtor has claimed an exemption of $2,319.00. The Court denies the Defendants' Motion for Summary Judgment, noting the Plaintiff has not filed a cross-motion. It cites Federal Rule of Civil Procedure 56(f), allowing the Court to grant summary judgment for a nonmovant after providing notice and time to respond. Both parties acknowledge no genuine material facts are disputed, and the Court sets a deadline of July 20, 2015, for the USDA and Plaintiff to present any opposing legal or factual grounds regarding the summary judgment on the stay violation and attorney's fees, respectively. Failure to respond will lead to entry of summary judgment. Additionally, it is agreed that the Treasury must be dismissed as a defendant under 26 U.S.C. 6402(g). An Order reflecting these rulings will be issued, with findings of fact treated as conclusions of law and vice versa. There is a dispute regarding whether the USDA was properly notified as a creditor due to an alleged incorrect mailing address.
At the hearing on the USDA's motion for summary judgment, USDA counsel acknowledged that the Debt Servicing Center received the Debtor's letter. The Court conducted two pre-trial conferences while awaiting the outcome of the Sexton appeal to the U.S. District Court for the Western District of Virginia, which was dismissed on March 31, 2015, on procedural grounds without addressing the merits. The Court noted that the USDA, IRS, and U.S. Attorney's Office were likely familiar with the Sexton case prior to the offset in question, although Sexton was not mentioned in the government's initial argument until prompted by the Court. The same counsel represented the USDA in both matters. The Court emphasized the importance of considering relevant opinions from other judges to avoid creating conflicting authority within the same Court. The Treasury's interception of the taxpayer's refund was only partial due to negotiations concerning tax refunds in community property states, a matter deemed irrelevant to the current issue. The principle of mutuality dictates that the debt must be owed in the same right and between the same parties. Generally, the federal government is viewed as a single 'unitary creditor' for setoff purposes. The government retains options, as it may legally place a hold on the refund to maintain the status quo, provided it promptly seeks relief from stay to exercise its right of setoff, as established in Strumpf.
