In re Bathrick
| Decision Date | 06 December 1979 |
| Docket Number | Bankruptcy No. 76-HB-233. |
| Citation | 1 BR 428 |
| Parties | In re Alton M. BATHRICK, Bankrupt. William A. SHORT, Jr., Trustee, Plaintiff, v. INTERNAL REVENUE SERVICE, Blythe Bathrick, Defendants. |
| Court | U.S. Bankruptcy Court — Southern District of Texas |
Michael H. Saks, Houston, Tex., for trustee.
M. Carr Ferguson, Asst. Atty. Gen., Washington, D.C., Howard A. Weinberger, Atty., Tax Div., Dept. of Justice, Dallas, Tex., for I.R.S.
John E. O'Neill, Houston, Tex., for Blythe Bathrick.
The matter is before the Court on the complaint of the trustee asserting that a tax refund owed jointly to the bankrupt and his wife (not a bankrupt), is entirely property vesting in the trustee of the husband's estate upon the filing of the petition. On March 26, 1976, Mr. Bathrick filed a voluntary petition in bankruptcy. At the time of the bankruptcy proceeding, and for several years prior to that action, Alton Bathrick was married to Blythe Bathrick.
In April of 1976, Mr. and Mrs. Bathrick together filed a joint tax return for 1975, the year preceding Mr. Bathrick's bankruptcy. All but $46 of the income reported by the Bathricks for 1975 came from the earnings of Mr. Bathrick. Additionally, most if not all, of the 1975 tax payments were made in the form of withholding taxes retained by Mr. Bathrick's employer and paid over to the government pursuant to law. It was determined that the Bathricks were entitled to a tax refund of $8,377.66. The refund was generated largely by deductions for capital and real estate losses.
After Mr. Bathrick's petition was filed, notice of the filing was mailed — as is customary in all bankruptcy cases — to the Internal Revenue Service. After his appointment, the trustee, in a letter dated February 15, 1977, made a demand on the I.R.S. for "the refund check due to Alton Bathrick." The trustee did not give notice to Mr. or Mrs. Bathrick of his demand on the I.R.S. until shortly before this complaint was filed. Although the trustee could have been more diligent in noticing the parties of his claim to the refund, the I.R.S. created this problem when, after considering the matter and without noticing any other party, it deliberately divided the refund check into two checks, each for $4,188.33, and forwarded one to Mrs. Bathrick and the other to Mr. Bathrick's trustee.
Upon the receipt of the check from the I.R.S., Mrs. Bathrick, without notice to the Trustee, endorsed the check and mailed it to HUD in payment of a federally guaranteed loan made to the Bathricks by Union Bank for improvements to their home. The tax refund had not been specifically pledged as security for this loan, which was listed on the bankrupt's schedules as a secured debt owed to Union Bank. Neither the FHA nor HUD has been scheduled as a creditor of the bankrupt or has attempted to file a claim.
The Trustee then filed a complaint against Mrs. Bathrick and the I.R.S. claiming title to the check had passed to the trustee and hence seeking to compel turnover of the refund sent to Mrs. Bathrick. Alternatively, the Trustee alleges that the delivery of the check by the I.R.S. to Mrs. Bathrick constituted a conversion for which the I.R.S. is now liable. No action has been brought against HUD or the FHA.
Disposition of this case involves questions of both state and federal law. Whether the tax refund was property which passed to the bankruptcy trustee is a question of federal law. However, the proper marital characterization of the refund must be made under the community property laws of Texas as the Bathricks were residents of that state at all times material to these proceedings.
The law of the state where the property is situated determines the extent of the bankrupt's interest in the property. United States v. Bess, 357 U.S. 51, 78 S.Ct. 1054, 2 L.Ed.2d 1135 (1958); In re Wetteroff, 453 F.2d 544, 546 (8th Cir. 1972), cert. denied, 409 U.S. 934, 93 S.Ct. 242, 34 L.Ed.2d 188 (1972). Texas is a community property state in which the income produced by either spouse during marriage is community property. Tex.Family Code Ann. § 5.21 (1975). The source of an overpayment of income tax determines the character of the refund, with a refund of excess withholding tax merely being a repayment of earnings from employment. Gehrig v. Shreves, 491 F.2d 668, 671-673 (8th Cir. 1974). Therefore, the tax refund would be community property under Texas law.
Personal earnings, while community property, are by statute subject to the sole management, control and disposition of the spouse who earned them. Tex.Family Code Ann. § 5.22 (1975). As previously stated, virtually all of the income reported on the 1975 tax return was earned by Mr. Bathrick; therefore, the refund, as excess payments of personal earnings, would be community property under the sole control, management and disposition of Mr. Bathrick.
Given the character of the bankrupt's interest in the refund, it must be determined whether a tax refund is property even capable of being transferred to the trustee in bankruptcy. Section 70a(5) of the Bankruptcy Act provides:
The trustee of the estate of the bankrupt . . . shall in turn be vested by operation of law with the title of the bankrupt as of the date of the filing of the petition initiating a proceeding under this Act, except insofar as it is to property which is held to be exempt, to all of the following kinds of property wherever located . . . (5) property, including rights of action, which prior to the filing of the petition he could by any means have transferred or which might have been levied upon and sold under judicial process against him, or otherwise seized, impounded or sequestered. . . .
The United States Supreme Court dealt with the issue of whether an income tax refund is property potentially transferable to a trustee in bankruptcy in Kokoszka v. Belford, 417 U.S. 642, 94 S.Ct. 2431, 41 L.Ed.2d 374 (1974). The debtor in Kokoszka filed bankruptcy in early January, 1972. As in the present case, the debtor did not file his tax return until after he had filed his petition in bankruptcy and did not receive his refund check for some weeks after that. Citing their earlier holding in Segal v. Rochelle, the Court concluded that the refund was "sufficiently rooted in the prebankruptcy past and so little entangled with the bankrupt's ability to make an unencumbered fresh start that it should be regarded as `property' under § 70a(5)." 417 U.S. at 647, 94 S.Ct. at 2434 citing Segal v. Rochelle, 382 U.S. 375 at 380, 86 S.Ct. 511, 15 L.Ed.2d 428 (1976).
Thus to the extent the tax refund was capable of being levied upon by Mr. Bathrick's creditors, the refund would have been property which passed to the trustee upon the filing of bankruptcy. If Mr. Bathrick's creditors could have reached only one-half of the refund, then only one-half of the refund is property of the estate and the I.R.S. would have been correct in dividing the check.
Texas has set out the rules governing liability of property subject to a spouse's sole control, management, and disposition in its Family Code, § 5.61, subsections (b) and (c), which read:
Thus property subject to the...
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