In re Donnell

• Decision Date: 05 December 2006
• Docket Number: No. 05-53073-LMC.,05-53073-LMC.
• Citation: 357 B.R. 386
• Parties: In re Joe DONNELL and Raquel Villa Donnell, Debtors.
• Court: U.S. Bankruptcy Court — Western District of Texas

Page 386

357 B.R. 386

In re Joe DONNELL and Raquel Villa Donnell, Debtors.

No. 05-53073-LMC.

United States Bankruptcy Court, W.D. Texas, San Antonio Division.

December 5, 2006.

COPYRIGHT MATERIAL OMITTED

J. Todd Malaise, San Antonio, TX, for Debtors.

DECISION AND ORDER ON TRUSTEE'S MOTION TO COMPEL DEBTORS TO TURN OVER POTION OF 2005 FEDERAL INCOME TAX REFUND

LEIF M. CLARK, Bankruptcy Judge.

Before the Court is a Motion by the chapter 7 trustee ("Trustee") seeking to compel turnover of a portion of the married debtors' 2005 income tax refunds. The Court must determine whether a bankruptcy estate is entitled to any portion of the debtors' federal income tax refunds for the tax year during which the debtors filed for Chapter 7 bankruptcy. For the reasons stated below, the motion is GRANTED IN PART and DENIED IN PART.

Facts

Mr. & Mrs. Donnell filed this Chapter 7 case on May 26, 2005 and received their discharge on September 5, 2005. In 2006, Mr. and Mrs. Donnell ("Debtors") filed separate federal income tax returns for the 2005 tax year. They received refunds of $6,729.00 and $4,338.00 respectively. The Chapter 7 trustee filed this motion seeking turnover of a portion of the refunds, on grounds that the refunds derive from a tax year including the pre-bankruptcy filing period. The trustee maintains that that portion of the refunds equal to the ratio of the number of pre-petition days in the tax year to the total number of days in the tax year is necessarily property of the estate under section 541 and thus subject to turnover. He seeks a share calculated at 145/365 of each of the Donnells' tax refunds.

Mr. Donnell's tax return shows that his refund of $6,729 resulted from $9,328 of wage withholding, less a total tax of $2,599. According to pay stubs introduced by Mr. Donnell, somewhere between $3,634 and $3,191 was withheld in the pre-petition portion of the year.¹

Mrs. Donnell's tax return showed a refund of $4,388, resulting from wage withholding for the year of $2,266, $1,914 of earned income credit, and $540 of additional child tax credit. Mrs. Donnell's total tax was $382.² The record indicates that all of Mrs. Donnell's prepetition withholding, totaling $613, came from her Texas unemployment compensation benefits.

Neither of the Donnells made the "short year election" allowed under 26 U.S.C. § 1398.

Discussion

A taxpayer is generally entitled to the refund of any overpayments of income tax for the applicable tax year. 26 U.S.C. § 6402(a) ("In the case of any overpayment, the Secretary ... shall . . . refund any balance to [the taxpayer].").³ Overpayments result when the sum of any "refundable" tax credits, such as overpayments, wage withholding and earned income credit ("EIC"), exceed the tax imposed under the Internal Revenue Code in that year. Id. at § 6401. Unless a debtor makes a "short year election", the taxable year of a Chapter 7 debtor is determined without regard to the bankruptcy filing. See 26 U.S.C. § 1398(a), (d).⁴

The Bankruptcy Code makes, with limited exceptions, "all legal or equitable interests of the debtor in property as of the commencement of the case" property of the bankruptcy estate. 11 U.S.C. § 541(a). Therefore, any part of the Donnells' post-petition refunds representing "interests of the debtor[s] in property as of the commencement of the case" must be turned over to the Trustee. Id.; see also 11 U.S.C. § 542(a). The initial inquiry is simple — how do we determine what part, if any, of the income tax refunds, is property in which the Donnells had an interest on the date of filing?

Post-Petition Income Tax Refunds May Be Property of the Estate

The Supreme Court first addressed whether a tax refund could be property of the estate in a Bankruptcy Act decision, Segal v. Rochelle, 382 U.S. 375, 86 S.Ct. 511, 15 L.Ed.2d 428 (1966). In Segal, the debtors received a tax refund post-petition, resulting from the application of loss-carrybacks to pre-petition tax years. Id. at 376, 86 S.Ct. 511. The Bankruptcy Act (unlike the Bankruptcy Code) lacked a specific definition of what constituted property of the bankruptcy estate, requiring the Court to supply a standard. The Court stated that, in developing a rule for what constitutes property of the estate, the Court needed to be attentive to the overall purposes of the Bankruptcy Act. The Court divined two overarching purposes, the first of which was "to secure for creditors everything of value the bankrupt may possess in alienable or leviable form when he files his petition." Id. at 379, 86 S.Ct. 511. The Court added that the term "property" had been broadly construed to achieve that end, permitting even novel or contingent interests to be included. Id. On the other hand, said the Court, there is a prudential limitation on this otherwise broad reach. Because a principle purpose of the Bankruptcy Act was "to leave the bankrupt free after the date of his petition to accumulate new wealth in the future," some items that might otherwise conceivably be swept up as property are excluded, such as future wages, or a promised gift, "even though state law might permit all of these to be alienated in advance." Id. at 379-80, 86 S.Ct. 511. Thus, in response to this limitation on the breadth of property includible in the estate, the Court ruled that only property that is "sufficiently rooted in the pre-bankruptcy past and so little entangled with the bankrupts' ability to make an unencumbered fresh start" should be includible as estate property. Id. at 380, 86 S.Ct. 511. The Court found that the loss-carryback refund claims at issue in the case passed this second test, and so could be included as property of the estate. Id.

The Supreme Court next addressed the status of tax refunds in bankruptcy in Kokoszka v. Belford, 417 U.S. 642, 94 S.Ct. 2431, 41 L.Ed.2d 374 (1974). In Kokoszka, another Bankruptcy Act case, the debtor filed, his bankruptcy petition in early January, 1972. Id. at 644, 94 S.Ct. 2431. The Court ruled that the entire 1971 tax refund was property of the estate — despite the refund not being in the debtor's possession at the time of the filing — because "[t]he tax payments refunded here were income tax payments withheld from the petitioner prior to his filing for bankruptcy and are based on earnings prior to that filing." Id. at 647, 94 S.Ct. 2431. Applying Segal, the Court said that the tax refund was sufficiently rooted in the debtor's pre-bankruptcy past that it would not be unfair to the debtor to treat the refund as property of the estate. Id. at 648, 94 S.Ct. 2431.

The Fifth Circuit has only tangentially addressed the question of tax refunds as property of the estate. See In re Luongo, 259 F.3d 323, 329 n. 4 (5th Cir.2001). Focusing on whether a bankruptcy court had jurisdiction to entertain a section 505 action in which the estate would realize no benefit (because the refund, if allowed, was claimed as exempt), the Fifth Circuit noted in passing that the refund would be property of the estate because "any overpayment . . . occurred prepetition and any right to a refund is therefore property of the estate." Id. The court cited Kokoszka for authority for this assertion, but engaged in no further analysis.

The Tenth Circuit has addressed the question more directly, applying its understanding of Segal and Kokoszka to decide that the pre-petition portion of a tax refund was property of the estate. Barowsky v. Serelson (In re Barowsky), 946 F.2d 1516, 1518 (10th Cir.1991). Said the court, "the pre-petition portion of the refund essentially represents excessive tax withholding which would have been other assets of the bankruptcy estate if the excessive withholdings had not been made." Id. Barowsky stated that (at least in the context of tax refunds) the Bankruptcy Code's explicit definition for "property of the estate" did not overrule the holding in Segal that a tax refund arising from a prepetition tax year would be property of the estate, citing with approval to the legislative history to section 541(a)(1). See id. at 1518-19.⁵

The Fifth Circuit's recent en banc decision in Burgess significantly informs our analysis of this issue. The court there held that, with the enactment of an explicit statutory definition for "property of the estate" in the Bankruptcy Reform Act of 1978, "Segal's `sufficiently rooted' test did not survive the enactment of the Bankruptcy Code." Burgess v. Sikes (In re Burgess), 438 F.3d 493, 498 (5th Cir.2006) (en bane). This conclusion is consistent with the actual holding in Barowsky, though it more explicitly (and correctly) rejects the notion that "sufficiently rooted in the pre-bankruptcy past" describes the scope of the estate's interest in property.⁶

Burgess was not a tax refund case. It involved crop disaster relief payments resulting from Congressional legislation enacted after the debtor's discharge. Although the payments were made in compensation for crop losses suffered by the debtor pre-bankruptcy, the Fifth Circuit ruled that the payments in question were not property of the bankruptcy estate because the law authorizing the payments was not enacted until after the farmer's bankruptcy filing. Id. at 503. The Chapter 7 trustee had argued that Segal's "sufficiently rooted" test meant that the payments should be property of the estate because they were based upon crop losses that occurred before the debtor's bankruptcy filing. The court disagreed with this reading of Segal, noting that the Bankruptcy Act (under which Segal was decided), unlike the Bankruptcy Code, did not contain a definition of property of the estate, necessitating the court-created two-pronged test crafted in Segal. Id. at 498-99 (citing Goff v. Taylor, 706 F.2d 574, 578 (5th Cir.1983)). Acknowledging that Congress did not intend to overrule the result in Segal when it enacted section 541(a)(1), the court nonetheless rejected the trustee's contention that the "sufficiently rooted" phraseology should be read to e...