In re Earned Income Tax Credit Exemption Constitutional Challenge Cases

• Decision Date: 02 August 2012
• Docket Number: 11–12855,Nos. 11–11131,11–13302.,s. 11–11131
• Citation: 110 A.F.T.R.2d 2012,477 B.R. 791
• Parties: In re EARNED INCOME TAX CREDIT EXEMPTION CONSTITUTIONAL CHALLENGE CASES. In re Anthony Taylor Lea, Meredith Renee Lea, Debtors. In re Laurie Louise Hudson, Debtor. In re Ricky Wayne Fogle, Jerri Lyn Fogle, Debtors.
• Court: U.S. Bankruptcy Court — District of Kansas

477 B.R. 791
110 A.F.T.R.2d 2012-5467

In re EARNED INCOME TAX CREDIT EXEMPTION CONSTITUTIONAL CHALLENGE CASES.
In re Anthony Taylor Lea, Meredith Renee Lea, Debtors.
In re Laurie Louise Hudson, Debtor.
In re Ricky Wayne Fogle, Jerri Lyn Fogle, Debtors.

Nos. 11–11131, 11–12855, 11–13302.

United States Bankruptcy Court,
D. Kansas.

Aug. 2, 2012.

[477 B.R. 793]

Martin J. Peck, Wellington, KS, for Anthony Tylor Lea and Meredith Renee Lea.

Jeffrey W. Rockett, Nicholas R. Grillot, Redmond & Nazar, LLP, Wichita, KS, for Edward J. Nazar, Trustee.

Derenda J. Mitchell, Kansas Attorney General, Topeka, KS, for Derek Schmidt.

Donald C. Astle, Wichita, KS, for Laurie Louise Hudson.

[477 B.R. 794]

Rachel E. Lomas, Hite, Fanning & Honeyman L.L.P., Wichita, KS, for Linda S. Parks, Trustee.

Douglas D. Depew, Depew Law Firm, Neodesha, KS, for Ricky W. Fogle and Jerri L. Fogle.

Steven L. Speth, Wichita, KS, Trustee.

MEMORANDUM OPINION
ROBERT E. NUGENT, Chief Judge.

Congress and the Kansas Legislature have each enacted an earned income tax credit (EIC) to afford lower-income families with children not only a refund of over-withheld wages, but also an additional refundable tax credit. ¹ Until last year, the right to receive the credit, along with the debtor's income tax refund, was subject to turnover to a chapter 7 debtor's trustee for administration and distribution to the creditors. Recognizing that the proceeds of the credit were intended by Congress and the state legislature to provide some relief for working lower-income families, the Kansas Legislature enacted Kan. Stat. Ann.. § 60–2315 (2011 Supp.) which exempts the right to receive the credit for those Kansans who file for bankruptcy relief (the “Act”).² The debtors in these three cases claimed this exemption and their Trustees objected, claiming that Kansas's bankruptcy specific exemption of the EIC runs afoul of the Bankruptcy Clause and the Supremacy Clause of the United States Constitution. They also assert that the Act's language making it applicable to individual debtors under the Federal Bankruptcy Reform Act of 1978 renders it inapplicable to bankruptcy cases filed after the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA).

Because the Bankruptcy Code expressly accommodates the several states' exemption schemes by allowing states to “opt out” of the federal exemptions in 11 U.S.C. § 522(b) and because this exemption will apply uniformly to all Kansas debtors in bankruptcy, the Act does not violate either the Bankruptcy or Supremacy Clauses. It plainly applies to the 1978 Bankruptcy Reform Act because that act was amended, not superseded, by BAPCPA. The Trustees' objections must be overruled and that part of these and similarly situated debtors' tax refunds that have been retained in trust pending resolution of these objections should be released to the debtors.³

Jurisdiction

This Court may hear and determine objections to the validity of a debtor's exemptions as a core proceeding.⁴

Factual Summary

In the three captioned cases, the parties submitted stipulations to the Court which are summarized below.⁵ Edward J. Nazar is the Trustee of the Lea case; Linda S. Parks is the Trustee of the Hudson case; and Steven L. Speth is the Trustee of the Fogle case. Nazar and Parks submitted

[477 B.R. 795]

briefing on the issues before me; Speth did not. The State of Kansas was allowed to intervene to defend the constitutionality of the EIC exemption statute and submitted briefs in response to the Trustees' submissions.⁶ The debtors Lea and Fogle also submitted briefs defending their right to claim the exemption.⁷

Lea

Anthony and Meredith Lea filed their chapter 7 case on April 25, 2011 and on June 23, amended their Schedule C to claim the EIC exemption. They received a federal and state income tax refund of $7,989 from which their counsel withheld $574 pursuant to an attorney's fee assignment, leaving a net refund amount of $7,415. Part of their federal refund was the EIC which amounted to $2,149. Because April 25 was the 115th day of 2011, 115/365 of the Leas' refund, after deducting the attorneys fee, is property of their bankruptcy estate. If their attempt to exempt the EIC fails, that amount will be $2,336.23; if they prevail, it will be $1,659.15 and they will be permitted to retain the $677.08 that represents 115/365 of the EIC.

Hudson

Laurie Hudson filed her chapter 7 case on September 15, 2011 and claimed the EIC exemption. She received a federal income tax refund of $2,744, $2,335 of which represented the EIC. She received a state income tax refund of $297, but was entitled to a state EIC of $420. Her estate owns 258/365 of her federal and state refunds. If the EIC exemption is upheld, the estate's share of the federal refund will be $289.10.⁸ Because the state EIC exceeds the amount of her refund, she will be entitled to retain all of it. If, however, the EIC exemption falls, Ms. Hudson's estate will receive 258/365 of $3,041, the sum of the federal and state refunds, or $2,149.52.

Fogle

Ricky and Jerry Fogle filed their case on October 26, 2011 and exempted their EIC benefit. According to the very brief stipulation filed in that case, they received $6,052 in federal and state refunds including an EIC of $2,957.13. I calculate that the estate's share of their non-exempt tax refund is equal to 299/365 of the total amount. If the EIC exemption survives, the estate will receive $2,535.24; ⁹ if it doesn't, the estate will get $4,957.66. ¹⁰

The only legal controversy in these cases is whether the Act and the exemption it offers to bankrupt Kansans is a constitutional enactment of the State. There are no other factual controversies in these three matters.

Constitutionality and Exemption Standards

The determination of whether a state statute is constitutional is a question of law subject to unlimited review.¹¹ State statutes are presumed to be constitutional and courts resolve all doubts in favor of a statute's validity.¹² Courts are required to interpret a statute in a way that makes it

[477 B.R. 796]

constitutional if a reasonable construction would maintain the legislature's apparent intent.¹³

Exemption statutes such as the EIC statute at issue here are to be liberally construed in favor of the exemption and to give effect to the statute's beneficent purpose.¹⁴ Exemptions claimed by debtors in bankruptcy are presumed valid.¹⁵ As the parties objecting to the claimed EIC exemption and attacking the constitutionality of the EIC exemption statute, the Trustees have the burden of rebutting the presumption of validity. ¹⁶

Analysis

Bankruptcy Judge Janice Miller Karlin has already addressed most of the constitutional challenges to the Kansas EIC exemption that are advanced in these three cases in In re Westby.¹⁷ She issued a well-reasoned and articulate decision that handily disposed of many of the objections raised by the Trustees in these cases. And, on a related, but not identical exemption issue, this judge has recently addressed the interplay between the Kansas exemptions and the federal domiciliary requirement set out in § 522(b) in rejecting the chapter 13 trustee's objection to a debtor's use of the federal exemptions that was based on preemption.¹⁸ Both Judge Karlin and I agree that when Congress allowed the states to opt out of the usage of the federal exemptions in § 522(b), it implicitly recognized that different states would place varying limitations on their citizens' rights to exempt property from execution.

A. The Earned Income Credit

The EIC is a refundable tax credit.¹⁹ As the Tenth Circuit noted in

[477 B.R. 797]

In re Montgomery, an individual's tax credits are applied to tax owed for a taxable year and if they exceed the amount of tax owed, they are considered an overpayment that is refunded.²⁰ So, whether an individual has actually paid in withholdings or not, she is entitled to receive the excess credit as if she had. The EIC “was enacted to reduce the disincentive to work caused by the imposition of Social Security taxes on earned income (welfare payments are not similarly taxed), to stimulate the economy by funneling funds to persons likely to spend the money immediately, and to provide relief for low-income families hurt by rising food and energy prices.” ²¹ As the Tenth Circuit Bankruptcy Appellate Panel has noted, “the EIC benefits low-income married couples and heads of households with qualifying dependent children.” ²² The state's EIC is computed as a percentage of the federal EIC, currently set at 18 per cent.²³

B. The Kansas EIC Exemption

Kan. Stat. Ann.. § 60–2315 (2011 Supp.) provides:

An individual debtor under the federal bankruptcy reform act of 1978 (11 U.S.C. § 101 et seq.), may exempt the debtor's right to receive tax credits allowed pursuant to section 32 of the federal internal revenue code of 1986, as amended, and K.S.A. 79–32,205, and amendments thereto [the Earned Income Credit or EIC]. An exemption pursuant to this section shall not exceed the maximum credit allowed to the debtor under section 32 of the federal internal revenue code of 1986, as amended, for one tax year. Nothing in this section shall be construed to limit the right of offset, attachment or other process with respect to the earned income tax credit for the payment of child support or spousal maintenance.²⁴

Thus, a Kansas debtor may exempt the right to receive the EIC portion of his or her tax refunds for one tax year, presumably a year preceding or in which the debtor files his case. A Kansas resident not filing a bankruptcy case may not claim this exemption and that is the seed of the Trustees' discontent. The Trustees believe that “bankruptcy-specific” exemptions improperly invade the province of Congress to establish uniform bankruptcy laws and violate the Supremacy Clause by venturing into an area that congressional action has preempted. They also complain that four different bankruptcy code sections are in direct conflict with the Act...