In re McInerney

• Decision Date: 15 November 2019
• Docket Number: Bankruptcy Case No. 16 B 40442
• Citation: 609 B.R. 497
• Parties: IN RE: Gerald O. MCINERNEY, Debtor.
• Court: U.S. Bankruptcy Court — Northern District of Illinois

609 B.R. 497

IN RE: Gerald O. MCINERNEY, Debtor.

Bankruptcy Case No. 16 B 40442

United States Bankruptcy Court, N.D. Illinois, Eastern Division.

Signed November 15, 2019

Arthur G. Jaros, Jr., Law Office of Arthur G. Jaros, Jr., Oak Brook, IL, for Debtor.

Joseph E. Cohen, Gina B. Krol, Esq., Cohen & Krol, Monica C. O'Brien, Rachel S. Sandler, Gregory K. Stern, Gregory K. Stern, P.C., Chicago, IL, for Trustee.

MEMORANDUM OPINION

Janet S. Baer, United States Bankruptcy Judge

This matter comes before the Court on the motion filed by Gina B. Krol (the "Trustee"), chapter 7 trustee for the bankruptcy estate of Gerald O. McInerney (the "Debtor"), for turnover of the estate's interest in the Debtor's federal and state income tax refunds for 2016 pursuant to 11 U.S.C. §§ 541 and 542.¹ At issue is the proper allocation of those income tax refunds filed jointly by the Debtor and his non-debtor spouse. For the reasons set forth below, the Court holds that the appropriate method of allocating the refunds between the Debtor and his spouse is the "Withholding Rule." Applying that Rule, the Court finds that, absent adjustments as discussed herein, the estate's interest in the refunds totals $6,254.91, and the Debtor is ordered to turn over to the Trustee, in addition to the amount already tendered, the sum of $5,035.42. As such, the Trustee's motion is granted in part and denied in part.

JURISDICTION

The Court has jurisdiction over this matter pursuant to 28 U.S.C. § 1334 and Internal Operating Procedure 15(a) of the United States District Court for the Northern District of Illinois. This is a core proceeding under 28 U.S.C. §§ 157(b)(2)(A) and (E).

BACKGROUND

The material facts in this matter are undisputed. Those facts, gleaned from the docket, the parties' papers, and the exhibits attached thereto, are as follows.

The Debtor filed a voluntary petition for relief under chapter 7 of the Bankruptcy Code on December 27, 2016 (the "Petition Date"). (Bankr. No. 16-40442, Docket No. 1.² ) He did not disclose in either his original or amended schedules any anticipated tax refund owed to him. (See Docket Nos. 14 & 55.)

About eleven months after the Petition Date, on November 10, 2017, the Debtor and his non-debtor spouse executed a document entitled "Spousal 2016 and Later Years' Income Tax Allocation Agreement" (the "Agreement"). (Docket No. 90, Ex. A.) The purpose of the Agreement is "to avoid ... dispute[s] over the allocation of any joint refund and/or the burden of any balance due" in tax years in which the Debtor and his spouse file a joint tax return. (Id. ) For 2016 and any tax year thereafter in which the Debtor and his spouse file joint returns, the Agreement provides as follows:

Each spouse shall determine and be credited with his or her own contributions (that is, payments and refundable credits) on a separate basis. Payments made from a joint account shall be equitably traced to the spouse whose funds are deemed to have supplied such monies.

Each spouse shall also determine his [or her] separate income tax liability (net of other credits) on a pro forma married filing separately basis.

The proforma separate income tax liability (net of other credits) shall then be reduced by 50% of the aggregate benefit from filing on a joint basis determined by reference to the combined proforma separate tax liabilities (net of other credits) of the spouses. (This 50/50 split is in recognition of the facts (i) that neither of us can compel the other to file a joint return, and (ii) that by agreeing to file a joint return, each spouse takes on personal liability for the other's own tax liability). [sic]

Each spouse's share of the joint refund or joint balance due, as the case may be, shall then be determined by subtracting that spouse's contributions from that spouse's adjusted share of separate income tax liability (net of other credits).

(Id. ) The Debtor's attorney acknowledges that the Agreement was drafted and executed on his own initiative in order to "reflect the principles set forth" in the Debtor's response to the Trustee's turnover motion. (Docket No. 98 at 8.) The Trustee was not advised of nor did she agree to the terms of the Agreement in connection with the Debtor's 2016 tax returns. (Docket No. 90 ¶ 8.)

On or about November 15, 2017, five days after executing the Agreement, the Debtor and his non-debtor spouse filed their joint federal and state income tax returns for 2016.³ (See Docket No. 93, Exs. B-1 & B-2.) Pursuant to those returns, the joint wages for the Debtor and his spouse were $223,374; they also had income of $90,381 from ordinary dividends, pensions, and Social Security payments. (Id. ) After accounting for taxable refunds, credits, or offsets, as well as capital and supplemental losses, their adjusted gross income ("AGI") was $283,636. (Id. )

The Debtor and his spouse made payments toward both their federal and state income taxes through withholding and/or estimated payments. Their federal tax return reflects that the total of withholding and estimated payments was $54,971, which, after subtracting the tax liability of $49,688, resulted in a joint federal overpayment of $5,283. (Id. , Ex. B-1.) Their state tax return indicates that the total of withholding and estimated payments was $8,425, which, after subtracting the tax liability of $6,630, resulted in a joint state overpayment of $1,795. (Id. , Ex. B-2.) Based on both overpayments, the Debtor and his spouse received tax refunds totaling $7,078 for 2016.

The dollar figures corresponding to the amounts above for the Debtor and his spouse separately were calculated and reflected on hypothetical married-filing-separately tax returns, prepared by the Debtor's attorney, who is also a certified public accountant, and submitted as exhibits to the Debtor's response to the Trustee's motion for turnover. (See id. , Exs. C-1, C-2, D-1 & D-2.) According to those returns, the Debtor's wages were $212,894; he also had income of $36,317 from pension and Social Security payments received in 2016. (Id. , Exs. C-1 & C-2.) After adjustments, the Debtor's AGI was $234,152. (Id. ) The Debtor's spouse's wages were $10,480; she also had income of $54,064 from pension payments and ordinary dividends. (Id. , Exs. D-1 & D-2.) After adjustments, her AGI was $49,484.⁴ (Id. )

According to their jointly filed federal tax return, the Debtor and his spouse claimed one tax credit, a residential energy credit, of $300. (Id. , Ex. B-1.) That credit was apportioned equally between the spouses, with each claiming $150. (Id. , Exs. C-1 & D-1.)

Through withholding and estimated payments, the Debtor paid a total of $56,045 in taxes for 2016 $47,922 in federal taxes and $8,123 in state taxes.⁵ (Id. , Exs. C-1 & C-2.)

The Debtor's spouse paid a total of $7,375 in taxes through withholding and estimated payments $7,049 in federal taxes and $326 in state taxes.⁶ (Id. , Exs. D-1 & D-2.)

Based on the Agreement, and an allocation analysis prepared by the Debtor's attorney, the Debtor voluntarily tendered $1,219.49 to the Trustee on or around January 10, 2018. (See id. , Ex. A; see also Docket No. 90 ¶ 10.) According to the Debtor, that amount represents the bankruptcy estate's interest in the 2016 refunds. (Id. )

Disagreeing with the Debtor's analysis, the Trustee filed the instant motion for turnover on February 8, 2018. The Trustee argues that the Debtor's calculations are based on the Agreement, which she neither authorized nor approved. The Trustee further contends that the case law supports the equal division of the joint refunds between the Debtor and his non-debtor spouse. Thus, the Trustee demands turnover of an additional $2,280.41, for a total of $3,499.90.⁷ (Docket No. 90 ¶ 11.)

On February 14, 2018, the Debtor filed his response to the Trustee's turnover motion, urging the Court to apply and adopt the methodology used by his counsel, and set forth in the Agreement, in allocating the refunds. That "hybrid" methodology divides the tax refunds equally between the Debtor and his spouse, but only to allocate the portion of the refunds equal to the dollar amount of the tax benefit derived from the spouses' decision to file jointly. (Docket No. 90, Ex. A; Docket No. 93 at 2.) The rest of the refund is then allocated based on the balance owed or the refund due as computed on pro forma married-filing-separately returns. (Id. )

At the Court's request, the Debtor filed a supplemental response on February 27, 2018, both to provide some general background about the bankruptcy case and to explain the circumstances of the filing of the elaborate response to the turnover motion.⁸ (Docket No. 98.) Opting to stand on her motion, the Trustee declined the Court's subsequent invitation to file a reply, and the Court then took the matter under advisement. Having reviewed all of the relevant documents, exhibits, and arguments, as well as the applicable case law, the Court is now ready to rule.

DISCUSSION

The sole issue in this matter is the proper allocation of the income tax refunds generated by the filing of joint returns by the Debtor and his non-debtor spouse. The Seventh Circuit Court of Appeals has not addressed how to divide such refunds outside the context of a marriage dissolution proceeding, and courts, both in the circuit and across the nation, are greatly divided on the question of the portion of tax refunds to which a debtor's estate is entitled when there is a joint return with a non-debtor spouse. Before examining the various approaches that courts have used to resolve the issue, as well as the hybrid method advanced by the Debtor, the Court first considers the validity and applicability of the Agreement.

1. The Agreement

In response to the Trustee's contention that she neither knew of the Agreement nor authorized its execution, the Debtor posits two arguments. First, the Debtor maintains that the Trustee may not make the determination as to whether he and his non-debtor spouse file joint tax returns or elect to...