In re Searles

• Decision Date: 23 January 1978
• Docket Number: Civ. No. H-77-518.
• Citation: 445 F. Supp. 749
• Court: U.S. District Court — District of Connecticut
• Parties: In re Cynthia Ann SEARLES, Bankrupt. Martin W. HOFFMAN, Trustee, Plaintiff, Appellee, v. Cynthia Ann SEARLES, Bankrupt, Defendant, Appellant.

445 F. Supp. 749

In re Cynthia Ann SEARLES, Bankrupt.

Martin W. HOFFMAN, Trustee, Plaintiff, Appellee, v. Cynthia Ann SEARLES, Bankrupt, Defendant, Appellant.

Civ. No. H-77-518.

United States District Court, D. Connecticut.

January 23, 1978.

Martin W. Hoffman, Hartford, Conn., for plaintiff, appellee.

Pamela Hershinson, Hugh Barber, Hartford, Conn., for defendant, appellant.

MEMORANDUM OF DECISION

BLUMENFELD, District Judge.

This case presents a question of bankruptcy law to which two Bankruptcy Judges in this district have given squarely opposing answers. The question presented is whether that portion of an income tax refund attributable to the earned income credit of the bankrupt constitutes "property" within the meaning of § 70a of the Bankruptcy Act. Judge Trevethan has held that the credit does not constitute property within the meaning of the Act. In Re Treffery, No. B-76-30 (D.Conn., filed Sept. 27, 1976). In this case, which is before me on appeal, Judge Seidman ruled that the earned income credit received by the bankrupt is property which passes to the Trustee under § 70a.

Facts

Cynthia Ann Searles, the bankrupt-appellant, filed her petition on December 23, 1976. In 1977, she received a tax refund for the tax year 1976 in the amount of $290.04. The bankrupt earned $2,288.05 in 1976, and the Federal Income Tax that was withheld, based upon those earnings, was $61.24. The refund of $290.04 was broken down as follows: $61.24 from withholding and $228.80 from the earned income tax credit. The bankrupt has turned over to the Trustee $61.24, but has refused to turn over the $228.80 attributable to the earned income tax credit, claiming that portion of the tax refund is exempt from the claim of the Trustee. The Trustee formally raised the issue by filing a complaint seeking recovery of the earned income portion of the refund amounting to $228.80, and the case was submitted for resolution on briefs without oral argument. From Judge Seidman's order directing the bankrupt to turn that amount over to the Trustee, the bankrupt appeals.

I.

What constitutes "property" of a debtor that must be distributed to his creditors in bankruptcy is determined under § 70a(5) of the Bankruptcy Act, 11 U.S.C. § 110(a)(5):

"(a) The trustee of the estate of a bankrupt and his successor or successors, if any, upon his or their appointment and qualification, 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 title, 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 . . .."

It is neither necessary nor desirable to rely upon generalities or rigidly adhere to common law concepts in determining whether the earned income credit is "property" within § 70a(5). At times the jargon of a subject can be willingly accepted almost irrespective of the theory behind it but, as pointed out in Segal v. Rochelle, 382 U.S. 375, 379, 86 S.Ct. 511, 515, 15 L.Ed.2d 428 (1966), what constitutes "property" in the estate of a bankrupt must be limited by the purpose of the Bankruptcy Act:

"Admittedly, in interpreting this section `it is impossible to give any categorical definition to the word "property," . ..' Fisher v. Cushman, 103 F. 860, 864. Whether an item is classed as `property' by the Fifth Amendment's Just-Compensation Clause or for purposes of a state taxing statute cannot decide hard cases under the Bankruptcy Act, whose own purposes must ultimately govern.

". . . However, . . . one purpose which is highly prominent and is relevant in this case is to leave the bankrupt free after the date of his petition to accumulate new wealth in the future." (emphasis added)

In view of the dual purposes of the Bankruptcy Act to pay creditors and to afford the bankrupt a fresh start, Kokoszka v. Belford, 417 U.S. 642, 646, 94 S.Ct. 2431, 41 L.Ed.2d 374 (1974), reh'g denied, 419 U.S. 886, 95 S.Ct. 160, 42 L.Ed.2d 131 (1974), an asset in the hands of the bankrupt can be taken by the Trustee to pay creditors under § 70a(5) if "it is sufficiently rooted in the pre-bankruptcy past and not sufficiently entangled with the bankrupt's ability to make an unencumbered fresh start . . ." Segal v. Rochelle, supra, 382 U.S. at 380, 86 S.Ct. at 515.

In Kokoszka v. Belford, supra, the Court held that an income tax refund "does not relate conceptually to future wages and it is not the equivalent of future wages for the purpose of giving the bankrupt a `fresh start,'" 417 U.S. at 647, 94 S.Ct. at 2434, and that it was "`sufficiently rooted in the prebankruptcy past' to be defined as `property' under § 70a(5)," id. at 648, 94 S.Ct. at 2435 (footnote omitted). Earlier, the "fresh start" doctrine enunciated in Segal, supra, 382 U.S. at 380, 86 S.Ct. 511, was applied in Lines v. Frederick, 400 U.S. 18, 91 S.Ct. 113, 27 L.Ed.2d 124 (1970), to support the Court's holding that accrued vacation pay for employees did not constitute "property" since the function of vacation pay was

"to support the basic requirements of life for them and their families during brief vacation periods or in the event of layoff. . . .

"The wage-earning bankrupt who must take a vacation without pay or forgo a vacation altogether cannot be said to have achieved the `new opportunity in life . . .' . . . which it was the purpose of the statute to provide." 400 U.S. at 20, 91 S.Ct. at 114 (citation omitted).

II.

This court must decide whether the policy of the Bankruptcy Act to afford bankrupts a "fresh start" and allow them to accumulate new wealth requires that the portion of appellant's tax refund check attributable to the earned income credit must be treated differently from the portion attributable to excess withholding tax. This can only be decided by examining Congress' purposes in establishing the earned income credit. The fact that the earned income credit operates through a tax return and is paid in the same check as excess withholding tax as a matter of administrative convenience does not necessarily mold the two payments into one kind of "property."

Appellant received an earned income credit through the operation of the Tax Reduction Act of 1975, Pub.L.No.94-12, § 204(a), 89 Stat. 26, 30-32, as amended by Tax Reform Act of 1976, Pub.L.No.94-455, § 401(c), 90 Stat. 1520, 1556-57 (codified at I.R.C. § 43). Under this provision, 10 percent of the first $4,000 of earned income is credited to the taxpayer, but the amount of the credit is reduced as adjusted gross income increases above $4,000, dropping to zero when adjusted gross income reaches $8,000. Only taxpayers with dependent children living in their households are eligible for the credit. I.R.C. § 43(c)(1)(A). It is thus designed to benefit only working low-income taxpayers with dependent children. The legislative history shows that Congress intended to aid "those who are most in need of the relief." S.Rep.No.94-36, 94th Cong., 1st Sess. 11 (1975), reprinted in 1975 U.S.Code Cong. & Admin.News 54, 64. The Senate Committee on Finance noted that the tax credit would "provide relief to families who currently pay little or no income tax. These people have been hurt the most by rising food and energy costs." Id.

The credit applies only to earned income, because one purpose for its enactment was to provide "an added bonus or incentive for low-income people to work." Id. The credit was also intended to stimulate the economy "because the low-income people were expected to spend a large fraction of their increased disposable incomes." Id. But the primary purpose was clearly to afford economic relief to low-income heads of households who work for a living.

These legislative purposes clearly distinguish the earned income credit from a refund of excess withholding taxes, which was held to constitute "property" under § 70a(5) in Kokoszka v. Belford, supra. The normal income tax refund is an amount actually deducted from the taxpayer's earnings in excess of the amount required by accurate computation of the rate applied to actual income. Thus it is money earned in the prior tax year (for a bankrupt, the pre-bankruptcy period), the receipt of which is delayed by excess withholding. Were it not for a miscalculation of tax liability, the money would have been available in the pre-bankruptcy period to pay the bankrupt's debts. See Kokoszka v. Belford, supra, 417 U.S. at 648, 94 S.Ct. 2431. The earned income credit is given effect through a refund, but it is not a refund of taxes previously paid. Most of the people who receive the credit have little or no tax liability; part or all of what they receive exceeds the amounts withheld from their earnings. The effect of the earned income credit legislation is to put money in the pockets of certain needy taxpayers after tax returns are filed, and not to reduce their tax burden during the tax year. The Senate Committee on Finance stated:

"Since the credit is refundable, eligible individuals with low incomes on which little or no income tax is due are to receive a cash payment equal to the amount of the credit reduced by any tax due. . . . It is hoped that through the simplicity of the 1040A form, plus efforts by the Internal Revenue Service to build public awareness of the availability of the credit, all eligible taxpayers will file for the credit available to them." S.Rep.No.94-36, supra, at 35, reprinted in 1975 U.S.Code Cong. & Admin.News 54, 85-86.

Like the vacation pay considered in Lines v. Frederick, supra, and unlike the refund of excess withholding of income taxes, the earned income credit is meant to supplement wages in a future period. See Kokoszka v. Belford, supr...