U.S. Bankruptcy Court determines tax refund to be a joint asset

Daily Record (Rochester, NY), Mar 8, 2004 by Nora A. Jones

How should a joint income tax refund be distributed where one spouse has filed for bankruptcy and the other has not? Is the bankruptcy estate entitled to one half of the refund or is the refund proportionate to the income earned by each spouse?

Judge Carl L. Bucki wrestled with these questions in In re Clyde B. Barrow before the U.S. Bankruptcy Court for the Western District of New York. Citing case law that has varied in its approach, Bankruptcy Judge Bucki concluded that the refund was a joint asset that belonged equally to the non-debtor spouse and the debtor's bankruptcy estate.

Background

Clyde Barrow filed an individual petition for Chapter 7 relief on March 22, 2001. Among his outstanding debts was a $3,821 obligation to the Internal Revenue Service for incomes taxes due for 1995, 1996 and 1997. For each of these years, the basis of liability was a non- joint tax return.

For calendar year 2000, Barrow and his wife filed a joint federal income tax return. The return indicates a refund entitlement of $9,128.

Bound by the automatic stay of 11 USC Section 362, the IRS is holding the 2000 tax refund until further direction of the court. If Clyde had not filed for bankruptcy protection, the IRS would have offset the refund against Clyde's outstanding tax liabilities. However, in this case, the refund represents an interest of an innocent spouse, June Barrow.

It was June's separate earnings that accounted for most of the couple's income in 2000, and thus it was her income tax withholding that provided the bulk of the refund entitlement.

Based on this scenario, June Barrow filed a motion to authorize the IRS to process her application for treatment as an innocent spouse and to release the tax refund to her - allocated as $8,836 to her and only $292 to the IRS to set of his back taxes.

Trustee's View

The Chapter 7 trustee objects to this allocation, relying on the recent decision in In re Hejmowski, 296 BR 645 (Bankr. WDNY 2003), for the proposition that the movant has gifted an interest in the refund to the debtor, so that the entire refund is now subject to offset by the IRS for payment of the debtor's taxes.

Granting such an offset would decrease the total claims against the bankruptcy estate, and will thereby allow a greater distribution to other unsecured creditors.

Court's View

A trustee may exercise control over an income tax refund, but only to the extent that it constitutes an asset of the estate under 11 USC Section 541, wrote Judge Bucki. Accordingly, a resolution of the present dispute requires a determination of the ownership of the joint tax refund. As to this issue, bankruptcy courts have adopted widely divergent positions.

Citing In re Kelinfeldt, 287 BR 291 (BAP 10th Cir. 2002), the court noted that most courts would allocate a joint tax refund between spouses in proportion to their tax withholdings.

However, other courts, following the reasoning in In re Levine, 50 BR 587 (Bankr. SD Fla 1985), would divide the refund in proportion to the income that each spouse generated.

Still other courts have ruled that each spouse owns the refund equally, so that the refund will be allocated evenly between them, added Judge Bucki, citing In re Aldrich, 250 BR 907 (Bankr. WD Tenn 2000) for this approach.

Recently, the Western District of New York had occasion to rule on this issue in In re Hejmowski, 296 BR 645, when Judge Michael J. Kaplan concluded that for Section 541 and Section 522 purposes only, the 'refund' is owned jointly, and in equal shares.

In my view, this result is generally correct, but any presumption of joint ownership is rebuttable, continued Judge Bucki, noting that the Internal Revenue Code's treatment of a tax overpayment does not necessarily determine its characterization for other purposes in the context of bankruptcy.

The filing of joint tax returns does not alter property rights between husband and wife, wrote the Court of Appeals in Callaway v. C.I.R., 231 F3d 106, 117 (2d Cir. 2000). In particular, the filing of a joint return does not have the effect of converting the income of one spouse into the income of another.

Based on this, we must look not to the tax code, but to otherwise applicable law, wrote Judge Bucki. I disagree with those courts that allocate refunds in proportion either to income or amount of withholdings. *** For many taxpayers, a significant portion of the refund is attributable not to these factors, but to any of a number of credits, such as the child tax credit or credits for education or for child and dependent care expenses.

Continuing his analysis, Judge Bucki stated, It is simply inaccurate to say that the greater refund is attributable only to the income and withholdings of the employed spouse. *** [A]s a general rule, the refund on a joint tax return is a joint asset that spouses own 'in equal shares.' *** [J]oint ownership appropriately parallels the potential of joint liability for any unpaid tax deficiency. Bass v. Hall, 79 BR 653 (W.D. Va. 1987). This court will, therefore, presume equal ownership of any joint tax refund.