Alabama Bankruptcy Lawyer Blog

As a Chapter 7 Trustee, I consistently encounter questions involving the allocation of tax refunds between a spouse who filed Chapter 7, and one who didn't, where a joint return is filed. My interpretation of the law is pretty simple: the source of the refund will be excess withholdings. The refund should therefore be pro-rated based upon the percentage of withholdings attributable to each spouse. If a spouse does not pay anything in, he or she is not entitled to the refund.

So what does this say to the spouse who does not work outside the home, but nevertheless provides a valuable contribution? Not much, I'm afraid, except that neither the law nor the life guarantees a result that is altogether fair to every one all the time

The basis of my position is Gordon v. United States, 757 F.2d 1157, 1160 (11th Cir. 1985). Gordon is, admittedly, a tax case. The court reasoned that the question of "who owns what" part of a tax refund depends upon who paid in what withholdings. "Where spouses claim a refund under a joint return, the refund is divided between the spouses, with each receiving a percentage of the refund equivalent to his or her proportion of the withheld tax payments. See, e.g., Rosen v. United States, 397 F. Supp. 342 (E.D.Pa.1975); United States v. Mooney, 400 F. Supp. 98 (N.D.Tex.1975)."

The issue has also been addressed in a bankruptcy context in the Middle District of Florida, where the court held:

"The filing of a joint tax return does not affect the underlying property interests of the parties. U.S. v. Elam, 112 F.3d 1036, 1038 (9th Cir. 1997). Spouses filing a joint return have separate interests in any overpayment, the interest of each depending upon his or her income, i.e., an overpayment is apportionable to a spouse to the extent that he or she contributed to the overpaid tax." Rosen v. United States, 397 F. Supp. 342, 343 (E.D. Pa. 1975). See also Gordon v. United States, 757 F.2d 1157, 1160 (11th Cir. 1985) ("Where spouses claim a refund under a joint return, the refund is divided between the spouses, with each receiving a percentage of the refund equivalent to his or her proportion of the withheld tax payments."); Gens v. United States, 230 Ct. Cl. 42, 673 F.2d 366, 368 (Ct. Cl. 1982), cert. denied, 459 U.S. 906, 74 L. Ed. 2d 167, 103 S. Ct. 209 (1982), and reh'g denied, 459 U.S. 1081, 74 L. Ed. 2d 642, 103 S. Ct. 503 (1981) (holding that Wife was not entitled to any part of the overpayment for failure of proof that she paid any part of it). Claimant's interest in the refund check therefore equals the amount which she contributed to the 1991 income taxes."
In re Jones, 219 B.R. 631, 635 (Bankr. M.D.Fla. 1998).

So back to my simple formula: ownership of tax refunds directly correlates to the amount contributed to withholdings by each taxpayer. This position does strike me as wholly consistent with the rationale of the court in Gordon.

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Not according to the Fifth Circuit, applying Louisiana law to determine the meaning of "property" or "interest in property." Here's the short version of the facts in In re Laughlin, 602 F.3d 417 (5th Cir. 2010).

On June 4, 2007, debtor completed a procedurally proper pre-petition disclaimer of any interest in his father's estate. On July 21, 2007, he filed Chapter 7. The trustee filed an AP seeking denial of discharge on the grounds debtor's renunciation was a transfer of property made within one year of bankruptcy with the intent to delay, hinder or defraud creditors. The Bankruptcy Court agreed, applying the rationale of the U. S. Supreme Court in Drye v. United States, 528 U.S.49, 120 S.Ct. 474, 145 L.Ed. 2d 466 (1999)(holding that a disclaimed interest was "property" subject to IRS liens). The District Court affirmed. The 5th Circuit, however, saw it differently, finding Drye inapplicable.

The issue, in a nutshell, is whether the disclaimer of an inheritable interest operates as a "transfer" of "property" or a "property interest." If there was no transfer of property or a property interest, that is the end of the discussion. Now, the question of whether a transfer has occurred is one of federal law, since the applicable statute defines "transfer." That part is easy enough. The difficulty arises, however, in defining "property" or "property interest" since neither is defined in the Bankruptcy Code. It thus becomes necessary to look to state law.

Most states appear to employ a "relation back" fiction to hold that if you disclaim an inheritable interest, that disclaimer "relates back" so that the beneficiary never receives or possesses the interest. There is accordingly nothing to transfer, and there can be no fraudulent transfer for purposes of Section 727. Alabama's statute (Ala. Code 43-8-294) reads similarly to those from states cited in McLaughlin, in expressly providing for relation back. I would suspect the Eleventh Circuit would see it similarly if presented with the question.

A few months ago, I discussed the decision of a Delaware bankruptcy court in which a contractually created triangular setoff arrangement was found to be violative of Section 553's mutuality requirement. The case was In re Semcrude, L.P., Case No. 08-11525 (BLS), 2009 WL 68873 (Bankr. D. Del. January 9, 2009). In a relatively short opinion released April 30, 2010, the District Court affirmed, adopting without revision the Bankruptcy Court's rationale and conclusions. The citation to the District Court's decision is In re Semcrude, L.P., --- B.R. ---, 2010 WL 1737103 (D. Del. April 30, 2010).

For the typical practitioner, myself included, triangular setoff will rarely, if ever, be an issue. I just happen to have a case in which the issue is pivotal, and thought the affirming opinion by the District Court was well worth noting. We'll have to wait and see if it is appealed further.