The 9th Circuit Court of Appeals upheld a lower court’s ruling compelling Chapter 7 debtors to turn over tax credits to the Trustee. The credits arose from a refund for overpayment of 2001 federal and state (Arizona) income taxes. Rather than receive a refund directly, the debtors opted to have those funds applied to future tax liability. Sixteen days after making that election, the debtors filed for bankruptcy protection.
In early 2003, the debtors signed their 2002 federal and state income tax returns and applied the overpayments from 2001 to their 2002 tax liabilities. The Trustee contended that those credits from 2001 were the property of the Chapter 7 estate. The debtors argued that since they made the election, they had effectively given up their entitlement to a refund. They also contended that pursuant to Sections 6402(b) and 6513(d) of the Internal Revenue Code, the elections were irrevocable, and thus there was no interest left for the bankruptcy estate.
The 9th Circuit disagreed. Bankruptcy Code Section 541 defines property as “all legal or equitable interests of the debtor in property as of the commencement of the case.”
Interpreting the term “property” broadly, …’because the right to receive a tax refund constitutes an interest in property…the election to….relinquish the right to a refund necessarily implicates a property interest.’
The Court found that as a result of the election, the debtors were left with a tax credit that reduced their tax liability in the next year. If they had not made such an election, the tax refunds would have been property of the bankruptcy estate when they filed their petition a mere 16 days later. For those reasons, the court held that the ‘credit’ towards future taxes was estate property at the time the debtors filed bankruptcy.
The case is Nichols, et al. v. Birdsell, 9th Circuit No. 05-15554
