IRS Isn't Required To Turn Over An Overpayment Credited Against Next Year's Tax To Chap. 7 Trustee

Chief Counsel Advice 201103020

In Chief Counsel Advice (CCA), IRS has concluded that once a taxpayer's prepetition Code Sec. 6402(b) election to credit an overpayment to future tax liabilities has become irrevocable, IRS isn't required to turn the overpayment over to a Chapter 7 bankruptcy trustee. In so holding, IRS determined that the taxpayer had no right to a refund of the overpayment at the time that the bankruptcy case was commenced, so the overpayment wasn't a debt owed to the taxpayer subject to turnover under 11 USC 542.

Background on bankruptcy estate property. Under 11 USC 541, property of the bankruptcy estate generally includes all legal and equitable interests of the debtor in property as of the commencement of the case. If the debtor had the right to claim a tax refund, the right to claim a refund and to bring a refund suit, if necessary, becomes property of the estate. Any such refund claim would be a debt owed to the debtor and should be paid to a Chapter 7 trustee under 11 USC 542(b).

Background on overpayments. Instead of receiving a refund of an income tax overpayment, a taxpayer may elect under Code Sec. 6402(b) to apply all or part of the overpayment for a tax year towards the estimated tax for the immediately succeeding tax year. The election is generally made on the taxpayer's original or amended return for the year of the overpayment. If a Code Sec. 6402(b) election is made, Code Sec. 6513(d) places the overpayment beyond the reach of the taxpayer, stating that “no claim for refund of such overpayment shall be allowed for the taxable year in which the overpayment arises.”

Facts. Married taxpayers filed Form 1040 for tax year 2008 on Mar. 10, 2009, reporting a $2,000 overpayment. They requested a refund of $1,200 and elected to apply the remaining $800 to their tax liability for 2009. Sometime after making the election to credit their 2008 overpayment to their 2009 taxes and after the deadline for filing their 2008 tax return had passed, the taxpayers filed a voluntary petition for Chapter 7 bankruptcy. The bankruptcy trustee requested that the $800 be turned over to him pursuant to 11 USC 542.

Analysis. IRS concluded that, since a taxpayer has no right to demand the refund of an overpayment for which a Code Sec. 6402(b) election has been made, that overpayment is not a debt owing to the debtor subject to turnover under 11 USC 542. IRS noted that a Code Sec. 6402(b) election is generally treated by the courts as being irrevocable and binding against both the taxpayer and IRS.

IRS's decision was consistent with that of the Court of Appeals for the Tenth Circuit in Weinman v. Graves, (CA 10 6/29/2010) 106 AFTR 2d 2010-5050. In Graves, a Chapter 7 trustee sought an order compelling the debtor to turn over the value of an overpayment for which the debtor had made a prepetition election under Code Sec. 6402(b) to apply to the next year's estimated tax liability. The Court emphasized that a bankruptcy trustee succeeds only to the title and rights in property that the debtor had at the time that the bankruptcy petition was filed and held that, since the debtor didn't possess any right to the overpayment, the trustee similarly had no such right.

IRS acknowledged that the Graves decision was “at odds” with the Court of Appeals for the Ninth Circuit's decision in Nichols v. Birdsell, (CA 9 5/9/2007) 99 AFTR 2d 2007-2730, which also involved an overpayment for which a prepetition Code Sec. 6402(b) election had been made. In Nichols, the Ninth Circuit analogized the effect of the debtors' election to a credit that provided a dollar-for-dollar tax reduction in the following year and ordered the debtors to pay over the value of the credit to the trustee. However, IRS agreed with the Tenth Circuit's statement in the Graves decision that, since the Nichols court “neither discussed turnover nor analyzed the case in light of the language of 11 USC 542(a),” it was unclear “how the Ninth Circuit would apply the statutory requirements for turnover.” IRS further distinguished Nichols on the ground that it involved a turnover request against the debtor, not a 11 USC 542(b) turnover request against IRS.

References: For the estate's right to refund applied by debtor to prepayment of taxes before bankruptcy, see FTC 2d/FIN ¶T-5742.2. For an individual's election to apply an overpayment to next year's estimated tax, see FTC 2d/FIN ¶S-5250; TaxDesk ¶577,510; TG ¶70801. For the status in bankruptcy of rights to refunds, see FTC 2d/FIN ¶C-9811; United States Tax Reporter ¶13,984.03; TaxDesk ¶577,510; TG ¶70727.