In re James W . NICHOLS and Beverly Ann Nichols, Debtors. David A. Birdsell, Trustee, Plaintiff, v. James W. Nichols and Beverly Ann Nichols, Defendants., United States Bankruptcy Court, D. Arizona., 309 B.R. 41, Bankruptcy No. 2-02-01744-PHX-RJH. Adversary No. 03-00722., May 4, 2004

In re James W . NICHOLS and Beverly Ann Nichols, Debtors. David A. Birdsell, Trustee, Plaintiff, v. James W. Nichols and Beverly Ann Nichols, Defendants.

United States Bankruptcy Court, D. Arizona.

309 B.R. 41

Bankruptcy No. 2-02-01744-PHX-RJH. Adversary No. 03-00722.

May 4, 2004.

Terry A. Dake, Esq., Phoenix, AZ, for Plaintiff-Trustee.

Michael J. Fatta, Esq., Glendale, AZ, for Debtors/Defendants.

OPINION

RANDOLPH J. HAINES, Bankruptcy Judge.

The issue here is whether a debtor's prepetition application of his right to tax refund to postpetition tax obligations con╜stitutes an asset that must be turned over to the trustee pursuant to Bankruptcy Code ╖ 542, ¹ even though on the petition date the debtor could not have recovered such asset from the IRS, and it was ulti╜mately used to satisfy postpetition tax obli╜gations. The Court concludes that it was such an asset on the petition date, even though not immediately realizable, and that the Debtor must therefore deliver to the Trustee the value of such property pursuant to ╖ 542(a).

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^1. ═ Unless otherwise indicated, all chapter and statutory references are to the Bankruptcy Code, 11 U.S.C.╖╖ 101-1330.

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Background Facts

On January 20, 2002, the Debtors filed their 2001 federal and state income tax returns. The federal return reflected the Debtors had a right to a refund of $2,231.57, and the state return showed a right to refund of $376. Instead of elect╜ing to receive such refunds, however, the Debtors elected to apply them to future tax liability. The Debtors filed the pres╜ent chapter 7 case shortly thereafter, on February 5, 2002.

When the Debtors filed their 2002 tax returns on February 4, 2003, virtually all of the overpayments from 2001 were uti╜lized to satisfy their tax obligations, so that the Debtors received virtually no refund for the 2002 tax year.

The Trustee filed an adversary com╜plaint against the Debtors seeking to re╜cover the amount of the 2001 tax overpay╜ments. The First Amended Complaint asserted essentially two theories in support of the relief requested. The com╜plaint asserted that the Debtors' interest in the tax overpayments was property of the estate as of the petition date that must be turned over to the Trustee pursu╜ant to ╖ 542. In addition, the complaint alleged that the transfer to the state and federal governments of the right to a tax refund was made for no consideration while the Debtors were insolvent, or alter╜natively that the Debtors made the trans╜fer with actual intent to hinder, delay and defraud their creditors, rendering it avoid╜able pursuant to Bankruptcy Code ╖ 548.

The Trustee moved for summary judg╜ment on his ╖ 542 theory. Debtors re╜sponded and cross moved for summary judgment in their favor. The Court took the matter under advisement at the con╜clusion of oral argument.

Analysis

The Debtors' principal point in response to the Trustee's complaint and motion for partial summary judgment is that once the election was made to apply the 2001 over╜payment to future tax liabilities, the elec╜tion was irrevocable. The Debtors cite compelling statutory and case law authori╜ties for this proposition, ² and the Trustee does not attempt to refute it.

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^2. ═ 26 U.S.C. ╖ 6513(d) provides that once an election has been made to apply an overpay╜ment of income tax as a credit against esti╜mated tax for the succeeding taxable year, "no claim for credit or refund of such over╜payment shall be allowed for the taxable year in which the overpayment arises." Georges v. United States, 916 F.2d 1520 (11th Cir.1990) ("the plain meaning of the relevant statute supports the District Court's holding that this election is irrevocable"); Starr v. Comm'r, 267 F.2d 148 (7th Cir.1959).

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The Court agrees that the election once made is irrevocable. This means that on the date this petition was filed, 16 days after the Debtors made the election, nei╜ther the Debtors nor the Trustee could require the Internal Revenue Service ("IRS") to issue a tax refund to the Debt╜ors simply by revoking the election.

From this undisputed proposition, how╜ever, the Debtors argue that because no tax refund could have been obtained on the petition date, there was then no asset that was property of the estate under ╖ 541. Debtors cite a district court opinion and a bankruptcy court opinion in support of this conclusion. United States v. Pritchard (In re Block), 141 B.R. 609, 611 (N.D.Tex. 1992) ("Once they made the election, they no longer had an overpayment for which they could file a claim for refund; the overpayment became an advance payment of the Blocks' 1989 taxes . . . . Once the overpayment was properly transferred to the IRS pre-petition, it could not become property of the estate, and was not recov╜erable under Section 542 of the Bankrupt╜cy Code."); Grant v. United States (In re Simmons), 124 B.R. 606, 607-08 (Bankr. M.D.Fla.1991) ("Once debtor made this election, as a matter of law, he no longer had an overpayment for which he could file a claim for refund. Consequently, the debtor's prepetition estimated tax payment cannot be considered a legal or equitable interest of the debtor in property as of the commencement of the case, and such pay╜ment is not subject to turnover [by the IRS].").

Because neither the Texas nor the Flori╜da decision is binding precedent for this Court, the Court will begin its analysis with the binding precedent that does exist, the Ninth Circuit's decision in United States v. Sims (In re Feiler), 218 F.3d 948 (9th Cir.2000). Feiler was not a ╖ 542 turnover action but rather a ╖ 548 fraudu╜lent transfer action asserted against the IRS with respect to a debtor's election to treat net operating losses ("NOLs") as car╜ry forwards rather than a carryback. The Ninth Circuit held that the trustee's avoid╜ing powers override the otherwise irrevo╜cable nature of that election. Id . at 956-57.

Because it was an avoidance action against the IRS, Feiler does not determine the significance, for ╖ 542 purposes, of the irrevocability of the debtor's election. This is because the Feiler result could easily be reached notwithstanding the irre╜vocability of the election under applicable nonbankruptcy law. Indeed, most fraudu╜lent transfers are irrevocable by the debt╜or who made them because they were transfers that were fully enforceable against the transferor under state law. That is precisely why fraudulent transfer law is necessary for creditors to be able to recover such transfers when made by an insolvent debtor without receipt of reason╜ably equivalent value in exchange, or made with fraudulent intent to hinder, delay or defraud creditors.

But although the Trustee here pled a ╖ 548 cause of action, his summary judg╜ment motion was brought on the ╖ 542 theory alone. Therefore the question is whether the Feiler holding contains any╜thing of significance to the ╖ 542 theory. It does, but it does not assist the Trustee. The Ninth Circuit noted that "Pre-election, the right to carry back the NOLs repre╜sented simply the right to a tax refund; as in Segal, the refund itself was the property interest." Feiler, 218 F.3d at 956, citing Segal v. Rochelle, 382 U.S. 375, 86 S.Ct. 511, 15 L.Ed.2d 428 (1966). Necessarily, to uphold a fraudulent transfer theory the court had to find that the asset that the debtor transferred was a property inter╜est. In the present case, however, this only means that when the Debtors made their election on January 20, they trans╜ferred a property interest. It does not necessarily mean that the Debtors still had any property interest as of the date of the petition.

The Ninth Circuit addressed that ques╜tion in its next sentence: "After the elec╜tion, whether the Feilers retained a property interest in the NOLs that were carried forward is irrelevant, because the trustee need not have a property interest in what the debtor receives in return for a fraudulent transfer in order to avoid the transfer." Id . (emphasis in original). This is certainly true because in the most blatant fraudulent transfers, where the debtor transfers a property interest to a relative for no consideration, the debtor retains no property interest what╜soever, but this fact establishes the fraudulent transfer rather than refuting it. But for the Trustee's ╖ 542 theory here, Feiler does not establish that the Debtors had any property interest with respect to the tax overpayment as of the petition date.

But just as Feiler does not determine what asset the debtor received in exchange for the fraudulent transfer, ³ neither do Block and Simmons determine that the debtor received nothing of value simply because the transfer was irrevocable. The proper issue here is not whether the Debt╜ors or the Trustee could recover the tax refund that was relinquished prepetition, but whether the Debtors received anything of value for such relinquishment, and con╜tinued to hold such value as of the petition date.

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^3. ═ In Feiler, the government conceded that the future tax benefits obtained by carrying the NOLs forward were less than and not reason╜ably equivalent to the value of the tax refund that was relinquished. 218 F.3d at 951. The opinion does not reveal why the government made this concession or how the future tax benefits were valued for this purpose. Foot╜note 4 of the opinion reflects why that future value may not be reasonably equivalent for the estate, but does not explicitly hold that value to the estate is the proper measure. Id . Ordinarily, an individual debtor would re╜ceive equivalent value in the future tax bene╜fits, present value considerations aside. Sim╜mons , 124 B.R. at 608. This issue does not arise when the future tax benefits flow to someone other than the debtor, as in Parker v. Saunders (In re Bakersfield Westar, Inc.), 226 B.R. 227 (9th Cir. BAP 1998) (prepetition revocation of corporate debtor's sub S elec╜tion held avoidable). The seminal case on this point, Gibson v. United States (In re Rus╜sell), 927 F.2d 413, 419 (8th Cir.1991), was remanded for a determination of whether the debtor's election was made with intent to hinder, delay or defraud creditors, and did not address the reasonably equivalent value issue.

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In fact, the Debtors did receive something of value in this case by electing to apply the overpayment to future tax liabilities: the Debtors received a credit that would either reduce future tax liabili╜ties or, if there were no such tax liabilities in the succeeding tax year, result in a refund. That credit, although not immedi╜ately realizable by the Debtors on the petition date, was an asset that would ulti╜mately realize for the Debtors a dollar-for-dollar value at the conclusion of the suc╜ceeding tax year, except only for the de minimis time value of money.

Nothing in ╖ 541 requires that the debtor's interest be immediately capa╜ble of being liquidated into cash in order to constitute property of the estate. To the contrary, ╖ 541(c)(1) provides that such debtor's interests become property of the estate even though they could not be liqui╜dated and transferred by the debtor under applicable nonbankruptcy law. Moreover, ╖ 542(a) is not limited to property that the debtor can transfer in kind to the trustee, because it alternatively requires that the "value of such property" be delivered to the trustee. As the Supreme Court held in Segal, an interest is not outside of prop╜erty of the estate simply "because it is novel or contingent or because enjoyment must be postponed." 382 U.S. at 379, 86 S.Ct. 511. Feiler makes clear that Segal's holding to this effect is still good law under the Code and in the Ninth Circuit. Feiler, 218 F.3d at 955. Consequently the tax credit that the Debtors had as of the peti╜tion date was property of the estate, and the Debtors must turn over to the Trustee its value.

This analysis is consistent with that of the Texas Bankruptcy Court in Wright v. IRS (In re Canon), 130 B.R. 748 (Bankr. N.D.Tex.1991), which concluded that in es╜sence the application of a tax overpayment to a subsequent year's tax liability "was virtually a savings account" for the debtor. Id. at 751-52. Actually, a better analogy would be to a certificate of deposit that the debtor could not cash on the petition date but that would be realizable subsequently, or to an annuity. In either case, the cred╜it, or the account, was an asset of the estate having ascertainable value on the petition date, though realizable subse╜quently, and under ╖ 542 the debtor must pay the trustee the value of such asset.

This Court disagrees with the Canon court's effort to distinguish Simmons on the basis that in Simmons the overpay╜ment was necessary to satisfy the subse╜quent year's tax liability, whereas in Can╜on it was refunded to the debtor. That is a distinction without a difference. In ei╜ther case, the credit that the debtor estab╜lished with the IRS was an asset that was ultimately realizable by the debtor either in the form of a refund or in the form of payment of tax liability in the subsequent year. The Canon court should have sim╜ply recognized that the Simmons court failed to consider that analysis rather than attempting to distinguish the Simmons case on the facts.

Canon may be regarded as having been overruled by Block, a decision one year later by the District Court also located in the Northern District of Texas. For that reason, some courts have declined to follow Canon. Morton v. United States (In re Metcalf), 2001 Bankr.LEXIS 1231, *5, 2001 WL 1203344, *2 (Bankr.N.D.Tex. 2001). In fact, however, Block failed to note the significant difference between a trustee's seeking recovery from the IRS and seeking a recovery from the debtor.

Block relied on Simmons, in which re╜covery was sought solely from the IRS, not from the debtor. See Simmons, 124 B.R. at 606. Because the election to apply a refund to subsequent year's taxes is irre╜vocable, and because it is regarded as a prepayment of future tax liability, the Simmons court may have been entirely correct in concluding that the trustee may not recover from the IRS on a ╖ 542 theo╜ry. That is an issue w e need not decide here, where the IRS is not a defendant.

In Block, however, the trustee's ╖ 542 complaint was asserted against both the IRS and the debtor. Relying on Sim╜mons , the Block court reasoned that "Once the overpayment was properly transferred to the IRS pre-petition, it could not be╜come property of the estate, and was not recoverable under Section 542 of the Bank╜ruptcy Code." Block, 141 B.R. at 611. With little additional analysis, the Block court concluded that because the "tax re╜fund was not property of the estate under Section 541 when the bankruptcy petition was filed, the trustee is not entitled to those funds." Id . In reversing the bank╜ruptcy court's judgment holding both the debtor and the IRS jointly and severally liable for that tax refund, the court failed to distinguish the trustee's rights against the debtor as compared to the trustee's rights against the IRS.

As noted above, the Simmons court may have been correct that the IRS can╜not be compelled to turnover an advance payment of future taxes, on a ╖ 542 theo╜ry. But the debtor still had a credit with the IRS for which the debtor would ulti╜mately obtain a dollar-for-dollar benefit, ignoring the nominal present value dis╜count. Segal necessarily implies that credit was property of the estate on the date of the petition, and ╖ 542(a) unequiv╜ocally requires the debtor to deliver to the trustee "the value of such property," even if the property itself is not transferable. This important distinction means that Metcalf may be correct in following Block when the only defendant was the IRS, but that such reliance on Block is misplaced when the defendant is the debtor, such as in Traina v. Orrill (In re Orrill) , 226 B.R. 563 (Bankr.E.D.La.1997), and as in this case.

For the foregoing reasons, the Court grants the Trustee's motion for summary judgment. The Debtors are liable to the Trustee for the value of the credits that the Debtors had established with the IRS and the State of Arizona as of the petition date resulting from the Debtors' prepeti╜tion election to apply their right to tax refunds to their future tax liabilities. The Trustee is requested to lodge an appropri╜ate form of judgment.

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