- Outside of bankruptcy, the IRS has the right to set off tax
overpayments against tax debts. I.R.C. § 6402. B.C. §553 provides
that the Bankruptcy Code does not affect a creditor's right to offset
a mutual debt owing by such creditor to the debtor that arose before
the commencement of the case, against the claim of such creditor
against the debtor that also arose before the petition date. This
means that the Bankruptcy Code permits the IRS to offset prepetition
tax overpayments against prepetition tax debts.
- Prepetition tax refunds are property of the estate under Section
541(a). The IRS may be required to turn over the refund to the trustee.
- The creditor's right of setoff is preserved in the bankruptcy
by B.C. § 553, but exercise of the right is subject to the automatic
stay. B.C. § 362(a)(7). The Service cannot exercise its setoff rights
until the automatic stay is lifted either by operation of law or
by motion. Temporary retention of a refund to preserve setoff rights
does not violate the automatic stay. Citizens Bank v. Strumpf
, 515 U.S. 16 (1995).
- In many jurisdictions, bankruptcy courts have issued standing
court orders that modify the automatic stay to permit setoff in
some or all circumstances and dispense with the requirement to turn
over prepetition refunds to the bankruptcy trustee.
- Generally, in Chapter 7 and 11 cases, post-petition overpayments
can be offset directly to post-petition tax periods. In Chapter
13 cases, however, a post-petition refund may be property of the
estate and thus remain protected by the automatic stay.
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