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Part 5. Collecting Process

Chapter 9. Bankruptcy

Section 4. Common Bankruptcy Issues

5.9.4  Common Bankruptcy Issues

5.9.4.1  (05-13-2008)
Property of the Estate

  1. The Bankruptcy Estate. The filing of the bankruptcy petition creates the bankruptcy estate. The estate consists of all of the debtor’s interests in any property at the time the case is filed (11 USC § 541(a)(1)). It also encompasses the interest of the debtor and the non-debtor spouse in certain community property states. (See 11 USC § 541(a)(2) and IRM 5.9.3.5.1.1,Community Property;IRM 5.9.10.8.1, Property of the Estate After Confirmation; IRM 5.9.6.15,Bankruptcy Estate Income Taxes – IRC § 1398; and IRM 5.9.8.13,Internal Revenue Code § 1398 Issues .)

  2. After-Acquired Property. In a Chapter 12 or 13 bankruptcy, property acquired after the petition date but before the case is closed, dismissed, or converted to another chapter, including wages and community property, becomes property of the estate (11 USC §§ 1207 and 1306). In general, some property, especially wages or other income used to fund the plan, may continue to be property of the estate after confirmation. IRM 5.9.10.8.1 gives additional information about the post-confirmation estate in a Chapter 13 bankruptcy.

  3. BAPCPA Individual Chapter 11. As with Chapter 12 and 13 cases, property of the estate for individual Chapter 11 cases filed on or after October 17, 2005, includes wages and other property acquired postpetition but before the case is closed or converted (11 USC § 1115).

    Note:

    This change has significant tax implications. Interim guidance on how to address the tax consequences of these changes are found in Notice 2006-83, 2006-40 IRB 596.

  4. Counsel Guidance. Complex issues surround what constitutes the property of a bankruptcy estate. Counsel should be contacted for guidance when case-specific issues arise.

  5. Exempt, Excluded, and Abandoned Property. Property may be exempted or excluded from the estate or abandoned by the trustee. IRM 5.9.17.4provides a full discussion of these property issues as they affect possible postpetition collection.

5.9.4.2  (01-01-2006)
ASED/CSED

  1. Automatic Statute Computations. Master file computes appropriate statute extensions for assessment and collection in most instances when a TC 521 posts and reverses the bankruptcy freeze code.

    Note:

    The statutory period for assessment is not directly affected by bankruptcy for cases filed after October 22, 1994, the effective date of the Bankruptcy Reform Act (BRA), unless the Tax Court petition period is suspended by the automatic stay. (See IRM 5.9.4.2.1, BRA 94 and BAPCPA's Effects on Assessments.

    )

  2. Assessment Statute Expiration Date (ASED) Suspension Timeframes. For bankruptcy cases filed before the enactment of BRA 94, the running of the statutory period for assessment (ASED) is suspended during the period the assessment is prohibited (while the automatic stay is in effect) and for 60 days thereafter (IRC § 6503(h)(1)). To compute a new ASED, 60 days are added to the unexpired time (number of days) remaining on the original statute as of the petition date. Then that amount of time is added to the date of discharge or dismissal (or the date the stay was lifted) to establish the new ASED. (For ASEDs on Exam cases, Examination should be consulted.)

  3. Collection Statute Expiration Date (CSED) Suspension Timeframes. The running of the statutory period for collection (CSED) is suspended for the period collection is prohibited (e.g., while the automatic stay is in effect, and in the Chapter 11 context, post-confirmation during the period in which (1) the Service's claim is allowed, (2) the confirmed plan provides for full payment of the tax debt, and (3) the plan is not in substantial default) plus six months (IRC § 6503(h)(2)). Computation of a new CSED is similar to an ASED computation. Six months are added to the unexpired time (number of days) remaining on the original statute as of the petition date and that total is added to the discharge or dismissal date (or the date the stay was lifted) to establish the new CSED.

    Note:

    The IRS will never receive less than the original statute plus 60 days for an ASED extension, or the original statute plus six months for a CSED extension.

  4. CSED Recomputation – Manual Input of TC 550. For non master file (NMF) accounts, a manual input of TC 550 is necessary. The input of a TC 550 must be timely (for example, when the court grants a discharge or dismisses a case). The presence of an unreversed TC 520 in the module will not prevent TC 550 from posting. If a TC 550 is input to a module with an unreversed TC 520 with a bankruptcy closing code, automatic computation of the CSED when the TC 521 posts will not occur.

  5. CSED - Taxpayer Identification Number (TIN) Indicators. The CSED for a tax module is displayed on IDRS. This information is used by Collection employees to determine the time remaining on a collection statute (i.e., if collection actions may be taken on a balance due account).

    1. Individual Tax Return. If a debtor filed an income tax return in any status other than " married filing joint," the CSED is extended for the period the stay is in effect plus six months regardless of the debtor's marital status or if the bankruptcy was a individual or joint filing.

    2. Joint Return - Spouses Filed Joint Bankruptcy. If the tax module is for an IMF joint assessment and the husband and wife have filed a joint bankruptcy, the collection statute is extended against the husband and the wife.

    3. Joint Return - Both Spouses Filed Individual Bankruptcies. If the spouses filed a joint return, but filed individual bankruptcies, the CSED is extended individually for each debtor with each spouse's extension being dependent upon the duration of the stay in his or her own bankruptcy case. In this situation the MFT 30 module usually must be mirrored to two MFT 31 modules, taxpayers residing in community property states being possible exceptions.

    4. Joint Return - Only One Spouse in Bankruptcy. If only one spouse files bankruptcy, and the joint (prepetition) tax return was filed under the non-debtor spouse's Social Security Number (SSN), then Service personnel handling the account(s) must know to whose SSN the CSED extension and freeze code apply. CSED Indicator Codes make this identification possible. An Individual master file (IMF) CSED TIN indicator is input as part of the transaction data of the TC 520. MFT 31 mirroring is usually required when the bankruptcy is discharged or dismissed.

    5. CSED Indicator Codes. The TC 520, closing code, and CSED TIN indicator, can identify which taxpayer spouse is in bankruptcy and to whom the CSED extension applies. The CSED TIN indicator is input by the Insolvency Interface Program (IIP) during initial processing. The indicator codes can also be input manually (i.e., as part of the manual TC 550 extensions in bankruptcy). The applicable IMF CSED TIN indicator codes are:
      P — the CSED applies to the Primary TIN;
      S — the CSED applies to the Secondary TIN; and
      B — the CSED applies to Both TINs.

  6. CSED Protection - MFT 31 for Non-Debtor Spouse. To protect the collection statute, Insolvency must be aware of CSED problems that may develop on the non-debtor spouse account. (See IRM 5.9.3.5.1.1,Community Property, and IRM 5.9.17.6, Joint Account and Non-Debtor Spouse.) When considering collection from a non-debtor spouse, an MFT 31 mirroring may be appropriate if a CSED is imminent. IRM 5.9.17.22.3 provides procedures for the MFT 31 mirror process. Protection of the CSED on a non-debtor spouse is unnecessary if:

    1. plan payments are sufficient to satisfy the claim and pay the total outstanding liability to a level below the tolerance amount for an MFT 31 transfer;

    2. the case would, absent the bankruptcy, expire in the queue (where IDRS accounts are maintained in a hold file and assigned a lower priority status than current accounts; or

    3. the account has an unreversed currently-not-collectable (CNC) closure based on financial data (TC 530 cc24 through cc 32).

    Caution:

    In community property states Counsel advice should be sought before taking collection action against a non-debtor spouse.

  7. OI Potential. If, at the time a bankruptcy petition is filed, a case is assigned to an RO, an OI may be initiated to ensure continuity of case actions. OIs may be useful in Chapter 7 cases (for example, investigating exempt, excluded, and abandoned property and lien equities).

5.9.4.2.1  (03-01-2007)
BRA 94 and BAPCPA's Effect on Assessments

  1. BRA 94. The Bankruptcy Reform Act of 1994 (BRA 94) brought about significant changes affecting the IRS, including:

    1. Sovereign Immunity. BRA 94 waived the government's sovereign immunity against judgments in connection with enumerated provisions (preferences, violations of stay, etc.). However, sovereign immunity remains in effect on the awarding of punitive damages, and attorney fees are capped.

    2. Assessments Allowed. Before BRA 94, the Bankruptcy Code prohibited assessment of a tax liability unless the court granted relief from the automatic stay. After October 22, 1994, in most cases, the automatic stay for assessment of any tax, including original tax returns, adjustments, Trust Fund Recovery Penalty (TFRP), and agreed audit deficiencies no longer applied (11 USC § 362(b)(9)).

      Note:

      Deficiencies in which the statutory period for petitioning the tax court has expired prior to the bankruptcy petition can also be assessed even though the assessment may post to IDRS after the petition date.

  2. Impact on ASEDs. BRA 94 has had an impact on ASED computations.

    1. Most Taxes Can Now Be Assessed. For debtors who filed bankruptcy on or after October 22, 1994, the automatic stay does not prohibit the IRS from assessing any tax where the Service would not be required to issue the taxpayer a statutory notice of deficiency. These include 1) the taxpayer's self-assessments arising from filed returns; 2) agreed audit deficiencies; 3) Trust Fund Recovery Penalty (TFRP) assessments; and 4) audit deficiencies where the statutory period for petitioning the Tax Court has expired prior to the filing of bankruptcy.

    2. Unagreed Prepetition Audit Deficiencies. For debtors who filed bankruptcy on or after October 22, 1994, 11 USC § 362(a)(8) and IRC § 6213(f) stay the debtor from filing a Tax Court petition for the period of the automatic stay plus 60 days thereafter. Accordingly, for debtors with an outstanding notice of deficiency, the ASED is suspended as a result of the bankruptcy petition

  3. Computation of the ASED in Bankruptcy Situations. Due to IRC § 362(a)(8) and IRC § 6213(f), bankruptcy suspends the statute of limitations on assessment in cases where a statutory notice of deficiency has been issued and the stay prohibits the commencement or continuation of a Tax Court proceeding involving that tax liability. Rev. Rul. 2003-80, 2003-29 IRB 80 provides published guidance explaining the effects of bankruptcy on the limitations period for assessment.

  4. BAPCPA. For cases filed on or after October 17, 2005, BAPCPA limits the stay on Tax Court proceedings regarding an individual debtor’s tax liability only with respect to a taxable period ending before the order for relief (the stay applies to both prepetition and postpetition corporate liabilities so long as it is a liability the bankruptcy court may determine) (11 USC § 362(a)(8)). Therefore, the indirect ASED stay with respect to deficiency liabilities resulting from IRC § 6213(a) will no longer apply with respect to an individual debtor’s postpetition liabilities.

  5. Consent to Extend ASED. Under BRA 94 the Service may obtain a valid consent to extend the statute of limitations on assessment from entities in bankruptcy. A TC 560, input by Examination, indicates an extension of the ASED.

5.9.4.3  (05-13-2008)
Examination and Insolvency

  1. Insolvency Notification System. Using the Insolvency Notification System (INS), the examination function will make a timely determination if any returns of the taxpayer are under examination, and, if not, whether an examination will be made because of this notification.

  2. Exam (INS/AIMS) and Insolvency (AIS). Since INS is an interface between the Automated Insolvency System (AIS) and Exam's Audit Information Management System (AIMS), its effectiveness depends upon both systems having current information. For INS to function as designed, Insolvency must enter date information timely on AIS, such as petition, bar, conversion, dismissal, and discharge dates. All actions taken on the case should be input on the system as the events occur, including all case closing actions.

  3. Examination Contacts to Insolvency. If an examination is open on a prepetition period, an Examination employee will:

    1. contact the responsible Field Insolvency caseworker or CIO liaison; but

    2. continue with established examination bankruptcy procedures; and

    3. advise Insolvency of any proposed Exam-initiated deficiencies or adjustments that might result in a refund or a credit to the taxpayer. This should be done at the earliest possible time before the bar date by sending Insolvency a memorandum, or a locally developed form (along with a copy of the transmittal letter to the Examination report), or a copy of the Revenue Agent Report (RAR).

      Note:

      Insolvency will not perform a periodic follow-up with Examination. Responsibility to notify Insolvency rests entirely with Exam.

  4. Exam's "HOLD" File. Examination establishes a "HOLD" file of cases for which a statutory notice has been issued, and assessment is stayed because a Tax Court petition cannot be filed under 11 USC § 362(a)(8). Periodically Examination transmits a list of these cases to Insolvency.

    1. Timeframe for Insolvency to Contact Exam. Within five workdays of receipt of the exam list, Insolvency will advise Examination which assessments (if any) can be made. Insolvency's response will show the date the stay was lifted, if applicable.

    2. Determining the -L Freeze. INS does not pick up bankruptcies filed in geographical areas outside of where the primary Examination case is assigned. As a safeguard, Insolvency must run IIP Process D to detect the -L freeze, which indicates accounts selected for an audit and which may require interoffice coordination.

    3. Alternatively, or, in addition, access to the Automated Insolvency System (AIS) (read only capabilities) can be granted to the examination function.

  5. Abusive Tax Avoidance Transactions (ATAT). During the initial case review process Insolvency caseworkers will determine if a TC 420 (-L freeze) is present with ATAT project codes. CIO cases will be reassigned to the designated Field Insolvency specialist or advisor if any ATAT code is identified. The Field Insolvency caseworker must review the following to identify inconsistencies:

    • Bankruptcy schedules

    • Statement of Financial Affairs

    • Tax returns

    • Financial statements

    The Field Insolvency caseworker should contact the Exam ATAT Coordinator to determine if further investigation is needed. In cooperation with Area Counsel and Exam and Collection ATAT Coordinators, Insolvency will decide if a bankruptcy fraud referral should be pursued.

  6. Employee Plans. Insolvency will advise the Employee Plan (EP) function of the TEGE division when a large dollar or significant case Chapter 11 bankruptcy is filed so EP can research any impact the bankruptcy might have on the EP program. (See IRM 5.9.8.4(15),Notice to TEGE.)

  7. Insolvency Follow–Up/Monitoring. Because confirmations take place quickly in some bankruptcies (notably in Chapter 13), monitoring methods must be established by Field Insolvency for cases involving examination issues. If research indicates one or more tax periods are being examined, and the assigned Exam function has not contacted the Insolvency group, Insolvency should contact that Exam unit to gather current information on the status of the audit.

  8. Reminders - Assessment of Taxes. The Service may, notwithstanding the automatic stay,:

    • assess an agreed tax deficiency (26 USC § 6213(d)).

    • assess a tax shown on a return filed by the taxpayer (26 USC § 6201(a)(1)).

    • assess taxes which are not subject to the deficiency procedures (e.g., the Trust Fund Recovery Penalty, whether the taxpayer agrees or not) (26 USC § 6671).

      Note:

      Unless the period for petitioning the Tax Court is suspended, the automatic stay no longer provides an extension of the ASED; therefore, the Service must take timely action to protect the statute.

    • assess a tax deficiency on an individual debtor's postpetition period for bankruptcies filed on or after October 17, 2005 (11 USC § 362(a)(8)).

  9. Unagreed Deficiency Assessments. Postpetition assessments of unagreed deficiencies on prepetition periods for which the statutory response time to file a Tax Court petition has not expired are violations of IRC 6213 and must be reversed within two days of identification. Such an assessment would not be valid because the debtor cannot petition the Tax Court while the automatic stay is in effect, and the time to file the petition is therefore tolled. When an Insolvency caseworker determines that such an assessment has posted, the caseworker must contact the Exam or AUR bankruptcy coordinator by phone or secure email to request a reversal of the TC 300/290 assessment. Exam or AUR will input the reversal upon Insolvency notification to meet the two business day requirement. If contact with the bankruptcy coordinator cannot be made to ensure the reversal will be initiated within two business days, the Insolvency caseworker must input the reversal on-line or send an expedited request to Centralized Case Processing (CCP) to have the assessment reversed. If the reversal of the assessment is input by Insolvency or CCP, the Insolvency caseworker must advise the applicable bankruptcy coordinator by phone or secure email of the reversal as soon as possible so the assessment file can be suspensed until closure of the bankruptcy.

    Note:

    These procedures facilitate reassessment of the deficiency after the case is closed by the bankruptcy court.

  10. Documentation. Insolvency must accurately document all contacts with Examination functions in the AIS history at the time of contact. IRM 5.9.5.4,AIS Documentation, provides guidance on required AIS documentation.

5.9.4.3.1  (05-13-2008)
Examination and MFT 31 Mirrors

  1. Mirroring Procedures. Procedures are in place for creating MFT 31 mirror modules when Exam must make an assessment on a non-debtor spouse while a bankruptcy is pending.

  2. Petitions to Tax Court. When one spouse is in bankruptcy during an examination of a joint prepetition tax year, and the IRS issues a statutory notice of deficiency, the time for filing the debtor's Tax Court petition is suspended, and the assessment statute is suspended until the debtor is granted or denied a discharge or dismissed from bankruptcy. However, the time to file a Tax Court petition and the assessment statute for the deficiency is not extended on the spouse who did not file bankruptcy. If the non-debtor spouse does not timely file a Tax Court petition, the deficiency against the non-debtor spouse must be assessed to protect the ASED.

  3. Exam's Request for Mirroring. If Examination determines the deficiency assessment must be made on the non-bankrupt spouse because of the assessment statute, the Exam function will contact the CIO. Because Exam does not have the ability to establish MFT 31 modules, Centralized Insolvency will mirror the module so the assessment can be made.

  4. Exam's Required Actions. Exam will:

    1. contact Insolvency with their determination the non-bankruptcy spouse must be assessed the deficiency;

    2. input the TC 421 to reverse the MFT 30 –L freeze so mirroring of the MFT 30 module can be done;

    3. monitor for the TC 421 to post on MFT 30 module and contact Insolvency; and

    4. monitor for the creation of the MFT 31 mirrored modules and re-input the TC 420 on the MFT 30 module.

  5. Insolvency's Required Actions. Insolvency will:

    1. maintain the bankruptcy freeze (-V or –W for closing code 81). The mirroring can be accomplished without the reversal of the bankruptcy freeze and will remain unreversed to ensure the automatic stay is not violated;

    2. input the required transaction codes to mirror the module (see IRM 5.9.17.22.1,MFT 31 Mirror Modules ); and

    3. input TC 521 on the MFT 30 module after the TC 420 is re-input to ensure the module remains on the system. (See IRM 5.9.13.9(2), Examination Adjustments.)

    Caution:

    Only Insolvency can reverse the bankruptcy freeze code on the modules when necessary.

5.9.4.4  (05-13-2008)
Credits, Refunds, and Offsets

  1. Authority of Right to Offset. The IRS has a right to offset credits owed to a taxpayer against debts the taxpayer owes to the Service. This right is codified in IRC § 6402 and related Treasury Regulations. The Bankruptcy Code preserves the Service's non-bankruptcy rights to setoff in 11 USC § 553.

  2. Mutuality of Debts. Although 11 USC § 553 expressly preserves only the right to setoff when both the credit and the debt occur prepetition, nothing in the Bankruptcy Code abrogates the Service's non-bankruptcy rights to setoff. Thus, setoff may also be available when the credit or the debt occurs postpetition as long as the debts are mutual. ( See IRM 5.9.4.4.2, Postpetition Payments and Credits.) Although the Service has a right to setoff mutual debts, for bankruptcies filed before October 17, 2005, the automatic stay prohibits the actual making of the setoff until the stay is lifted. BAPCPA created an exception to the stay for offsets of prepetition income tax refunds against prepetition income tax claims as explained in paragraph (3) below. Insolvency caseworkers should consult Area Counsel for advice for a specific jurisdiction on the applicability of the automatic stay for setoffs not covered by BAPCPA.

  3. BAPCPA Provision. BAPCPA allows prepetition income tax refunds to be offset against prepetition income tax liabilities without a lift stay for bankruptcies filed on or after October 17, 2005. The exception does not apply if an action is pending to determine the amount or legality of a tax liability. (11 USC § 362(b)(26)) However, the IRS may hold any prepetition income tax refund until the validity of the liability is resolved or until the Service is granted adequate protection.

  4. Violations of the Automatic Stay. After a bankruptcy is filed, accounts should be examined and research completed promptly to determine if credits are present that need to be resolved, if refunds should be retained or turned over to the debtor or trustee, and if any illegal offsets have occurred. This should be done during the initial review of accounts in Insolvency. (See IRM 5.9.13.4, Case Reviews.)

    1. Timeframe to Correct. If a violation of the Bankruptcy Code has inadvertently occurred, corrective actions must be initiated within two workdays.

    2. Erroneous No Liability Case. An offset may be discovered in an apparent "no liability" case where a tax refund was applied to full pay an existing balance due tax account after a bankruptcy petition was filed. If the bankruptcy freeze code was not input timely, the account could erroneously appear to be one of " no liability" when it is reviewed later in Insolvency. An offset action of this type may be a violation of the automatic stay.

      Note:

      Whenever such an offset is discovered, immediate steps to correct the violation must be taken by the Service, including expedited refund issuance and filing or amending a claim, if appropriate.

  5. Refunds Not Offset but Retained by the Service. The Service may retain ("freeze" under controlling case law) refunds to protect its right of setoff. These refunds may be retained whether they arise prepetition or postpetition. Service policy emphasizes making prompt determinations. Counsel advice may needed when a refund will be frozen for a substantial length of time.

  6. Timeframe. When Insolvency discovers refunds are being retained, the Insolvency caseworker will begin the refund credit resolution process within 30 calendar days. Refunds must not be held solely in anticipation of a future dismissal or discharge that will lift the stay and allow for the Service to offset a credit generated during the pendency of the bankruptcy.

  7. Refund Determination. Insolvency must make a refund determination within 30 calendar days of identification of the credit, either to:

    1. Issue Refund. Issue the refund to the trustee or debtor, as required by local rules/agreement, order, plan or practice; or

    2. Refer to Counsel. An expedited referral should be made to Counsel (if necessary) to file a motion to lift the automatic stay to effectuate a refund offset; or

    3. Retain Refund. Retain the refund to protect the Service's right of offset, but only with concurrence of Counsel.

  8. Guidelines for Refund Determination. SBSE Counsel has issued tolerance criteria for referrals of issues to Associate Area Counsel offices. (See LEM 5.9.4.) These criteria may be adjusted by local Counsel depending on staffing and case loads. If a referral for offset is not appropriate, general refund guidelines are set forth in IRM 5.9.4.4.1(2), Table - Credits, Refunds, Offsets.

    1. Stay Lifted to Allow Refund Offset. It is Service policy not to offset a refund unless the automatic stay has been lifted for periods protected by the automatic stay.

      Reminder:

      For bankruptcies filed on or after October 17, 2005, prepetition income tax refunds can generally be offset to prepetition income tax liabilities without requesting a lift stay.

    2. Secured Status. Generally, the refund entitles the Service to a secured status on the proof of claim – to the extent of the outstanding tax liabilities. Any refund excess will be refunded to the debtor or trustee, per local guidelines or Counsel advice.

    3. Clarify Claim Status. Also, Insolvency must amend or withdraw a claim or issue a credit letter to the trustee, per local procedures, after the offset is completed to clarify the Service's claim for the court.

  9. Chapter 13. After a Chapter 13 confirmation, the Centralized Insolvency Operation must make a prompt decision either to retain a refund, forward it to the debtor or the trustee, or, if the refund arose postpetition, offset it against other postpetition liabilities.

  10. Contacts to Insolvency. If an IRS employee (outside of Insolvency), receives a written inquiry regarding a refund, credit, or offset issue on a debtor whose bankruptcy case is still active (i.e., unreversed TC 520 with a bankruptcy closing code), the employee must promptly contact the CIO liaison for resolution. If the inquiry is received by phone, after disclosure verification, the caller can be directed to call the CIO toll free at 1-800-913-9358. (See the "exception" below.) Insolvency actions will depend upon the bankruptcy chapter, the petition date, when the credit became available, and standing orders or local rules covering a specific bankruptcy court. If appropriate, the CIO liaison will direct the initiating employee or the debtor to a Field Insolvency caseworker to handle the issue.

    Exception:

    If IDRS shows the refund in question is being systemically refunded to the taxpayer (TC 846 is present), the non-Insolvency IRS employee can provide that information to the correspondent or caller, after disclosure verification, along with the date the refund can be expected to be mailed or electronically transferred to the taxpayer's financial account. When an unreversed TC 846 is present, the CIO need not be contacted.

  11. Refund Considerations/Problems: Insolvency must consider issues surrounding potential refunds for accounts under bankruptcy protections such as the following :

    • Improper FMS/TOP offset potential exists

    • Offset for domestic support obligations allowed under BAPCPA 2005 for cases filed on or after October 17, 2005

    • Inability to generate a systemic refund (the manual refund issuance process takes longer)

    • Court order or plan dictating how refund disposition is to be handled

    • Potential or actual violation of the automatic stay

    • Potential for duplicate refunds

    • Change of venue (i.e., case relocated to another court after bankruptcy petition filed)

    • Mailing address problems

    • Mandated redirection of the refund to an entity other than the debtor

    • Debtor and non-debtor spousal issues on a joint return/joint refund situation

  12. Preparation of Manual Refunds. AIS has a template for Form 5792, Request for IDRS Generated Refund , to be completed by the Field Insolvency specialist or the CIO caseworker. Form 3210, Document Transmittal, can also be generated from AIS to transmit Forms 5792 for processing. IRM 5.9.16.4,Manual Refunds, details steps to be taken by both Field Insolvency and the CIO in processing refund requests.

5.9.4.4.1  (01-01-2006)
Addressing Credits, Refunds, and Offsets

  1. Prepetition Credits. A "prepetition credit" is a credit available on a tax module when the taxable period ends prior to the petition date. Although the prepetition credit may be available and is valid as a credit to the debtor's account (e.g., tax refund), transferring the funds to effect a setoff may be a violation of the automatic stay (unless allowed by local standing orders or local rules).

    Note:

    BAPCPA generally allows prepetition income tax refunds to be offset to prepetition income tax liabilities for cases filed on or after October 17, 2005.

  2. TABLE — Credits, Refunds, Offsets. Unless any standing orders, local rules, or agreements allow for different treatment, prepetition credits and refunds may be resolved using the following table:

    IF the bankruptcy is filed on or after October 17, 2005, and ... THEN...
    the credit is a prepetition income tax refund and the debtor owes a prepetition income tax liability, the Service can offset the credit to a prepetition liability if such a liability exists.
    the prepetition credit is not an income tax refund or if the prepetition liability is not for income tax, the court must approve an offset which can be through standing orders, local rules, or an order for lift stay.
    1) The credit must first be applied to dischargeable tax, penalty, and interest due as of the date of petition.
    2) Secondly, the credit must be applied to any non-dischargeable tax, penalty, or interest due.
    3) Finally any balance must be refunded to the trustee or the debtor, per local guidelines.
    a Chapter 7 trustee requests turnover of a prepetition income tax refund credit for the estate, after paying the IRS prepetition liability any balance of the refund is refunded to the trustee.
    a claim is required, a prepetition income tax refund is available, Insolvency may apply the refund to the liability (the oldest assessment first, then to the second oldest assessment, and so on) so the proof of claim, when filed, will reflect a liability after the refund has been offset.
    IF the bankruptcy is filed prior to October 17, 2005... THEN...
    a Chapter 7 trustee requests turnover of a prepetition income tax refund credit for the estate, and no standing orders or local rules are in place allowing offset, a referral for a lift of stay must be considered to offset the liability based on LEM 5.9.4 criteria.
    a Chapter 7 trustee requests turnover of a prepetition income tax refund credit for the estate, and the court allows the offset, after paying the IRS prepetition liability, any balance of the refund is sent to the trustee.
    a Chapter 7 trustee requests turnover of a prepetition income tax refund credit for the estate, and the court does not allow the offset or no prepetition liability exists, a manual refund must be prepared to go to the trustee.
    Note: See IRM 5.9.6.1.3,Chapter 7 Tax Refunds to Trustees, for procedures for turnover of refunds to Chapter 7 trustees.
    a claim is required, a prepetition income tax refund is available, the refund should be used as a setoff, and the proof of claim must state the amount of the refund being retained for setoff. (See IRM 5.9.4.4 (7), Refund Determination. )
    Reminder: Prior to a CH 11 or 13 confirmation, a refund may be retained to preserve the IRS's future setoff rights, but the Service cannot make a setoff while the stay is in effect without permission of the court. Notice of retention of a refund should be given on a promptly filed claim or amendment.
    Chapter 12 and Chapter 13 plans have been confirmed or the credit is not an income tax refund regardless of petition date, local guidelines and the tolerance set in LEM 5.9.4 should be followed to seek a refund offset. (See IRM 5.9.4.4(7), Refund Determination.) If the lifting of the stay is not requested and the plan is not in default, Insolvency will generally request a prompt refund be issued to the debtor or to the trustee if a turnover request has been received. If the refund is to be retained, Counsel must concur.
    Exception:         In some jurisdictions standing orders or local rules permit a setoff.
    no tax debt is showing currently on IDRS, but an offset has occurred in violation of the automatic stay regardless of the petition date, 1) IRM 5.9.4.4(4), Violations of the Automatic Stay, provides guidance. IRM 5.9.4 4 (4)(b), Erroneous No Liability Case, deserves special attention.
    2) Corrective actions must be initiated within two workdays of discovery of such an offset.
    3) If appropriate, an expedited manual refund should be requested to go to the trustee or debtor.
    4) The Insolvency caseworker or CIO unit initiating the refund request ensure the case is monitored to guard against issuance of duplicate refunds.
    5) After offset correction is made, should a balance due exist exceeding the LEM criterion, the assigned Insolvency caseworker must file a manual proof of claim if the bar date has not passed. If too late, Counsel advice should be sought.
    Note: Also see IRM 5.9.4.4.3,Offsets to Other Agencies, and IRM 5.9.4.4.4, Federal Payment Levy Program (FPLP).

  3. Language for Claiming Setoff Amounts. IRM 5.9.13.21(3), Language for Insertion on Claim, provides wording to include on the proof of claim when the Service is claiming a right of setoff.

5.9.4.4.2  (01-01-2006)
Postpetition Payments and Credits

  1. Postpetition Credits and Postpetition Debts. Generally, postpetition credits (e.g., tax refunds) owed to the taxpayer can be offset directly against postpetition tax periods for taxes owed by the taxpayer as explained in IRM 5.9.4.4 above.

  2. Postpetition Credits and Prepetition Debts. Since 11 USC § 553 does not create an independent right to setoff but rather preserves the Service's non-bankruptcy rights, the Service holds it can set off postpetition credits against prepetition debts and vice versa as long as the debts are mutual (i.e., both the credit and the debt are owed to/by the taxpayer). However, some courts have held the Service does not have a right to set off postpetition credits against prepetition liabilities.

    Caution:

    Insolvency should consult Counsel to determine the action to be taken, especially in Chapter 13 cases. Some standing orders and local rules/agreements allow these offsets while the taxpayer is in bankruptcy.

  3. Non-Mutual Debts - Chapters 7 and 11 Individuals. In a Chapter 7 or 11 individual case, the bankruptcy estate generally is a separate taxable entity. A credit owed to a debtor in these chapters cannot be set off against a tax owed by the estate due to the lack of mutuality.

  4. Chapter 7 Discharge/Payments/Offsets. If payments are received from taxpayers for taxes that have been discharged under Chapter 7, or refunds have been offset to dischargeable periods, corrective actions must be initiated within two workdays of the date the Service becomes aware of the violation of the Bankruptcy Code. (See IRM 5.9.6.6,Automatic Stay, and IRM 5.9.17.8, Discharge Injunction.) Paragraph (5) below discusses an exception to this general rule.

    Caution:

    The Service is prohibited by the discharge injunction imposed by 11 USC § 524 from applying payments to taxes that have been discharged. Sanctions can be imposed against the Service if this provision is disregarded.

  5. Voluntary Payments – Guidelines. At times an individual debtor may make a voluntary postpetition payment. Acceptance of such payments does not violate the automatic stay as long as the payments are truly voluntary. Voluntary payments by an individual Chapter 7 debtor can be accepted and applied to non-dischargeable periods. However, the payments cannot be made from property of the estate. (See IRM 5.9.4.17(6), Payments Received on a Pre-Existing Installment Agreement.)

  6. Table - Postpetition Payments and Credits. The table below provides additional information on postpetition payments and credits.

    IF... THEN...
    the automatic stay is in effect, but standing orders or local rules/agreement allow the offset, application of a credit to prepetition tax period(s) can be made pursuant to such rules or orders. In Chapter 7, application should be made to non-dischargeable period(s) with any remaining balance being refunded to the debtor or trustee.
    the automatic stay is in effect and no standing orders or local rules apply, the credit can generally be applied to postpetition tax period(s) with any remaining balance being refunded to the debtor or trustee. Counsel may be consulted, if necessary.
    the automatic stay is in effect, no postpetition liabilities exist, an offset to a prepetition period might be deemed a violation of the stay and the LEM criteria are met for referral to Counsel, Field Insolvency should consider retaining the refund and sending a referral to lift the stay to allow an offset with any remaining balance being refunded to the debtor or trustee.
    Note: Referrals for offset are not made on Chapter 7 No Asset accounts.
    the automatic stay is not in effect, the credit should first be applied to non-dischargeable prepetition tax, penalty, and interest, then to postpetition tax periods, and finally any excess must be refunded to the debtor.
    the Chapter 7 trustee of an individual debtor requests the credit and no postpetition tax liability exists, letter 1467 should be issued through AIS advising the trustee the credit is postpetition and not property of the estate, then after 20 calendar days without further explanation or complaint by the trustee, the credit can be refunded to the debtor.
    the credit module begins prepetition and ends postpetition,
    Example: Tax period 30/200112 has a credit of $500 and debtor filed bankruptcy on 04/20/2001; the credit module of 30/200112 begins 1/1/2001 (prepetition) and ends 12/31/2001 (postpetition)