IRS’ Right to Setoff Tax Refund Trumped Debtor’s Right to Exempt the Refund

IRS’ Right to Setoff Tax Refund Trumped Debtor’s Right to Exempt the Refund

Debtor filed Chapter 7 petition and listed debts for tax years 2006 and 2011 owed to the  Internal Revenue Service (IRS) as  unsecured non-priority claims. The Debtor and the IRS both filed Motions for Summary Judgment on the issues of whether the Debtor’s right to exempt her tax refund trumped the IRS’ right of setoff.

The Debtor listed a potential tax refund in the amount of $1.00 on Scheduled A/B and exempted the refund on Schedule C under Virginia law.  When the Debtor filed her tax return, she learned that her tax refund would be over $6,400 because of the Earned Income Tax Credit. Accordingly, the Debtor amended her Schedules to exempt the full refund. She also recorded a homestead deed in an attempt to fully exempt the tax refund. The IRS did not object to this exemption.

When the IRS processed her tax return it offset her $6,417 refund by the full amount to pay her tax liability from tax year 2006, and said even after the offset, she still owed over $4,000 for 2006.   The Debtor claimed her refund as exempt because she intended to assert an exemption in any overpayment she had with respect to her federal income tax liability for the tax year 2015, not the tax year 2006.


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