Diving Beneath the Surface of In re Webb

We welcome back Ken Weil to help us parse a technical bankruptcy issue impacting taxes.  Ken has his own practice in Seattle that focuses on representing individuals with tax debt and resolving that debt through administrative action with the IRS or through bankruptcy. He has written a book on his specialty area, Weil, Taxes and Bankruptcy, (CCH IntelliConnect Service Online Only) (3d ed. 2014). He is one of the top experts at the crossroads of personal bankruptcy and taxes. We are fortunate to have him back with us again. Keith

In Webb v. Internal Revenue Service (In re Webb), Bankr. N.D. W.Va. Adv. Proc. No 21-00014 (November 8, 2021), a Chapter 13 debtor brought an adversary proceeding to hold the IRS in contempt for an improper setoff of a tax refund against a tax debt.  On the IRS’s Rule 12(b)(6) motion to dismiss, the court held for the IRS. 

The court stated that “[a]n order of contempt is a serious reprimand and is appropriate only in the case of a deliberate violation in the face of succinct directions to the contrary.”  Id. at p.3.  Because the debtor’s Chapter 13 plan did not explicitly prevent tax setoffs, the court found that the high standard necessary to hold the IRS in contempt was not met.  In note 2, the court stated that it “need not discuss the legality of the IRS’s actions because the Debtor only alleges the [IRS’s] actions constituted contempt of the confirmation order.”

Because contempt was the only issue before him, Judge Bissett decided the case without diving into the more complicated issues lurking beneath the surface.  What makes this case blog-worthy are the issues that would or could have been before the court if the case had been presented differently.  In particular, because of the IRS’s implicit election to treat its 2019 tax debt to Ms. Webb as a prepetition debt, there are multiple opportunities to discuss an analytical tool that I call deemed versus defined, which I first learned from Professor Harvey Dale almost 40 years ago.


   1.   Factual background.

          In November 2019, Marie Webb (the Debtor) filed a Chapter 13 petition.  In her schedules, she listed taxes owed for 2013 and 2018.  In April 2020, the IRS filed its proof of claim, which it amended subsequently.  It listed the 2013 tax owed as an unsecured general claim, i.e., nonpriority claim.  It listed the 2018 tax owed as an unsecured priority claim.  In addition to the taxes scheduled by the Debtor, the IRS’s proof of claim listed the 2019 tax year as an unsecured priority claim and estimated the tax due. 

          In her Chapter 13 plan, the Debtor agreed to pay the 2019 tax debt as a priority obligation.  Corrective Order Confirming Chapter 13 Plan, Webb Docket No. 45, p.5, ¶ 10 (February 19, 2021) (Corrective Order).  The Debtor’s Chapter 13 plan left all property the Debtor acquired postpetition in the bankruptcy estate.  Corrective Order p.8, ¶ 10.

          In March 2021, the IRS set off the Debtor’s 2020 tax refund (IRS’s debt) against the 2019 tax obligation (IRS’s claim). In the Bankruptcy Code, setoffs are viewed from the creditor’s perspective.  Thus, the IRS’s refund owed is the debt, and the taxpayer’s unpaid tax obligation is the claim.  The Tax Code and 11 U.S.C. § 553 use the word “offset.”  I use “setoff” when used as a noun or adjective and “set off” when used as a verb. The Debtor objected to the setoff by filing an adversary proceeding seeking to hold the IRS in contempt.

     2.   Applicable law and its application in Webb.

          This paragraph discusses the law that would have been applicable if some of the underlying issues had been raised and argued by the parties.

          a.   I.R.C. §§ 1398-1399. 

          Tax Code §§ 1398 and 1399 provide rules for when a debtor’s tax year in the year of filing can be bifurcated.  The only time an individual’s tax year can be bifurcated is in an asset, Chapter 7 case. Assuming a calendar year-end, if the tax year of filing is bifurcated, a prepetition tax year runs from January 1 to the day before the petition is filed.  A second, postpetition year runs from the day of filing to December 31. See I.R.C. § 1398(d) (rules for taxable years of individual debtors); I.R.C. § 1399 (“Except in any case to which section 1398 applies, no separate taxable entity shall result from the commencement of a case under title 11 ….”); and Hall v. United States, 566 U.S. 506, 516 (2012) (Chapter 13 postpetition taxes are not incurred by the estate; they are a liability of the debtor).

          The Debtor filed for bankruptcy in November 2019.  This means the 2019 tax year ended after the bankruptcy filing and was a postpetition tax year.  The IRS’s proof of claim treated 2019 as a prepetition tax year.

          b.   11 U.S.C. § 1305.

          This paragraph discusses the things we know and do not know about 11 U.S.C. § 1305, and it looks at Webb through a § 1305 lens.

               i.   What we know about § 1305.

          Under 11 U.S.C. § 1305, a governmental unit can elect to file a proof of claim for taxes that [first] become payable while the case is pending.  11 U.S.C. §§ 1305(a)(1) and 1322(b)(6); and see Joye v. Franchise Tax Board Cal. (In re Joye), 578 F.3d 1070, 1075-1077 (9th Cir. 2009) (payable means first becomes payable); and In re DeVries, Bankr. D. Id. No. 13-41591 (April 28, 2015), 2015-1 USTC ¶ 50,287 (only governmental entity may file § 1305 claim).  Internal Revenue Manual guidance is found at IRM (08-07-2018).

          Beyond the proof of claim, no special form is needed for a governmental unit to elect § 1305.  The IRM states that IRS personnel should file a proof of claim and add to the proof of claim language stating that the proof of claim is being filed under the authority of § 1305.  IRM (08-07-2018).  The IRS’s proofs of claim in Webb did not have this language. 

          If the governmental unit so elects and the proof of claim is accepted as filed, the governmental unit’s postpetition claim is treated as if it were a prepetition claim.  In other words, a postpetition claim is deemed to be a prepetition claim.  Beyond this point, the applicable law is murky.

               ii.  The confusing world of § 1305.

          The election to use § 1305 raises a number of confusing issues.

                     I.  Are § 1305 claims entitled to priority?

          The argument that § 1305 claims do not receive priority is based on 11 U.S.C. § 507(a)(8), which has no provision for priority treatment of a deemed prepetition claim under § 1305.  In re Jagours, 236 B.R. 616, 619-620 (Bankr. E.D. Tex. 1999) (postpetition claim treated as filed prepetition but not entitled to priority because such a claim does not fit within the language of § 507(a)(8)(i)).  Cases that allow priority rely on § 1305(b), which states that a § 1305 claim shall be allowed or disallowed the same as if such claim had arisen prepetition.  In re Jagours, 236 B.R. at 616 n.3.  The IRM straddles the fence.  Compare IRM (08-07-2018) (benefit of filing § 1305 claim is that “Service will be paid as a priority creditor”), with IRM (08-07-2018) (risk of filing § 1305 claim is that “§ 1305 claims may not be accorded priority status”).

                     II.  Is a § 1305 claim dischargeable?

          In dicta, Jagours stated that § 1305 claims are not dischargeable.  In re Jagours, 236 B.R. at 620 (“rights of the creditor to collect are not impaired by the Chapter 13 plan”).  The IRM appears to disagree.  IRM (08-27-08) (“Once provided for in the plan, the tax liability may be dischargeable.”)

                     III. Is postpetition interest paid on § 1305 claims? 

          Assuming funds are insufficient to pay interest to unsecured creditors, postpetition interest will not run on a discharged § 1305 claim, regardless of whether the § 1305 claim is paid-in-full.  If the § 1305 claim is not discharged or if it is deemed a postpetition claim, postpetition interest will continue to run.  See Ward v. Bd. of Equalization of Cal. (In re Artisan Woodworkers), 204 F.3d 888 (9th Cir. 2000) (postpetition interest payable on nondischargeable tax debt fully paid through a Chapter 12 plan).

                     IV.  Are penalties paid on § 1305 claims?

          In Webb, what happens to the failure-to-pay penalty (assuming the Debtor filed her 2019 return timely)?  If a prepetition claim, during the bankruptcy, the penalty does not accrue.  I.R.C. § 6658.  If a prepetition claim, the portion of the penalty that accrued prepetition is dischargeable in the bankruptcy, regardless of age.  See 11 U.S.C. § 1328(a)(2) (by omission from the listed exceptions, all penalties discharged regardless of age; this rule is one of the last vestiges of the old Chapter 13 superdischarge that disappeared with the 2005 revisions to the Bankruptcy Code).  If a postpetition claim, the penalty accrues.  

               iii. Webb and § 1305.

          With its proofs of claim in Webb, the IRS implicitly filed a § 1305 claim and took the position that it was entitled to priority.  The Debtor agreed to that treatment.  If the plan is completed, the tax would be paid-in-full.  At that point, only the payment of interest would turn on the dischargeability issue. 

          If postpetition interest and penalties are not paid, this is a sweet deal for the Debtor, as a postpetition tax is paid interest-free over the life of the plan.

          c.   11 U.S.C. §§ 541, 1306, and 1327(b).

          Bankruptcy Code §§ 541 and 1306 tell us what property is included in the bankruptcy estate.  Section 541 broadly defines bankruptcy estate property.  Section 1306(a)(1) provides that property of the estate includes all property that the Chapter 13 “debtor acquires after the commencement of the case but before the case is closed, dismissed or converted ….”  Upon plan confirmation, all property of the estate vests in the debtor.  11 U.S.C. § 1327(b).  Section 1327(b) does not override § 1306.  In re Shay, 553 B.R. 412, 417-418 (Bankr. W.D. Wash. 2016) (Lynch J.).  A priori, it applies to prepetition property that is returned to the debtor upon confirmation.

          The Debtor’s Chapter 13 plan included all property acquired postpetition in her bankruptcy estate, which means it included any potential tax refund in her bankruptcy estate. Whether the refund could even be estate property is also debatable.  Because the right to overpayment arose before the IRS made its setoff, it was most likely estate property.  Copley v. United States, 959 F.3d 118, 122-123 (4th Cir. 2020).  West Virginia is in the Fourth Circuit.  Otherwise, under I.R.C. § 6402(a), a “debtor is generally only entitled to a tax refund to the extent that her overpayment exceeds her unpaid tax liability.”  IRS v. Luongo (In re Luongo), 259 F.3d 323, 335 (5th Cir. 2001); and United States v. Gould (In re Gould), 401 B.R. 415, 424-425 (B.A.P. 9th Cir. 2009) (citing Luongo with approval), aff’d, Gould v. United States (In re Gould), 603 F.3d 1100 (9th Cir. 2010) (adopting BAP opinion).

          d.   11 U.S.C. §§ 327(a), 362(a)(3), (b)(26), and (c)(1).

          The automatic stay protects the debtor from collection action by creditors while a bankruptcy case is pending and before discharge is entered.  In particular, the creditor may not act to obtain possession of estate property.  11 U.S.C. § 362(a)(3).  An exception is that a governmental unit may set off postpetition a prepetition debt (a tax refund) against a prepetition claim (a debtor’s unpaid tax debt).  11 U.S.C. § 362(b)(26).  Here, the 2020 tax refund is a postpetition debt.

          The Debtor’s plan kept all property in the bankruptcy estate, and § 362(a)(3) stayed collection as to that property.  The automatic stay remained in place as long as the property remained bankruptcy estate property.  11 U.S.C. § 362(c)(1); and see also 11 U.S.C. § 362(c)(2) (if property had been returned to debtor, stay would have remained in place until the case was closed, dismissed, or the debtor received a discharge.)

          Judge Bissett stated correctly that the Debtor’s plan failed to address explicitly whether the setoff of a postpetition tax refund was permissible.  Consistent with § 1306, the plan did state that all property acquired postpetition would be property of the bankruptcy estate.  It also provided that the Debtor could keep the first $1,500 of any tax refund and the remainder should be sent to the Chapter 13 trustee.  Corrective Order p.2, ¶ 3.

          Pursuant to 11 U.S.C. § 1327(a), all creditors, including the IRS were bound by the terms of the plan, and the Debtor’s complaint so alleged.  Webb v. Internal Revenue Service (In re Webb), Bankr. N.D. W.Va.Adv. Proc. No. 21-00014, Docket No. 1, Complaint ¶ 23 (June 21, 2021).

          e.   Setoffs, mutuality of obligation, and deemed versus defined.

          This paragraph discusses when setoffs are allowed in bankruptcy and the concept of mutuality of obligation.  It then applies the analytical tool of deemed versus defined to ask whether mutuality of obligation existed when the IRS made its setoff in Webb. For a thorough analysis of setoffs and taxes, see K. Fogg, “The Role of Offset in the Collection of Federal Taxes,” added to SSRN on February 26, 2021 and forthcoming in the Florida Tax Review.

               i. Setoffs and mutuality of obligation.

          As a general rule, the Bankruptcy Code “does not affect any right of a creditor to offset a mutual debt owing by such creditor to the debtor that arose” prepetition against a claim of the debtor that arose prepetition. One exception is the improvement-in-position test that a bankruptcy trustee can use to claw back into the bankruptcy estate setoffs made in the 90-day prepetition period. 11 U.S.C. § 553(b).11 U.S.C. § 553(a).

          Valid setoffs require a mutual debt, i.e., mutuality of obligation.  The debt and claim must be between the same persons.  Because a bankruptcy filing creates a new entity, i.e., the postpetition debtor, the mutual debt requirement may be flunked while a bankruptcy case is active.  For example, a setoff of a postpetition debt (IRS refund owed to the debtor in bankruptcy) against a prepetition claim owed by the prepetition debtor (IRS’s right to unpaid tax) is not a mutual debt.  After a bankruptcy case closes, this issue disappears.  There is no longer an existing bankruptcy case to force a division between events arising pre and postpetition.

               ii.  Did mutuality of obligation exist in Webb?

          The combination of the IRS’s implicit § 1305 election and its setoff of the 2020 refund against the 2019 claim also puts the deemed versus defined concept in play.  If the IRS’s 2019 tax claim is treated as defined, mutuality of obligation exists because the IRS set off a postpetition obligation against a postpetition claim.  This must be how the IRS viewed the world.  Yet, as long as the Debtor has rights in the overpayment, see n.3, supra, this setoff would violate the automatic stay.  11 U.S.C. §§ 1306 and 362(c)(1).  If the 2019 tax refund is treated as deemed, i.e., prepetition treatment under the Debtor’s Chapter 13 plan, mutuality of obligation does not exist.  The IRS set off its postpetition debt against its prepetition claim.   

     3.   Conclusion.

          Judge Bissett is a wise man.  He found the straight-forward answer to the issue at hand.  He wisely and successfully avoided the difficult issues that were lurking beneath the surface. See Webb at n.2 (“the court need not discuss the legality of the IRS’s actions”).

          In lieu of filing an adversary proceeding alleging contempt and depending on the legal analysis one thinks is correct, the Debtor might have sued the IRS for (i) turnover under 11 U.S.C. § 542(b) for failing to pay the tax refund to the bankruptcy estate, (ii) violation of the automatic stay for exercising control over estate property, or (iii) making a setoff without mutuality of obligation.

Bankruptcy and Farm Debt

The provision for farmers in the bankruptcy code is unusual, in part, because Congress placed it in an even numbered chapter while leaving the rest of the bankruptcy in odd numbered chapters and, in part, because of the amazingly different way Congress treats debts owed by farmers.  The case of In re Richards provides a glimpse of some of the unusual provisions in chapter 12 of the bankruptcy code.  At issue is whether the IRS can offset a tax refund against debts owed by the farming couple.


When chapter 12 came into the bankruptcy code in the early 1980s, the nation was in the midst of a farm crisis.  Interest rates had reached stratospheric highs, and many farmers were going bankrupt as a result.  Movie makers even took notice of the crisis.

In creating chapter 12 Congress created a remedy that kept most farmers from filing bankruptcy.  The basic remedy allowed farmers to rewrite their debt through chapter 12 to reduce the debt to the current value of the land and to reduce the interest rate to the current interest rate.  Knowing what would happen in a bankruptcy case, most banks worked with their debt-laden farm clients to restructure debt and avoid the cost of bankruptcy to all parties.

Even the generous provisions allowing farms to rewrite their debt did not work for all farmers and some still needed to file bankruptcy.  Congress decided that it needed to create additional relief in the last major bankruptcy reform package in 2005.  In that legislation it recognized that sometimes farmers sold part of the farm in order to generate cash and that such sales often involved low basis property, which created large capital gains and the resulting tax debt.  To address this problem, Congress passed BC 1222(a)(2)(A) which transforms priority tax claims into general unsecured claims.  This is a huge deal in allowing farmers to confirm plans and to discharge the taxes that do not get paid.  I will not go into a long explanation of why but trust me that this is important for both reasons.

Because even BC 1222(a)(2)(A) did not provide enough protection for farmers who sold property while the bankruptcy case was pending, Congress subsequently pass BC 1232 to allow farmers to strip priority status off of sales occurring after the filing of a bankruptcy petition.  A good deal for farmers.

The Richards confirmed their chapter 12 plan and in the plan was the following language that “no creditor shall take action to collect on any claim, whether by offset or otherwise, unless specifically authorized by this Plan”. That same paragraph later recites that “[t]his paragraph does not curtail the exercise of a valid right of setoff permitted under §553”.

Section 553 preserves a creditor’s right to offset if it exists outside of bankruptcy law.  Generally speaking, debts need to be mutual and pre-petition in order to allow offset in bankruptcy.  The court noted the current split of authority concerning whether the IRS can offset a liability of a debtor once a plan is confirmed.  The court provided:

Courts are divided as to whether a confirmed plan under §1141, §1227 or §1327 bars the IRS from exercising its §553 setoff rights. Courts within the Seventh Circuit have held that, absent an express plan provision extinguishing such rights, a creditor’s §553 rights survive confirmation. Section 553 provides that “this title does not affect any right of a creditor to offset a mutual debt” and courts have reasoned that the “effect of confirmation” provisions are contained in “this title” (Title 11) and thus, do not affect the creditor’s §553 rights. U.S. v. Munson, 248 B.R. 343, 346 (C.D. Ill. 2000 (§553 trumps §1327); In re Bare, 284 B.R. 870, 874-75 (Bankr. N. D. Ill. 2002) (“confirmation of a debtor’s plan . . . does not extinguish prepetition setoff rights, especially . . . where the plan does not specifically treat those setoff rights”). However, a creditor’s §553 setoff rights may be extinguished by express provision under a confirmed plan. Daewoo Int’l (America) Corp. Creditor Trust v. SSTS Am. Corp., No. 02 Civ. 9629 (NRB), 2003 WL 21355214 at *4 (S.D.N.Y. 2003) (“[i]ndeed, where there is a specific provision in the confirmation order prohibiting setoff claims, courts have indicated that the right to setoff may not survive the confirmation plan”); IRS v. Driggs, 185 B.R. 214, 215 (D Md. 1995); In re Lykes Bros. Steamship Co., 217 B.R. 304, 310 (Bankr. M.D. Fla. 1997) (holding that §1141 takes precedence over §553 where plan of reorganization specifically prohibited setoff).

We have been writing about offset quite a lot lately because of the role it plays in the EIP payments and in other matters here, here and here. We are also adding a new section on offset into Chapter 14A of the Saltzman and Book treatise “IRS Practice and Procedure.”  Bankruptcy adds another level of issues involving offset.

Here, the bankruptcy court decides that it does not need to get into the debate over the effect of confirmation, because the offset performed by the IRS in this instance did not satisfy the requirements of §553.  The refund was post-petition while the debt to which the IRS made the offset was prepetition, meaning that the debts lacked the necessary mutuality.  As such it violated the language of the plan in this case.

While the bankruptcy court decides that the IRS should not have offset the debt owed by the debtor against the post-petition refund, it also determines that it does not have the power to order the IRS to turn over the refund in the current proceeding.  It suggests that the debtor initiate a BC 505 proceeding to determine the correct amount of the refund and through that process obtain the refund it seeks.  The case provides a useful reminder of the impact of bankruptcy on the ability of the IRS to offset and also the special provisions of chapter 12.

Given the pressure that the pandemic places on farmers, not to mention the pressure that U.S. trade policy has placed on them, chapter 12 may become more prominent in the near future.  Be aware that it has provisions for farmers quite different that those applying to debtors in other chapters.  Approach any chapter 12 case with caution to get to know the lay of the land.

Summary Opinions for 6/7/14

Interesting posts on PT last week. We had two posts each by Keith and Les; in a two-part series Keith wrote about the consequences of IRS failing to issue a notice and demand, and Les wrote about penalties and reasonable cause and whether the IRS can collect penalties after a taxpayer dies. On to other procedure items that caught our attention:


  • Most folks don’t like paying much in taxes and often complain, but I think Louis Balestra has a substantially stronger case for b!*#ing than most. The first paragraph of the Court of Federal Claims opinion summarizes the issue well, “[t]his is a suit for a refund of…FICA taxes…At bottom, this case concerns a simple issue: whether the Balestras should have to pay FICA taxes on deferred compensation to which Mr. Balestra had a vested right but, due to the bankruptcy of his employer, he will never receive. So, does Mr. Balestra owe tax on the compensation he did not and will not receive? Yep. Under the Code, nonqualified deferred comp plans must be taken into account as wages for FICA the later of when the services are performed or when there is no substantial risk of forfeiture. See Section 3121(v)(2). “Substantial risk of forfeiture” is based on the taxpayer’s requirements, not the potential for his company to go belly up. I have not researched this issue, but the result does not surprise me based on what I know of this area.
  • Whistleblower 11332-13W is on a roll, which I guess is cool considering the death threats he/she received. The Tax Court has held it has jurisdiction to review the award determination the Whistleblower received, which the Government had contested arguing that the information provided by the Whistleblower was provided prior to the enactment of Section 7623(b). Section 7623(b)(4) states the Tax Court has jurisdiction to review determinations. The Court’s official holding was that it had jurisdiction to review the award determination where whistleblower alleged that he/she provided information to the Government before and after the effective date of the statute.
  • From Jack Townsend’s Federal Tax Procedure Blog, Jack discusses the 2013 Lockheed case and the government’s “second defense” arguing for a theoretical setoff. The lack of actual items for the setoff is troublesome, as Jack highlights, because it could result in a fishing expedition to find setoffs. The post goes on to discuss the needs for factual assertions in this type of matter and the split in circuits, and provides the revised version of Jack’s text on this matter.
  • On May 23, 2014, TIGTA issued a report that should be of great concern to corporate officers or employees responsible for paying over withheld employment taxes, especially if those companies are behind. TIGTA reported that it found trust fund recovery penalties were not always timely or adequate, and the investigations were incomplete. In well more than a third of cases, the actions were untimely or inadequate, and most took over 500 days to review and process. TIGTA and the Service have agreed that this needs to be rectified, TFRP cases need to be processed better and more efficiently. The Service plans to make additional changes to the program shortly.
  • CPA Amit Chandel posted a link to Parkertaxpublishing.com, which discussed the case Bruce v. Comm’r. In Bruce, married taxpayers were in the process of getting divorced. H filed a tax return as married filing jointly for 2010 in January of 2011, and informed his ex-to-be that they were getting a refund. She provided bank information for her share of the refund. Unbeknownst to H, W filed a 2010 tax return in March of 2011 filing as head of household, and taking the children as dependents. The Service then modified H’s return to married filing separately, and assessed additional tax. The Tax Court upheld the adjustment because W filed her return prior to April 15th, which she was allowed to do under Section 6702(a) and Treas. Reg. 1.6013-1(a)(1). I’ll be discussing this with our family law folks later today – what a great way to piss off your ex.
  • Jack Townsend has a post on his Federal Tax Crimes Blog on the potential changes to OVDP for non-willful violators, including substantial quotes from Comm’r Koskinen’s speech about the topic.
  • From Bloomberg BNA, for this filing season, virtual currencies do not have to be reported on FBARs, but that could change in the future.
  • Mary McNulty and Emily Parker of Thompson & Knight recently presented for the Tax Executives Institute on preparing clients for the new IDR process. The slides from the presentation are available here.