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In re Lee

United States District Court, S.D. Indiana, New Albany Division

March 31, 2014

In Re: LESTER L. LEE Debtor,
MICHAEL WALRO, Trustee, Appellee. No. 12-90007-JKC-7A. LESTER LEE, Appellant,



This matter is before the Court on an interlocutory appeal from a Chapter 7 Bankruptcy ruling filed by Appellant Lester Lee ("Debtor" or Mr. Lee") under 28 U.S.C. § 158 and Bankruptcy Rule 8003. Leave to appeal was properly sought by Mr. Lee on June 27, 2013, and this Court granted the requested leave on October 2, 2013. This is an appeal from an order of the United States Bankruptcy Court for the Southern District of Indiana ("Bankruptcy Court") granting Trustee Michael Walro's ("the Trustee") motion for turnover of the Joint Tax Refund belonging to Mr. Lee and his non-bankruptcy filing spouse, Brenda Lee ("Non-Debtor" or "Mrs. Lee") (collectively, "the Lees"). The sole issue for review on appeal is whether the Bankruptcy Court applied the proper legal standard for allocating ownership interests in a joint tax refund issued to the Debtor and Non-Debtor for purposes of determining how much of the refund should be included in the Debtor's bankruptcy estate. For the reasons set forth below, the decision of the Bankruptcy Court is REVERSED and REMANDED.


On January 3, 2012, Mr. Lee filed an individual petition for Chapter 7 Bankruptcy. On October 1, 2012, the Lees filed a Joint Federal Tax Return for the tax year 2011, as well as a Joint Indiana State Tax Return for the 2011 tax year (the "Returns"). Together, the couple was scheduled to receive a $25, 000.00 federal tax refund for overpayment of estimated tax liability ("Joint Federal Tax Refund"). With the combined State Tax Refund, the Lees received a total refund of $30, 751.00 for the tax year 2011 (the "Refund"). On February 14, 2013, the Trustee filed a Motion for Turnover seeking an order for Mr. Lee to turn over one half of the Joint Federal Tax Refund and one half of the Joint State Tax Refund for a total of $15, 375.50. Thereafter, on February 25, 2013, Mr. Lee filed his Objection to the Trustee's Motion, submitting calculations from his Certified Public Accountant James D. Kienhoop ("Mr. Keinhoop") showing that had the Lees filed individually, Mr. Lee would have incurred a $51, 744.00 federal tax liability, and Mrs. Lee would have received a $38, 774.00 federal tax refund. He also submitted a letter from Mr. Kienhoop explaining that the entire tax refund was attributable solely to Mrs. Lee's overpayment of her estimated tax liability. The parties then submitted a Joint Stipulation of Evidence Relating to Trustee's Motion for Turnover of Tax Refund and Debtor's Objection Thereto (Dkt. 11). The matter was argued to the Bankruptcy Court on April 4, 4013.

During the hearing, the Bankruptcy Court stated that it was aware of three different lines of cases regarding the issue of joint tax refund turnover. The Bankruptcy Court cited its own prior decision in applying the "minority approach" or "50/50 rule" by equally dividing the refund between the debtor and non-debtor, and indicated reluctance to consider a different approach. On April 25, 2013, the Bankruptcy Court issued an Order Approving Trustee's Motion for Turnover (Dkt. 10-4) and awarded the Trustee a turnover of $14, 588.00 from Mr. Lee, referring only to this amount as being Mr. Lee's "pro-rata share" and to "Debtor's portion (50%)."[1] It is undisputed that the Bankruptcy Court applied the 50/50 rule advocated by the Trustee; however, the Bankruptcy Court did not explain its reasoning for applying this rule in its order. Dkt. 10-4. At the hearing, however, the Bankruptcy Court expressed preference for the minority approach because it is a "bright-line rule." Dkt. 12 at 5 (under seal). On May 9, 2013, Mr. Lee filed his Motion for Leave to Appeal with the bankruptcy clerk, which was transmitted to this Court on June 25, 2013.


This Court has jurisdiction of this appeal under 28 U.S.C. § 158(a), which grants the district court jurisdiction to hear appeals from final judgments and orders, as well as from interlocutory orders of the bankruptcy court. "When a party appeals a bankruptcy court's decision under 28 U.S.C. § 158(a), district courts review a bankruptcy court's factual findings for clear error, and legal conclusions and the legal significance accorded to facts de novo. " In re Brown , 444 B.R. 173, 175 (S.D. Ind. 2011) (citing Ojeda v. Goldberg, 599 F.3d 712, 716 (7th Cir. 2010); Matter of Sheridan , 57 F.3d 627, 633 (7th Cir. 1995)). De novo review requires an independent examination of the applicable law without deference to the bankruptcy court's conclusions. Id.


The sole issue on appeal in this case is the appropriate legal standard to be applied in allocating the Refund resulting from jointly filed tax returns as between the Debtor and the Non-Debtor. Being that this is purely a matter of law and the parties have stipulated to the pertinent facts, the Court reviews the Bankruptcy Court's ruling de novo . Under the United States Bankruptcy Code, the property of a debtor's estate includes "all legal or equitable interest of the debtor in property as of the commencement of the [bankruptcy] case." 11 U.S.C. § 541(a)(1). "Although § 541 defines property of the estate', state law defines the nature and extent of those property interests." In re Hill , No. 11-10213-AJM-7, 2012 WL 5199171, at * 1 (Bankr. S.D. Ind. Oct. 22, 2012) (quoting Butner v. U.S. , 440 U.S. 48 (1979)). Refunds from jointly-filed returns present unique issues when only one of the spouses files bankruptcy. Id. Moreover, there has been no Seventh Circuit case law addressing the nature of each spouse's individual interest in a joint tax refund outside the context of a marriage dissolution proceeding. Id .

A. Methods of Allocating Joint Tax Refunds in Bankruptcy

There is a split of authority with respect to the appropriate method for allocating joint tax refunds between a debtor and a non-bankruptcy filing spouse for purposes of determining what funds may be included in the bankruptcy estate, and there are at least three different lines of cases regarding this issue. The split of authority exists not just between various circuits or districts, but even within this district. The "minority approach, " employed by the Bankruptcy Court below, is to apportion the right to the refund equally, regardless of which spouse earned the income, paid withholdings, or caused any exemptions or credits to apply (hereinafter, the "50/50 Approach"). See generally In re Page , No. 10-10728-JKC-7A, 2012 WL 174293 (Bankr. S.D. Ind. Jan. 10, 2012); In re Smith , No. 09-7276-BHL-7A, 2011 WL 345865 (Bankr. S.D. Ind. Feb. 2, 2011). The 50/50 Approach uses an allocation method based upon domestic dissolution law and presumes that spouses share equal ownership in a tax refund, which may be rebutted only by evidence of a domestic relations court order or an enforceable, written pre-petition contract between the spouses designating alternative ownership of the refund. Smith , 2011 WL 345865, at *2; see also Ind. Code § 31-15-7-5 (Rebuttable presumption that an equal division of marital property between the parties is just and reasonable). The rationale for the rule is that it provides a "bright-line rule which is easy to understand and apply, " and because a debtor spouse is jointly responsible and liable for a joint federal income tax deficiency, so should he or she "share in the good fortune of a tax refund." Smith , 2011 WL 345865, at *2.

Alternatively, the majority of courts utilize calculations that split joint tax refunds proportionately. One such approach to allocating the ownership of joint tax refunds holds that a joint refund should be allocated between spouses based upon the individuals' respective tax withholdings during the taxable year. Id. at *1. As such, a non-debtor spouse who had no tax withholdings during the relevant taxable year is not entitled to any portion of the tax refund, with the rationale that one who pays no taxes is not entitled to a refund. Id .; see also In re Kelinfeldt , 287 B.R. 291 (10th Cir. B.A.P. 2002); In re Gleason , 193 B.R. 387 (Bankr. D.N.H. 1996).

A third approach, known as the Separate Filings Rule or Internal Revenue Service Formula, requires a determination of what each spouse's contributions and tax liabilities would have been if filed separately, and applies that proportion to the joint tax refund resulting from filing the joint return. See In re Crowson , 431 B.R. 484, 491-96 (10th Cir. B.A.P. 2010). The Separate Filings Rule or Internal Revenue Service Formula apportions the refund between spouses based upon their respective tax liability and contributions, which may also allocate credit for nonfinancial contributions in the nature of tax credits. Id.

As mentioned earlier, here, the Bankruptcy court elected to use the 50/50 allocation and the Court's analysis ...

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