Internal Revenue Ser v. Luongo

Revised August 9, 2001

IN THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

_______________

No. 00-10475

_______________

In the Matter of: CONSTANCE LUONGO,

Debtor.

* * * * *

INTERNAL REVENUE SERVICE,

Appellee,

v.

CONSTANCE LUONGO,

Appellant.

---------------------------------

Appeal from the United States District Court

for the Northern District of Texas

---------------------------------

July 18, 2001

Before BARKSDALE, EMILIO M. GARZA and BENAVIDES, Circuit Judges.

BENAVIDES, Circuit Judge:

Factual and Procedural Background

This case involves a debtor’s claim to recover an income tax

overpayment for her 1997 tax year. Pursuant to 26 U.S.C. §

6402(a) of the Internal Revenue Code1 and 11 U.S.C. § 553(a) of

1

Section 6402(a) of the I.R.C. provides:

In the case of any overpayment, the Secretary . . . may credit

the amount of such overpayment . . . against any liability in

respect of an internal revenue tax on the part of the person

who made the overpayment and shall . . . refund any balance to

such person.

the Bankruptcy Code,2 the Internal Revenue Service (“IRS”) setoff

her overpayment against her unpaid 1993 tax liability, a

liability which had been discharged under § 727 of the Bankruptcy

Code. After the setoff occurred, the debtor moved to reopen her

case, and filed amended schedules which for the first time listed

her 1997 income tax overpayment as an exempt asset under § 522.

The IRS did not file any objection to the reopening of the case

or the amended schedules. The bankruptcy court granted the

motion to reopen and her schedules were amended. The

plaintiff/debtor, Constance Luongo, then brought an action in the

bankruptcy court to recover her 1997 tax overpayment. She

asserted that the setoff executed by the IRS was improper because

(1) the 1993 tax debt had been discharged in bankruptcy, and (2)

the 1997 tax overpayment had been exempted from her bankruptcy

estate. In response, the IRS argued that the bankruptcy court

lacked jurisdiction or that it should abstain from hearing the

matter. The IRS further asserted that Bankruptcy Code § 553

preserved the IRS’ right to setoff under § 6402(a),

notwithstanding the discharge of debtor’s unpaid 1993 tax debt or

her attempt to exempt the 1997 overpayment. The case was

submitted to the bankruptcy court on cross-motions for summary

judgment.

The bankruptcy court adopted the opinion in Alexander v.

2

“Although no federal right of setoff is created by the

Bankruptcy Code, 11 U.S.C. § 553(a) provides that, with certain

exceptions, whatever right of setoff otherwise exists is preserved

in bankruptcy.” Citizens Bank of Maryland v. Strumpf, 516 U.S. 16,

18, 116 S.Ct. 286, 289 (1995).

2

Internal Revenue Service, 225 B.R. 145 (Bankr. W.D. Ky. 1998),

and granted plaintiff’s motion for summary judgment. Construing

the conflicting mandates of the two sections in favor of the

debtor, the bankruptcy court in Alexander held that the language

in § 522(c) that “property exempted under this section is not

liable . . . for any debt of the debtor that arose . . . before

the commencement of the case . . .” took precedence over the

language of § 553(a) that “this title [the Bankruptcy Code] does

not affect any right of a creditor to offset. . . .” The IRS

appealed and the district court reversed. The district court

held that based on the clear and unambiguous language of § 553(a)

the IRS’ right of setoff was unaffected by Luongo’s claims that

the tax overpayment is exempt property and the tax liability was

discharged in the bankruptcy proceeding. Appellant Luongo filed

a timely notice of appeal.

While neither the district court nor the bankruptcy court

afforded the IRS’ jurisdictional claims meaningful discussion in

their respective opinions, we address these claims first as they

are necessarily antecedent to any determination of the merits.

In so doing, we conclude that the bankruptcy court had

jurisdiction to resolve the debtor’s tax dispute and did not

abuse its discretion in not abstaining. Further, we hold (1)

that the IRS permissibly setoff Appellant’s prepetition tax

overpayment against her discharged debt and (2) that Appellant

could not exempt the overpayment under § 522. Because we find

that Appellant could not properly exempt the overpayment at

issue, we do not reach the exemption issue decided below -- that

3

is, whether § 522(c) prevents a creditor from exercising its

right to setoff preserved in § 553. The judgment of the district

court is AFFIRMED.

Analysis

I. Jurisdiction and Abstention

The IRS contends first that the bankruptcy court lacked

jurisdiction to consider this matter, or in the alternative,

should have abstained. Section 505 authorizes bankruptcy courts

to determine the amount or legality of any tax liability of the

estate or the debtor. 11 U.S.C. § 505(a)(1).3 This authority,

however, is not unlimited. Section 505(a)(2)(B) provides that

the bankruptcy court may not determine –

(B) any right of the estate to a tax refund, before the

earlier of –

(i) 120 days after the trustee properly requests

such refund from the governmental unit from which

such refund is claimed; or

(ii) a determination by such governmental unit of such

request.

The IRS contends that the language of § 505(a)(2)(B) precludes a

bankruptcy court from deciding the personal tax liability of the

debtor. It relies on the inclusion of the terms “the estate” and

“the trustee” to argue that § 505 contemplates that only a

trustee may obtain a tax refund in bankruptcy court, and then

3

Section 505(a)(1) provides:

Except as provided in paragraph (2) of this subsection, the

court may determine the amount or legality of any tax, any

fine or penalty relating to a tax, or any addition to tax,

whether or not previously assessed, whether or not paid, and

whether or not contested before and adjudicated by a judicial

or administrative tribunal of competent jurisdiction.

4

only if the trustee is seeking a refund on behalf of the estate.

Initially, we note that the IRS’ reading of this subsection

is contrary to the broad grant of jurisdiction in § 505(a)(1)

permitting a bankruptcy court to determine “the amount or

legality of any tax, any fine or penalty relating to a tax, or

any addition to tax, whether or not previously assessed, whether

or not paid, and whether or not contested before and adjudicated

by a judicial or administrative tribunal of competent

jurisdiction.” Furthermore, the legislative statements

accompanying § 505 make clear that the section “authorizes the

bankruptcy court to rule on the merits of any tax claim involving

an unpaid tax, fine, or penalty relating to a tax, or any

addition to a tax, of the debtor or the estate.” 124 Cong.Rec. H

11110 (daily ed. Sept. 28, 1978) (remarks of Rep. Edwards

introducing the House amendment)(emphasis added), reprinted in,

1978 U.S.C.C.A.N. 5787, 6436, 6490. And under the paragraph

heading “Jurisdiction of the tax court in bankruptcy cases,” the

legislative statements instruct that “the bankruptcy judge will

have authority to determine which court will determine the merits

of the tax claim both as to claims against the estate and claims

against the debtor concerning his personal liability for

nondischargeable taxes.” 124 Cong.Rec. 32414 (1978) (Statement

of Representative Edwards), reprinted in 1978 U.S.C.C.A.N. 6436,

6492-93 (emphasis added); 124 Cong.Rec. 34014 (1978) (Statement

of Senator DeConcini), reprinted in 1978 U.S.C.C.A.N. 6505, 6562;

see also Begier v. IRS, 496 U.S. 53, 64-65 n. 5, 110 S.Ct. 2258,

2266 n. 5, 110 L.Ed.2d 46 (1990) (“Because of the absence of a

5

conference and the key roles played by Representative Edwards and

his counterpart floor manager Senator DeConcini, we have treated

their floor statements on the Bankruptcy Reform Act of 1978 as

persuasive evidence of congressional intent.”). The IRS cites no

case supporting its restrictive reading of the bankruptcy court’s

jurisdiction under § 505. On the contrary, absent the express

statutory limitations in § 505(a)(2)(A) and (B), bankruptcy

courts have universally recognized their jurisdiction to consider

tax issues brought by the debtor, limited only by their

discretion to abstain.4 In re Hunt, 95 B.R. 442, 445 (Bankr.

4

The dissent would dismiss Luongo’s action on the ground that

the bankruptcy court’s jurisdiction extends only to claims for

refunds that benefit the estate. We cannot agree. The dissent’s

conclusion would have a far-reaching impact on the scope of the

bankruptcy court’s jurisdiction over tax matters. Yet, no court

has recognized such a limitation. Several courts have, however,

recognized the right of a debtor to bring a refund action. See In

re Ryan, 64 F.3d 1516, 1520 (11th Cir. 1995) (allowing Chapter 7

debtor to maintain a refund action in bankruptcy court upon

compliance with treasury regulations); In re Gribben, 158 B.R. 920,

924 (S.D.N.Y. 1993) (concluding that Ҥ 106(a) waives the

Government’s sovereign immunity where a bankrupt debtor seeks a

refund in circumstances where the IRS has exercised the right under

§ 553(a) of the Bankruptcy Code to offset that refund against other

tax liabilities.”).

Section 505(a)(2)(B), like § 505(a)(2)(A), limits the

jurisdictional grant in § 505(a)(1). Section 505(a)(1) grants the

bankruptcy court jurisdiction over any tax claim, including refund

claims; § 505(a)(2)(B) then prescribes the limits particular to the

bankruptcy court’s ability to determine a refund. The intended

purpose of subsection (a)(2)(B) was to prevent a refund claim from

languishing in the administrative processes, not to restrict the

scope of the bankruptcy court’s jurisdiction over tax refunds to

those benefitting the estate. In re St. John’s Nursing Home, Inc.,

154 B.R. 117, 120 (Bankr.D.Mass. 1993). Section 505(a)(2)(B) thus

permits the bankruptcy court to make a determination of a refund if

the taxing authority does not act upon a refund claim within 120

days. Although not disputed by the parties, we note, in response

to the dissent, that Luongo complied with the requirements of §

6

505(a)(2)(B) by filing her annual tax return. See 26 C.F.R. §

301.6402-3(a)(5) (1994) (“A properly executed individual . . .

income tax return . . . shall constitute a claim for refund or

credit . . . for the amount of the overpayment disclosed by such

return”). The IRS, by setting off the overpayment against the

discharged tax liability, made a “determination” in accordance with

§ 505(a)(2)(B) of Luongo’s refund-request for the overpayment.

Even the dissent’s focus on the language “the right of the

estate to a refund” does not support its position that §

505(a)(2)(B) deprives the bankruptcy court of jurisdiction to hear

Luongo’s claim. In this regard, the dissent mistakenly concludes

that property listed as exempt by the debtor does not fall in this

category. On the contrary, it is a fundamental principle of

bankruptcy law that only property of the estate may be exempted by

the debtor. Owen v. Owen, 500 U.S. 305, 308 (1991). The estate

comprises “all legal or equitable interests of the debtor in

property as of the commencement of the case.” 11 U.S.C. § 541(a).

In the present case, any overpayment made by Luongo occurred

prepetition and any right to a refund is therefore property of the

estate. Kokoszka v. Belford, 417 U.S. 642, 645-58, 94 Sct. 2431,

2433-35 (1974). Upon proper recognition that exempted property

first enters the estate and that the estate has a right to any

refund in the present case, it becomes clear that our holding does

not read the term “right of the estate” out of the statute as

alleged by the dissent.

The dissent concedes that Luongo could bring a claim for a

determination of her tax liability. The dissent, however, would

not allow Luongo to bring her refund claim. The dissent’s

distinction apparently derives, in part, from its premise that

general unsecured creditors, not the debtor, are the intended

beneficiaries of § 505(a). Relying on this premise, the dissent

endeavors to rewrite the language of § 505(a)(2)(B) by converting

“the right of the estate to a refund” into “a refund that benefits

the estate.” While seemingly a benign distinction, the dissent’s

erroneous limitation of the estate to “property which will be used

to pay the creditors,” renders it significant. The dissent’s

ultimate result is thus to permit only refunds that benefit

creditors, not “what Luongo seeks through her action– a refund

solely for her own benefit.” Under the dissent’s interpretation,

even the trustee could not seek a refund if the debtor had listed

it as exempt on her schedules, thereby preventing the bankruptcy

court from protecting the debtor’s use of exemptions to gain a

fresh start regardless of who filed the refund action. The

dissent’s limitation on the bankruptcy court’s jurisdiction also

ignores the fact that a bankruptcy court is entitled to determine

the debtor’s nondischargeable tax liability. Congress’ allowance

7

N.D. Tex. 1989) (“[T]he reported decisions uniformly recognize

the Bankruptcy Court’s jurisdiction to determine a debtor’s tax

liability . . . .”).

The bankruptcy court’s ability to abstain is premised on

Congress’ use of the word “may” in § 505. In re Beisel, 195 B.R.

378, 379 (Bankr. S.D. Ohio 1996) (“Section 505(a)(1) allows but

does not require the Bankruptcy Court to determine a debtor’s tax

liabilities.”). The factors frequently cited by the courts in

deciding whether to abstain include the complexity of the tax

issues to be decided, the need to administer the bankruptcy case

in an orderly and efficient manner, the burden on the bankruptcy

court’s docket, the length of time required for trial and

decision, the asset and liability structure of the debtor, and

the prejudice to the taxing authority. In re Hunt, 95 B.R. at

445. Several courts have also taken into consideration what they

identify as the two-fold purpose of § 505: (1) “affording a forum

for the ready determination of the legality or amount of tax

claims, which determination, if left to other proceedings, might

delay conclusion of the administration of the bankruptcy estate,”

In re Diaz, 45 B.R. 137, 138 (Bankr. S.D. Fla. 1984), and (2)

“providing an opportunity for the trustee, on behalf of the

creditor, to contest the validity and amount of a tax claim when

the debtor has been unwilling or unable to do so.” In re

of the bankruptcy court to make such a determination undermines the

dissent’s assertion that § 505 serves the limited purpose of

allowing the bankruptcy court to adjudicate tax matters affecting

the estate or benefitting creditors.

8

Millsaps, 133 B.R. 547, 554 (Bankr. M.D. Fla.1991); see also City

of Amarillo v. Eakens, 399 F.2d 541, 543-44 (5th Cir. 1968) (“The

amendment, by authorizing redeterminations in those instances

where the tax claim was never appealed, serves to protect

creditors of the bankrupt from the bankrupt’s lack of

diligence.”).

The bankruptcy courts that have focused on these

requirements consider general unsecured creditors, not the

debtor, the intended beneficiaries of § 505(a). In re Williams,

190 B.R. 225, 227 (Bankr. W.D. Pa. 1995); In re Tropicano Inc.,

128 B.R. 153, 161 (Bankr. W.D. Tex. 1991). These courts conclude

that when neither of the above two purposes would be served by a

bankruptcy court determination of a chapter 7 debtor’s tax

liability, abstention is warranted. These cases improperly view

§ 505 in isolation without proper deference to the other goals of

the Bankruptcy Code. The bankruptcy court’s responsibility in

administering the estate is not only to achieve a fair and

equitable distribution of assets to the creditors, but also to

“relieve the honest debtor from the weight of oppressive

indebtedness and permit him to start afresh.” Local Loan v.

Hunt, 292 U.S. 234, 244, 54 S.Ct. 695, 699 (1934). Thus, a court

should consider the impact of the abstention not only on the

general administration of the estate, but also on the debtor. In

re Smith, 122 B.R. 130, 133-134 (M.D. Fla. 1990) (declining to

exercise discretion because it would not assist the debtor to

have a fresh start in life).

9

Another touchstone of the abstention inquiry is the

substantive law governing the material issues. When bankruptcy

issues are at the core of a dispute, it would be absurd for a

bankruptcy court to abstain from deciding those matters over

which it has particular expertise. On the other hand, simply

because tax law is somehow implicated does not automatically

trigger abstention. Just as bankruptcy courts are often called

upon to apply state law in resolving bankruptcy matters, so too

may they apply tax law in appropriate circumstances.5 In tax

cases, the issue of abstention often arises with respect to

questions of dischargeability. Many of the courts that have

abstained cite the legislative history that:

. . . in the case of nondischargeable Federal income

taxes, the IRS would be required to issue a deficiency

notice to an individual debtor, and the debtor could

then file a petition in the Tax Court–or a refund suit

in a district court–as the forum in which to litigate

his personal liability for a nondischargeable tax.

124 Cong. Rec. H 11110 (Sept. 28, 1978, remarks of Rep. Edwards);

S 17427 (Oct. 6, 1978, identical remarks of Sen. DeConcini).

This quote and the cases relying on it are predicated on the non-

dischargeability of the tax. Where the determination of

dischargeability or other bankruptcy specific issues is fully

resolved, we agree with the IRS that there is no reason why the

suit cannot be heard by a district court, the Tax Court, or the

5

“Bankruptcy courts routinely interpret state law in order to

resolve disputes in bankruptcy cases.” In re Wilson, 85 B.R. 722,

727 (Bankr.E.D.Pa.1988). For example, the bankruptcy court may

avoid a preference under 11 U.S.C. § 547 or a fraudulent transfer

under 11 U.S.C. § 548, even though these defenses are intertwined

with state law.

10

Court of Federal Claims.6 Our case, on the other hand, is more

analogous to those cases where the court was faced with the

preliminary bankruptcy question of whether the tax liability was

dischargeable. See In re Shapiro, 188 B.R. 140, 143 (Bankr. E.D.

Pa. 1995)(concluding that while the bankruptcy court is the

appropriate forum to determine the bankruptcy issue of

dischargeability, it would be inappropriate for the bankruptcy

court to decide the amount of the debtor’s non-dischargeable

liability, which relies on non-bankruptcy law); In re Wood, 1994

WL 759753 (Bankr. N.D. Ga. Nov. 21, 1994) (court abstained from

fixing the amount of the debt but set a trial with regard to the

issue of dischargeability); In re Gosciniak, 1994 WL 585928, at

*3 (Bankr. S.D. Ind. May 25, 1994) (court ruled on

dischargeability but abstained from deciding amount of

liability). In the instant case, Appellant was not requesting

the bankruptcy court to determine the amount of her tax

liability, but instead whether her tax overpayment, by virtue of

exemption or dischargeability, was protected from setoff by the

IRS.

In In re Shapiro, the bankruptcy court noted several cases

which follow the increasing trend of “dismissing a pending

adversary proceeding which does not involve bankruptcy law

issues, upon dismissal of the bankruptcy case itself.” 188 B.R.

at 148 (citing Chapman v. Currie Motors, Inc., 65 F.3d 78 (7th

6

Taxpayers can appeal adverse determinations by the IRS to

the Tax Court or Court of Federal Claims, or they can pay any

assessment and bring suit in the district court. I.R.C. § 7422.

11

Cir. 1995)). In Chapman, the Seventh Circuit found that the

bankruptcy court properly abstained from deciding a “related to”

proceeding where the resolution of the matter did not rely on

bankruptcy law and neither party alleged that the objectives of

the Bankruptcy Code would be impaired. 65 F.3d at 82. We find

such reasoning persuasive. Accordingly, we hold that where

bankruptcy issues predominate and the Code’s objectives will

potentially be impaired, bankruptcy courts should generally

exercise jurisdiction.7 Conversely, absent any bankruptcy issues

or implication of the Code’s objectives, it is usually

appropriate for the bankruptcy court to decline or relinquish

jurisdiction. We recognize, of course, that there may be

instances where exceptional factors involving judicial economy,

fairness and convenience to the litigants, or the simplicity of

the non-bankruptcy issues involved may counsel otherwise. See In

re Smith, 866 F.2d 576, 580 (3d Cir. 1989). Such instances

should be rare and we trust bankruptcy courts will exercise their

jurisdiction prudently.

We now consider the application of this standard to the

present case. This Court reviews the bankruptcy court’s decision

not to abstain for an abuse of discretion. Matter of Howe, 913

F.2d 1138, 1143 (5th Cir. 1990). In this case, Appellant

7

Such bankruptcy objectives include, but are not limited to,

ensuring the efficient administration and equitable distribution of

the estate for the benefit of the creditors and protecting the

debtor’s right to a fresh start. See In re Henderson, 18 F.3d

1305, 1307 (5th Cir. 1994) (recognizing “the Bankruptcy Code’s

important objective of allowing the debtor to gain a fresh start in

his financial life.”).

12

received a discharge of her 1993 tax liability pursuant to § 727

of the Bankruptcy Code. The IRS then exercised its right to

setoff established in § 6402 of the I.R.C. and preserved in § 553

of the Bankruptcy Code. Finally, Appellant claimed her tax

overpayment as an exempt asset under § 522 of the Bankruptcy

Code. We begin the abstention inquiry by identifying the

material issues: first, whether Appellant could exempt her tax

overpayment under § 522; second, whether § 522(c) immunizes

exempt property from setoff; and third, whether §§ 524(a)(2) and

553 of the Bankruptcy Code permit a creditor to setoff against

discharged debt. The resolution of these issues, although

involving the IRS’ right to setoff under § 6402(a) of the I.R.C.,

was governed predominantly by bankruptcy law. Notably, there is

no dispute over the amount of the parties’ respective tax

liabilities or that outside of bankruptcy the IRS would have the

right to setoff. Instead, the resolution of this matter required

the bankruptcy court to interpret conflicting sections of the

Bankruptcy Code and to determine the proper scope of the parties’

rights to dischargeability, exemption, and setoff. Such

determinations are best made by the bankruptcy court. The second

prong of the abstention inquiry also counsels in favor of the

bankruptcy court retaining jurisdiction. Appellant’s rights to

the integrity of her discharge and to the use of her exemptions

are integral to the Code’s objective in providing a fresh start.

Under the circumstances presented here, the bankruptcy court’s

decision not to abstain was clearly proper.

13

II. IRS’ Right to Setoff

On May 19, 1998, Appellant Luongo filed for relief under

Chapter 7 of the Bankruptcy Code. At the time of her filing she

owed the IRS $3,800 in unpaid taxes from her 1993 tax year. On

August 15, 1998, Appellant filed her 1997 income tax return

showing an overpayment of $1,395.94. The bankruptcy court

entered an order on September 10, 1998 discharging Appellant’s

personal liability for her 1993 income tax deficiency.

Subsequently, in November 1998, the IRS executed its claim to

setoff and applied all of Appellant’s 1997 tax overpayment to her

unpaid 1993 tax liability.8

Appellant first argues that the discharge of her 1993 tax

liability under § 524(a)(2) bars the IRS from executing its claim

to setoff. Section 524(a)(2) provides:

(a) A discharge in a case under this title –

(2) operates as an injunction against the commencement or

continuation of an action, the employment of process, or an

act, to collect, recover, or offset any such debt as a

personal liability of the debtor, whether or not discharge

of such debt is waived;

11 U.S.C. § 524(a)(2) (emphasis added). There is an apparent

inconsistency between § 524(a)(2)’s prohibition on offsets and §

553's recognition of setoff rights. Section 553(a) provides:

(a) Except as otherwise provided in this section and

8

A setoff or offset is “[a] deduction; a counterclaim; a

contrary claim or demand by which a given claim may be lessened or

canceled.” BLACK’S LAW DICTIONARY 1085 (6th Ed. 1990). Setoff is

distinguished from recoupment in that a setoff is “[a] counter-

claim demand which defendant holds against plaintiff, arising out

of a transaction extrinsic of plaintiff’s cause of action.” BLACK’S

LAW DICTIONARY 1372 (6th Ed. 1990).

14

sections 362 and 363 of this title, this title does not

affect any right of a creditor to offset a mutual debt by

such creditor to the debtor that arose before the

commencement of the case under this title against a claim of

such creditor against the debtor that arose before the

commencement of the case . . . .

We agree with the vast majority of courts considering the

relationship between § 524(a) and § 553 that a debtor’s discharge

in bankruptcy does not bar a creditor from asserting its right to

setoff. See In re Davidovich, 901 F.2d 1533 (10th Cir. 1990); In

re Buckenmaier, 127 B.R. 233 (9th Cir. B.A.P. 1991); Posey v.

Dept. of Treasury, 156 B.R. 910 (W.D.N.Y. 1993); Reich v.

Davidson Lumber Sales Emp. Ret. Plan, 154 B.R. 324 (D. Utah

1993); In re Thompson, 182 B.R. 140 (Bankr. E.D. Va. 1995); In re

Runnels, 134 B.R. 562 (Bankr. E.D. Tex. 1991); In re Morgan, 77

B.R. 81 (Bankr. S.D. Miss. 1987); In re Conti, 50 B.R. 142

(Bankr. E.D. Va. 1985); In re Ford, 35 B.R. 277 (Bankr. N.D. Ga.

1983); In re Shaw Constr. Corp., 17 B.R. 744 (Bankr. E.D. Pa.

1982); Krajci v. Mt. Vernon Consumer Discount Co., 16 B.R. 464

(Bankr. E.D. Pa. 1981). But see In re Dezarn, 96 B.R. 93, 95

(Bankr. E.D. Ky. 1988); In re Johnson, 13 B.R. 185, 189 (Bankr.

M.D. Tenn. 1981). It is impossible for us to ignore the clear

statement of § 553 that “this title [the Bankruptcy Code] does

not affect any right of a creditor to offset . . . .” We

interpret this statement to allow a discharged debt to be setoff

upon compliance with the terms and conditions provided in § 553,

notwithstanding § 524(a)’s post-discharge bar. This

interpretation avoids the “possible injustice in requiring a

15

creditor to file its claim for satisfaction in the bankruptcy

court, while at the same time compelling the same creditor to pay

in full its debt to the bankruptcy estate.” In re Davis, 889

F.2d at 661 (quoting In re Southern Indus. Banking Corp., 809

F.2d 329, 332 (6th Cir.1987)). Our interpretation also creates

an equitable balance by preventing affirmative action to collect

the discharged debt, while preserving the creditor’s right to

raise a discharged debt as a defense to a recovery action brought

by the debtor. “In these circumstances, where the creditor’s use

of § 553 is defensive, the spirit of § 524(a)(2), ‘to eliminate

any doubt concerning the effect of the discharge as a total

prohibition on debt collection efforts’ is not violated.” In re

Ford, 35 B.R. at 280 (quoting S.Rep. No. 598, 95th Cong., 2d

Sess. 80 (1978), U.S.C.C.A.N. 1978, 5866).

In order to establish a valid right to setoff under § 553,

the IRS must prove: (1) a debt owed by the creditor to the debtor

which arose prior to the commencement of the bankruptcy case; (2)

a claim of the creditor against the debtor which arose prior to

the commencement of the bankruptcy case; and (3) the debt and

claim must be mutual obligations. Braniff Airways, Inc. v. Exxon

Co., 814 F. 2d 1030, 1035 (5th Cir. 1987). The second and third

conditions are easily satisfied in the present case. First,

Appellant owed the IRS $3,800 arising out of her 1993 tax year.

Second, the debts involved are between the same parties standing

in the same capacity, the requisite for mutuality.

The final condition is that the IRS’ debt to Appellant arose

prior to the commencement of the bankruptcy case. Creditors are

16

limited by the terms of § 553 to offsetting debts owed the debtor

prepetition.9 In re Eggemeyer, 75 B.R. 20, 22 (Bankr. S.D. Ill.

1987) (“The discharge of a debt in a bankruptcy proceeding does

not affect the creditor’s right to setoff, provided the right of

setoff existed at the time the bankruptcy petition was filed.”).

Whether a debt arises prepetition is governed by when the debt

accrued, not when the action for recovery was brought. “A tax

obligation accrues when the event that triggers liability has

occurred.” Matter of Midland Indus. Service Corp., 35 F.3d 164,

167 (5th Cir. 1994). As of December 31, 1997 all of the events

necessary to establish Appellant’s tax liability for her 1997 tax

year had occurred.10 The date she actually filed her return is

not relevant in determining when the debt arose.11 Id. at 167

("[A] tax claim is incurred on the date it accrues rather than

the date it is assessed or becomes payable."). Thus, her

bankruptcy petition having been filed on May 19, 1998, the

overpayment (the debt owed the debtor by the creditor) arose

prior to the commencement of the case.

Practical considerations reinforce a rule governing setoff

9

Any incentive for a creditor to garner assets of the debtor

in anticipation of a pending bankruptcy is abated by the trustee’s

power to avoid such preferences under § 547.

10

The reference to December 31 does not imply that tax

liability or overpayments cannot be established on a pro rata basis

throughout the year. We need not consider that question in the

present case.

11

The right to setoff exists provided that the debt is owed

at the time the petition is filed even though it was not due or

liquidated. Braniff Airways, 814 F.2d at 1035-36; COLLIER ON

BANKRUPTCY, ¶ 553.03[1][d] at 553-16, [f] at 553-18 (15th ed. 1996).

17

against discharged debt that disregards the timing of the

debtor’s action in favor of when it accrued. A contrary

conclusion would open the proverbial floodgates to all manner of

deception.12 Specifically with regard to taxes, allowing

dischargeability to act as a bar would permit a debtor to shelter

assets from his creditors by making substantial overpayments to

the IRS during a given tax year. The debtor could withhold the

filing of his tax return until after he had filed for bankruptcy

and received a discharge. Post-discharge, the debtor could

obtain his tax refund free from the claims of his creditors.13

Such a result would not comport with the equitable nature of the

Bankruptcy Code. Accordingly, we find the IRS’ debt to Appellant

as a result of her overpayment during the 1997 tax year arose

prepetition. Having established a valid right of setoff under §

553, the IRS permissibly offset Appellant’s overpayment against

12

“If the court in [In re Johnson, 13 B.R. 185, 189 (Bankr.

M.D. Tenn. 1981)] were correct in its interpretation of § 553, then

a debtor could prevent a creditor from effecting a setoff by

waiting to file suit on a prepetition transaction until after he

had filed a petition for relief. We conclude that the proper

interpretation of § 553 is that it allows the setoff of mutual

debts both of which arose before bankruptcy, regardless of when

suit thereon is instituted. This would, thus, allow a creditor to

raise a discharged debt as a defense to an action brought by the

debtor, regardless of when that action is instituted, if that

action is based on a claim or cause of action which arose before

bankruptcy.” In re Shaw Construction Corp., 17 B.R. at 748.

13

In the present case, Appellant reopened her bankruptcy case

and listed the overpayment as an asset. In cases where the debtor

does not list the claim as an asset, yet later commences a

proceeding based on that claim, she would likely be judicially

estopped from prosecuting her action. See In re Coastal Plains,

Inc., 179 F.3d 197 (5th Cir. 1999).

18

her discharged 1993 tax liability.

After the IRS executed its setoff rights, Appellant moved to

reopen her case and filed amended schedules exempting the 1997

tax overpayment. Appellant’s second claim is that by virtue of

the exemption of her tax overpayment, the IRS is prohibited from

exercising its right to setoff. The commencement of the

bankruptcy case creates a bankruptcy estate, which includes all

“legal and equitable interests of the debtor.” 11 U.S.C. § 541;

Owen v. Owen, 500 U.S. 305, 308 (1991); Martin v. United States,

159 F.3d 932, 934 (5th Cir. 1998). Bankruptcy Code section 522

then permits a debtor to exempt certain property of the

bankruptcy estate. 11 U.S.C. § 522(b). Property exempted under

§ 522 is removed from the estate for the benefit of the debtor.

Thus, it is axiomatic that property cannot be exempted unless it

was first part of the estate:

An exemption is an interest withdrawn from the estate

(and hence from creditors) for the benefit of the

debtor.

***

Property that is properly exempted under § 522 is (with

some exceptions) immunized against liability for

prebankruptcy debts. § 522(c). No property can be

exempted (and therefore immunized), however, unless it

first falls within the bankruptcy estate. Section

522(b) provides that the debtor may exempt certain

property “from property of the estate”; obviously,

then, an interest that is not possessed by the estate

cannot be exempted.

Owen, 500 U.S. at 308 (emphasis in original). A debtor’s claim

to a tax refund is property of the estate. Mueller v.

Commissioner, 496 F.2d 899, 903 (5th Cir. 1974). However, under

26 U.S.C. § 6402(a) the debtor is generally only entitled to a

19

tax refund to the extent that her overpayment exceeds her unpaid

tax liability. In re Davis, 889 F.2d at 661. In the present

case, the estate had a tax liability totaling $3,800, while the

1997 overpayment totaled only $1,395.94. Section 6402(a) grants

the IRS discretion whether to offset against a debtor’s unpaid

tax liability or to refund the overpayment to the taxpayer. The

IRS elected to exercise that discretion to apply the overpayment

to Appellant’s past liability. Because the prior unpaid tax

liability exceeded the amount of the overpayment, the debtor was

not entitled to a refund and the tax refund did not become

property of the estate. Absent an interest in the estate to the

refund, it could not properly be exempted by the debtor under §

522.

Conclusion

We reject the IRS’ contention that the bankruptcy court

lacked jurisdiction over this proceeding. Section 505(a)(1)

vests the bankruptcy court with broad jurisdiction over tax

matters of the estate and the debtor, including determinations

with respect to the personal liability of the debtor. The IRS’

alternative contention that the bankruptcy court should have

abstained and permitted this action to be brought in the Tax

Court or the district court is also rejected. The bankruptcy

court did not abuse its discretion in not abstaining from a

proceeding involving issues governed predominantly by bankruptcy

law and implicating one of the Code’s paramount objectives of

providing the honest debtor with a fresh start. The bankruptcy

20

court erred, however, by preventing the IRS from enforcing its

statutory right to setoff, established in § 6402(a) of the I.R.C.

and preserved in § 553 of the Bankruptcy Code, against a tax

overpayment that arose prior to the commencement of the case.

Upon compliance with the terms of § 553, a creditor’s right to

setoff is not affected by the post-discharge bar on collection

efforts in § 524(a)(2). Additionally, under our controlling

caselaw, the estate did not have an interest in the tax

overpayment which could be exempted by Appellant. The bankruptcy

court erred in permitting Appellant to exempt property, pursuant

to § 522, which had not entered the estate. Because we find

Appellant could not exempt the overpayment under § 522, we leave

open the question of whether § 522(c) immunizes exempt property

from setoff. We AFFIRM the judgment of the district court.

21

EMILIO M. GARZA, Circuit Judge, dissenting:

In contrast to the majority, I would not reach the merits of

Constance Luongo’s claim for a refund. Instead, I would dismiss

her action on the ground that, under 11 U.S.C. § 505(a)(2)(B),

the bankruptcy court lacked jurisdiction over her refund claim.

I find that the bankruptcy court’s jurisdiction extends only to

claims for refunds that benefit the estate. The majority rejects

this contention with a cursory analysis of the statute—simply

reciting the statutory text, but relying on legislative history

pertaining only to tax liability claims. In dispensing with the

assertion that § 505 bars the bankruptcy court’s exercise of

jurisdiction over this case, the majority overlooks the plain

meaning of the statute and the legislative history regarding the

bankruptcy court’s jurisdiction over refund claims.

It is a cardinal rule of statutory interpretation that we

begin our analysis by examining the statute’s text. See INS v.

Phinpathya, 464 U.S. 183, 189, 104 S. Ct. 584, 589, 78 L. Ed. 2d

401 (1984) (“This Court has noted on numerous occasions that in

all cases involving statutory construction, our starting point

must be the language employed by Congress, . . . and we assume

that the legislative purpose is expressed by the ordinary meaning

of the words used.”) (quotations and citations omitted). Mere

quotation of the statute does not satisfy this requirement;

instead, we must give studied consideration to Congress’s words.

-22-

Moreover, § 505 abrogates the government’s sovereign immunity,

requiring us to strictly construe it in favor of the sovereign.

See 11 U.S.C. § 106 (expressly abrogating sovereign immunity

where suits are brought pursuant to § 505); Dept. of the Army v.

Blue Fox, 525 U.S. 255, 261, 119 S.Ct. 687, 691, 142 L. Ed. 2d

718 (1999) (statutes abrogating sovereign immunity are to be

strictly construed).

Section 505(a)(1) is a grant of jurisdiction, providing

that:

Except as provided in paragraph (2) of this subsection,

the court may determine the amount or legality of any

tax, any fine or penalty relating to a tax, or any

addition to tax, whether or not previously assessed,

whether or not paid, and whether or not contested

before and adjudicated by a judicial or administrative

tribunal of competent jurisdiction.

(Emphasis added). I agree with the majority that the word “may”

in § 505(a)(1) arms the bankruptcy court with the discretion to

exercise the jurisdiction granted to it by § 505. This grant of

jurisdiction is, however, limited. The prefatory phrase

“[e]xcept as provided in paragraph (2) of this subsection”

expressly limns this grant of discretionary jurisdiction to those

cases that are not within the parameters established by paragraph

(2). Even if (a)(1) did not contain this explicit exception,

paragraph (2) begins by stating that the “court may not so

determine” those cases set out in (2)(A) and (B). In its rules

of construction, the Bankruptcy Code provides that “‘may not’ is

-23-

prohibitive, and not permissive,” making clear that the

bankruptcy court is prohibited from deciding cases in (2)(A) and

(B). 11 U.S.C. § 102(4). Furthermore, our circuit has

previously accepted that paragraph (2) limits the bankruptcy

court’s jurisdiction, requiring us to determine whether the case

at hand falls within the circumstances set out by that paragraph.

See In re Armstrong, 206 F.3d 465, 474 (5th Cir. 2000) (holding

that the bankruptcy court lacked jurisdiction to consider a

refund claim where the trustee failed to comply with §

505(a)(2)(B)); Tex. Comptroller of Pub. Accounts v. Trans State

Outdoor Adver. Co. (In re Trans State Outdoor Adver. Co.), 140

F.3d 618, 620 (5th Cir. 1998) (holding that if the chapter 11

debtor’s tax liability claim fell within § 505(a)(2)(A), the

bankruptcy court lacked jurisdiction to consider the claim);

Internal Rev. Serv. v. Teal (In re Teal), 16 F.3d 619, 622 (5th

Cir. 1994) (“Simply stated § 505(a)(2)(A), a jurisdictional

statute, is mandatory”). Consequently, the plain meaning of the

text compels us to examine whether § 505(a)(2) deprives the

bankruptcy court of jurisdiction.

Section 505(a)(2)(B) provides that:

the court may not so determine

(B) any right of the estate to a refund, before

the earlier of—

(i) 120 days after the trustee properly

requests such refund from the governmental

unit from which the refund is claimed; or

(ii) a determination by such governmental unit of

such request.

-24-

Luongo claims that the IRS owes her a refund. Subparagraph (B)

is the only provision in § 505 that addresses “refund” claims.

Hence, subparagraph (B) must be the starting place for

determining whether the bankruptcy court has jurisdiction over

Luongo’s claim. See Constable Terminal Corp. v. City of Bayonne,

N.J. (In re Constable Terminal Corp.), 222 B.R. 734, 737 (Bankr.

D.N.J. 1998) aff’d In re Constable Terminal Corp., 246 B.R. 181

(D.N.J. 2000) (“Clearly, when addressing whether a court may

grant a debtor a tax refund, the court’s decision of the issue

must begin with the language of § 505(a)(2)(B).”); see also

Roberts v. Sullivan County (In re Penking Trust), 196 B.R. 389,

394 (Bankr. E.D. Tenn. 1996) (noting Congress’s “distinctive

treatment” of refund claims).

Subparagraph (B) establishes three conditions precedent to a

bankruptcy court’s jurisdiction over refund claims. First,

refund claims must be properly requested from the relevant

governmental unit. See 11 U.S.C. § 505(a)(2)(B)(i). In order to

“properly request” a refund, a trustee must comply with the

refund procedures set forth by the government from which it seeks

a refund. See In re Armstrong, 206 F.3d at 472 (“A ‘proper

request’ [for a refund] under the Internal Revenue Code requires

compliance with [26 U.S.C.] §§ 7422 and 6511”); Roberts, 196 B.R.

at 396 (“A ‘proper’ request under § 505(a)(2)(B) connotes

correctness and dictates conformity with the pertinent taxing

-25-

authority’s mechanism for seeking a refund.”). Failure to do so

deprives the bankruptcy court of jurisdiction. See In re

Armstrong, 206 F.3d at 472 (finding that where the trustee failed

to comply with Internal Revenue Code procedures for requesting a

refund, the bankruptcy court lacked jurisdiction to hear the

refund claim); City of Perth Amboy v. Custom Distrib. Servs.,

Inc. (In re Custom Distrib. Servs., Inc.), 224 F.3d 235, 243-44

(3d Cir. 2000) (holding that where the chapter 11 debtor failed

to comply with state procedural requirements, the bankruptcy

court lacked jurisdiction to hear the refund claim). Second, the

subparagraph sets out when in time the bankruptcy court may

exercise jurisdiction over a refund claim. The bankruptcy court

can act once the relevant governmental unit reaches a

determination on the claim or after the passage of 120 days from

the date on which the trustee made his request, whichever is

earlier. Thus, these two preconditions operate as an exhaustion

requirement, mandating that the trustee allow the governmental

unit to receive and act on the refund claim, although it must act

within 120 days, before the bankruptcy court can exercise

jurisdiction over the refund claim.

Third, and most important for this case, the text and

purpose of subparagraph (B) tell us what kind of refund claim the

bankruptcy court has jurisdiction to consider when the first two

conditions have been met: a refund claim brought for the benefit

-26-

of the estate. Section 505(a)(2)(B) refers to the “right of the

estate to a refund.” The estate encompasses the property

outlined in 11 U.S.C. § 541, which will be used to pay the

creditors. See 5 Collier on Bankruptcy ¶ 541. 01 (15th ed.

1999). “Congress is presumed to know the meaning of the words it

uses, especially in highly complex and intricate statutory

schemes.” United States v. Sotelo, 436 U.S. 268, 286-87, 98 S.

Ct. 1795, 1806, 56 L. Ed. 2d 275 (1978) (Rehnquist, J.

dissenting); cf. Molzof v. United States, 502 U.S. 301, 307, 112

S. Ct. 711, 716, 116 L. Ed. 2d 731 (1992) (“‘[W]here Congress

borrows terms of art in which are accumulated the legal tradition

and meaning of centuries of practice, it presumably knows and

adopts the cluster of ideas that were attached to each borrowed

word in the body of learning from which it was taken and the

meaning its use will convey to the judicial mind unless otherwise

instructed.’”) (quoting Morissette v. United States, 342 U.S.

246, 263, 72 S. Ct. 240, 250, 96 L. Ed. 288 (1952)). The

Bankruptcy Code is such a statutory scheme, and the word “estate”

does not include what Luongo seeks through her action—a refund

solely for her own benefit.14 We must presume that in using the

14

In response to this contention, the majority asserts that the

definition of the estate, as provided in § 541 undermines my

construction of the words “right of the estate.” The majority notes

that § 541 defines property of the estate broadly to include property

that the debtor may later declare exempt. Based on this definition, the

majority asserts that the estate has a right to the refund claim at

issue here and that its construction of § 505 does not read “‘the right

-27-

of the estate’ out of the statute,” as I later contend it does. While

the majority is correct that property that the debtor may later declare

exempt is property of the estate, the majority’s analysis fails to

account for the impact of the exemption. The Supreme Court defined an

exemption as “an interest withdrawn from the estate (and hence from the

creditors) for the benefit of the debtor.” Owen v. Owen, 500 U.S 305,

308, 111 S.Ct. 1833, 1835, 114 L.Ed.2d 350 (1991) (emphasis added); see

Wischan v. Adler, 77 F.3d 875, 877 (5th Cir. 1997) (“Although the

proceeds of the pre-petition personal injury causes are initially

property of the estate, some states and the federal government have

created exemptions for them”) (emphasis added). The exempt property

leaves the estate and vests in the debtor. See Bell v. Bell (In re

Bell), 225 F.3d 203, 216 (2d Cir. 2000) (“It is well-settled law that

the effect of . . . exemption is to remove property from the estate and

vest it in the debtor.”); Mayer v. Nguyen (In re Nguyen), 211 F.3d 105,

107 & 109 (4th Cir. 2000) (the operation of the exemption is to

“exclude” the exempt property from the estate); In re Gamble, 168 F.3d

442, 443 (11th Cir. 1999) (“exempt property is not part of the

bankruptcy estate”); Seror v. Kahan (In re Kahan), 28 F.3d 79, 81 (9th

Cir. 1994) (“The bankruptcy estate includes all of the debtor’s

interests in property at the commencement of the case, except property

that the debtor elects to exempt.”); Abramowitz v. Palmer, 999 F.2d

1274, 1276 (8th Cir. 1993) (holding that where trustee failed to object

to exemption, the trustee was “precluded from including” the property

in the debtor’s bankruptcy estate); In re Yonikus, 996 F.2d 866, 870

(7th Cir. 1993) (“[a]fter an asset is property of the estate . . ., it

can still past out of the estate (thus out of the reach of creditors)

as a” § 522 exemption); Taylor v. Freeland & Kronz, 938 F.2d 420, 422

(3d Cir. 1991) (“[T]he property so exempted is no longer considered

property of the bankruptcy estate.”); Sherk v. Tex. Bankers Life & Loan

Ins. Co. (In re Sherk), 918 F.2d 1170, 1174 (5th Cir. 1990) abrograted

on other grounds by Taylor v. Freeland & Kronz, 504 U.S. 638, 112 S.Ct.

1644, 118 L.Ed.2d 280 (1992) (exempt property “is no longer property of

the estate”); Norton Bankruptcy Law and Practice 2d § 51:2 (2000) (“The

debtor by acting affirmatively, may take the required action to set

aside his or her exemptions. The court may determine what is

appropriately exempted and what property remains in the estate.”)

(emphasis added); see also Graziadeai v. Graziadei (In re Graziadei),

32 F.3d 1408, 1410 n.2 (9th Cir. 1994) (bankruptcy court lacked

jurisdiction over homestead property because it was exempt and therefore

had no conceivable effect on the estate). But see Traina v. Sewell (In

re Sewell), 180 F.3d 707, 710 (5th Cir. 1999) (contrasting excluded

property with exempt property and noting that exempt property is

“included in the bankruptcy estate but ‘exempted from use in satisfying

claims of creditors and other authorized charges.”). Even the majority

-28-

phrase “right of the estate,” Congress intended for this to be

the only type of refund claim encompassed by § 505(a)(2)(B).

The modification of refund with “the right of the

estate” also contrasts sharply with § 505(a)(1)’s “any tax, any

fine . . . , or any addition to a tax” language. This difference

illustrates that had Congress intended to refer to refund claims

generally, it could have done so. See also Hartford Underwriters

Ins. v. Union Planters Bank, N.A., 530 U.S. 1, 7, 120 S. Ct.

1942, 1947-1948, 147 L. Ed. 2d 1 (2000) (in interpreting 11

U.S.C. § 506, finding that “had Congress intended the provision

to be broadly worded, it could simply have said so, as it did . .

. in other section of the Code.”). This difference in language

also accounts for the fact that the debtor can bring a claim for

a determination of his tax liabilities, but cannot bring a refund

claim that inures only to his benefit. Further, if we were to

adopt the majority’s position we would read the words “right of

the estate” out of the statute, a result eschewed in statutory

interpretation. See 2A Sutherland Statutory Construction § 46.06

(5th ed. 1992) (“A statute should be construed so that effect is

given to all its provisions, so that no part will be inoperative

or superfluous.”)

Additionally, in setting forth who requests the refund

acknowledges that “exempted property is removed from the estate.” Thus,

“the right of the estate” is properly construed as not including exempt

property.

-29-

claim, the statute refers only to the trustee. See 11 U.S.C. §

505(a)(2)(B). Congress’s failure to require that the debtor make

such a request cannot be seen merely as an omission because, as

the Supreme Court noted in construing § 506 of the Code, “the

fact that the sole party named -- the trustee -- has a unique

role in bankruptcy proceedings makes it entirely plausible that

Congress would provide a power to him and not others.” Hartford

Underwriters Ins., 530 U.S. at 7, 120 S. Ct. at 1947. So too it

is entirely plausible here that Congress entrusted this

responsibility only to the trustee.15 Moreover, giving this

responsibility to the trustee implies the refund claim will be

one benefitting the estate because the trustee’s duty is to act

for the benefit of the estate, i.e., for the benefit of the

creditors.16 As a result, the text’s delegation solely to the

15

Note, however, that the term trustee encompasses a debtor in

possession. Federal Rule of Bankruptcy Procedure 9001.01(10) provides

that “[t]rustee includes a debtor in possession in a chapter 11 case.”

Under 11 U.S.C. § 1107, with certain exceptions “a debtor in possession

shall have all the rights, . . . and powers, and shall perform all the

functions and duties, . . . of a trustee in a case under” chapter 11.

Here, Luongo is a chapter 7 debtor and a trustee has been appointed for

the estate.

16

The majority’s response to my interpretation of §

505(a)(2)(B) fails to account for the delegation of the duty to properly

request the refund to the trustee, instead treating the analysis as if

its only support rested in the words “right of the estate.” It is not

simply because the words “right of the estate” appear that§ 505 is so

limited, but also because the duty to request the refund is delegated

to the trustee. The trustee’s duty is to maximize the estate for the

purposes of distribution to the creditors. See 6 Collier on Bankruptcy

¶ 704.02[3] (15th ed. 2000) (“[I]t is the trustee’s duty to both the

debtor and the trustee to realize from the estate all that is possible

-30-

trustee the duty to properly request the refund claim considered

in tandem with the statute’s reference only to “the right of the

estate to a refund” demonstrates that § 505(a)(2)(B) concerns

only a refund that benefits the estate.

The purpose of § 505(a)(2)(B), as expressed in its text,

demonstrates that the text’s singular focus on a refund that

benefits the estate limits the bankruptcy court’s jurisdiction

over refund claims to those claims benefitting the estate that

have been properly requested and the tax authority has been

permitted 120 days to act upon that request. As described above,

the first two conditions precedent form an exhaustion

for distribution among the creditors.”) (emphasis added). In chapter

7 proceedings, the trustee’s main duty is to liquidate the estate as

expeditiously as possible. See 11 U.S.C. § 704(1) (trustee is to

“collect and reduce to money the property of the estate”). Further,

with respect to exemptions, the Code grants the right of exemption to

the debtor, not the trustee. See 11 U.S.C. § 522. The trustee, as a

party in interest, has standing to object to the debtor’s exemptions,

and should object where the exemption is invalid and would deplete the

value of the estate available for distribution to the creditors. Once

the period for objections to the debtor’s proposed exemptions passes and

the property becomes exempt, the trustee has no interest in exempt

property except to the extent that the property’s value exceeds any

applicable caps on the debtor’s exemption, in which case both the estate

and the debtor have an interest in the property. See 11 U.S.C. § 522(l)

(property declared exempt on the debtor’s schedules becomes exempt if

there are no objections); Bankr. R. Proc. 4003 (providing thirty days

in which to object). The Code recognizes that the trustee’s and the

debtor’s interests diverge regarding exemptions by allowing the debtor

to exempt property the trustee recovers, and, more importantly, by

permitting the debtor to avoid transfers the trustee can avoid in the

event the trustee fails to act. See 11 U.S.C. § 522(g) and (h). Thus,

the delegation to the trustee the duty to properly request the refund

claim is especially significant given the trustee’s and the debtor’s

roles with respect to exemptions.

-31-

requirement. This requirement compels the trustee to first avail

himself of the refund procedures provided by the government from

which he seeks a refund and allows the government to act first

with respect to that claim, rather than being subjected

automatically to the bankruptcy court’s jurisdiction. See

Roberts, 196 B.R. at 392 (“The purpose of § 505(a)(2)(B) is to

afford the taxing authority a reasonable opportunity to review

any refund claim under its normal procedures.”); St. John’s

Nursing Home, Inc. v. City of New Bedford (In re St. John’s

Nursing Home), 169 B.R. 795, 800 (D. Mass. 1994) (“Section

505(a)(2)(B) is thus designed to ‘give the taxing authorities

time to act on a refund request.’”) (quoting Benjamin Weintraub

and Alan N. Resnick, Bankruptcy Law Manual, ¶ 5.09 (3d ed.

1992)). Imposing such a requirement on refunds as opposed to tax

liabilities is particularly important from the government’s

perspective. When a debtor or a trustee seeks a determination of

tax liabilities, he is asking the bankruptcy court to fix what he

owes to the government. Where this occurs, the government may

receive payment. More importantly, it will not be making a

payment to the debtor or the estate. In contrast, when a trustee

calls upon the bankruptcy court to resolve the estate’s refund

claim, the trustee anticipates the receipt of a payment from the

government. At the resolution of such a claim, the government,

be it federal or local, may have to make a payment when the money

-32-

it has received from the debtor may have already left its

coffers. See City of Perth Amboy, 224 F.3d at 243 (“[§

505(a)(2)(B)(i)] is also a recognition of the havoc that would be

visited on the financial stability of a municipality if it were

forced to refund taxes paid years before”). If § 505(a)(2)(B)

applied solely to the right of the estate to a refund, the debtor

seeking a refund claim for her own benefit could go directly to

the bankruptcy court without allowing the government the

opportunity to examine the claim. Section 505(a)(2)(B)’s purpose

offers no basis for allowing one refund claim to escape the

government’s procedures but not the other. Cf. In re Dunhill

Med., Inc., No. 92-37700, 1996 WL 354696 at *5 (Bankr. D.N.J.

Mar. 27, 1996) (“A debtor should not be permitted to bypass”

§505(a)(2)(B)’s requirements “simply by classifying a claim as a

‘credit’ because the practical result of a credit is identical to

that of a refund.”). Such a result frustrates the statute’s

exhaustion purpose. Thus, that the text concerns only the

estate’s right to a refund cannot be construed to mean that

Luongo’s claim simply falls outside the reach of § 505(a)(2)(B)

and within the bankruptcy court’s jurisdiction.17 In light of

17

In quickly dispensing with the possible jurisdictional bar

posed by § 505, the majority fails to note in the text of its opinion

whether Luongo complied with § 505(a)(2)(B)’s requirements that a refund

be properly requested and that the bankruptcy court wait for the

government’s determination or 120 days after such a request to act

(whichever may have occurred earlier). Thus, the majority implies that

a debtor’s refund claim that benefits only the debtor is not bound by

-33-

this purpose and the text’s focus on the estate’s refund claims,

the bankruptcy court’s jurisdiction must then be limited to

refund claims brought for the benefit of the estate.18

Implicit in the majority’s contention that this reading of §

505(a)(2)(B) is too constrained is the assumption that Congress

could not have intended to so limit § 505(a)(1)’s broad grant of

jurisdiction. The interaction between § 505(a)(1) and §

505(a)(2)(A) demonstrates otherwise. Section 505(a)(2)(B)

provides that the court may not determine:

the amount or legality of a tax, fine, penalty, or

addition to tax if such amount or legality was

contested before and adjudicated by a judicial or

administrative tribunal of competent jurisdiction

these conditions. As described in text, the purpose of subparagraph (B)

does not permit such a distinction.

In response to my dissent, the majority states in a footnote that

Luongo has complied with the requirements of § 505(a)(2)(B). Hence,

despite the implication of the majority’s initial discussion of § 505,

the majority seems to interpret § 505(a)(2)(B) as applying to Luongo’s

claim. This interpretation is incorrect because it cannot overcome the

text’s focus on “the right of estate” together with the delegation to

the trustee the responsibility for seeking a refund claim.

18

The majority responds that other courts confronted with a

debtor’s refund claim inuring only to the benefit of the debtor have not

adopted the interpretation of § 505 I have set forth. In support of

this contention, the majority points to United States v. Ryan (In re

Ryan), 64 F.3d 1516 (11th Cir. 1995) and Gribben v. United States (In

re Gribben), 158 B.R. 920 (S.D.N.Y. 1993). In In re Gribben, the court

did not even broach the question of § 505’s applicability to the case,

let alone offer an interpretation of that section. Although the court

in In re Ryan at least discussed § 505, it merely recited the statutory

text and from there concluded, without discussion, that the debtor need

only meet § 505’s exhaustion requirements in order for the bankruptcy

court to have jurisdiction. See 64 F.3d at 1520-1521. Given the

nonexistent or truncated analysis found in these two cases, I find them

unpersuasive.

-34-

before the commencement of the case under this title

This exception recites the language of the last clause of

paragraph (1) adding only the timing provision, i.e., “before the

commencement of the case under this title.” Subparagraph (A)

thus precludes the bankruptcy court from determining any tax

liabilities contested and adjudicated pre-petition, cutting a

broad swath from the general grant of jurisdiction and leaving

only those claims contested subsequent to the beginning of the

bankruptcy case to fall within the scope of the bankruptcy

court’s jurisdiction. Given the substantial limitation

subparagraph (A) places on the bankruptcy court’s jurisdiction,

the assumption that Congress did not intend to so limit the

bankruptcy court’s jurisdiction cannot be made.

Moreover, the majority contends that the above

interpretation of § 505(a)(2)(B) contravenes Congress’s intent to

provided a broad grant of jurisdiction over “tax issues” as

evinced in the legislative history. In examining the legislative

history, the majority focuses solely on the legislative

statements pertaining to taxes owed by the debtor or the estate.

Specifically, the majority relies on two statements by

Representative Edwards and Senator DeConcini. First, the

majority relies on Representative Edwards’s statement that § 505

authorizes “the bankruptcy court to rule on the merits of any tax

claim involving an unpaid tax, fine, or penalty relating to the

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tax or an addition to a tax, of the debtor or the estate.” 124

Cong. Rec. 32413; see 124 Cong. Rec. 34013 (1978) (Statement of

Sen. DeConcini). Additionally, the majority points to

Representative Edwards’s and Senator DeConcini’s statement that

“the bankruptcy judge will have authority to determine which

court will determine the merits of the tax claim both as to the

claim against the estate and claims against the debtor concerning

his personal liability for nondischargeable taxes.” 124 Cong.

Rec. 32414 (1978) (statement of Sen. DeConcini); 124 Cong. Rec.

34014 (1978) (statement of Rep. Edwards). In these statements,

the majority zeroes in on the phrases “of the debtor or the

estate” and on “claims against the debtor concerning his

liability for nondischargeable taxes” in order to show that

Congress intended for the bankruptcy court to have jurisdiction

over refund claims not affecting the estate. But these

statements concern one kind of claim: one in which the debtor

owes money to the government. The first quotation refers to

“unpaid tax, fine, or penalty relating to a tax, addition to a

tax.” All of these items connote the taxing authority’s right to

a payment. Likewise, the second statement’s reference to “claims

against the debtor” connotes the government’s right to a payment

from the debtor. As such, these statements offer little insight

into Congress’s intent with respect to refund claims.

Representative Edwards’s and Senator DeConcini’s subsequent

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remarks clarify that § 505(a)(1)’s grant of jurisdiction is

subject to paragraph (2)’s limitations. The Legislators note

that the bankruptcy court “will not have jurisdiction to rule on

the merits of any tax claim which has been previously

adjudicated, in a contested proceeding, before a court of

competent jurisdiction,” recognizing the exception to

jurisdiction § 505(a)(2)(A) creates. More importantly, although

conspicuously absent from the majority’s recitation of the

legislative history, the Legislators addressed refund claims,

stating:

the bankruptcy court can, under certain conditions,

determine the amount of tax refund claim by the

trustee. . . . [I]f the refund results from an offset

or counterclaim to a claim or request for payment by

the Internal Revenue Service, or other tax authority,

the trustee wold not first have to file an

administrative claim for refund with the tax authority.

However, if the trustees requests a refund in

other situations, he would first have to submit an

administrative claim for the refund. . . . [I]f the

Internal Revenue Service or other tax authority does

not rule on the refund claim within 120 days, then the

bankruptcy court may rule on the merits of the refund

claim.

124 Cong. Rec. 34013 (1978) (Statement of Sen. DeConcini); 124

Cong. Rec. 32413 (1978) (Statement of Rep. Edwards) (emphasis

added). The statement refers only to refund claims brought by

the trustee and is devoid of any reference to the debtor. In

contrast, the legislative history of § 505 is replete with

references to the debtor where it discusses his debts. See,

e.g., 124 Cong. Rec. 34013 (1978) (Statement of Sen. DeConcini)

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(“[A]n individual debtor can also file a complaint to determine

dischargeability . . . so that the bankruptcy court would then

determine the validity of the claim against the assets in the

estate and also the personal liability of the debtor for any

nondischargeable debt.”) (emphasis added); 124 Cong. Rec. 32414

(1978) (Statement of Rep. Edwards) (summing up the interplay

between the automatic stay provision and § 505’s grant of

jurisdiction stating that “[i]n essence, . . . the bankruptcy

judge will have authority to determine which court will determine

the merits of the tax claim both as to claims against the estate

and claims against the debtor concerning his personal liability

for nondischargeable taxes.”) (emphasis added). This

juxtaposition between the discussion of refunds and the remainder

of § 505 again implies that these refund claims are claims

benefitting the estate, not the debtor personally. Furthermore,

the legislators noted that the bankruptcy court can exercise

jurisdiction over refund claims by the trustee only under

“certain circumstances,” evincing congressional intent to limit

the bankruptcy court’s jurisdiction over refund claims. Thus,

the legislative history shows that Congress granted the

bankruptcy courts only a limited role in adjudicating refund

claims.

In short, the plain language and the legislative history

demonstrate that the bankruptcy court has jurisdiction only to

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hear refund claims that benefit the estate and the government’s

immunity has not been abrogated for the purposes of this suit.

That § 505 does not provide the bankruptcy court with

jurisdiction cannot be overcome, as Luongo suggested at oral

argument, by § 106’s abrogation of immunity for actions brought

under §§ 522, 542, 543, or 362. None of these sections concerns

refunds. Because § 505 is an abrogation of sovereign immunity

specifically with respect to refunds, its grant of jurisdiction

and the limitations on that jurisdiction control. See In re

Armstrong, 206 F.3d at 470 (“One basic principle of statutory

construction is that where two statutes appear to conflict, the

statute addressing the relevant matter in more specific terms

governs.”). Consequently, Luongo’s contention does not defeat

the conclusion to which the plain language of § 505 and its

legislative history lead.

Finally, even if the majority’s view is correct and the

bankruptcy court can exercise jurisdiction over Luongo’s refund

claim, the bankruptcy court’s abstention is warranted. The text

of § 505(a)(2)(B) plainly focuses on the right of the estate to a

refund claim. Should the estate receive such a payment, it will

benefit the creditors, making them the intended beneficiaries of

§ 505(a)(2)(B). While I agree with the majority that one of the

broad purposes of the bankruptcy code is to provide debtors with

a fresh start, I disagree that this broader purpose should trump

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§ 505(a)(2)(B)’s more narrow purpose. Accordingly, even if the

bankruptcy court had jurisdiction, I would find that abstention

was warranted.

For the foregoing reasons, I would dismiss for lack of

jurisdiction.

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