District Court - Bankruptcy Court Cannot Enjoin IRS's Future Exercise of Rights to Setoff & Recoupment

The U.S. District Court for the Eastern District of New York ruled Sept. 15, 2012, that A bankruptcy court has no jurisdiction to enjoin the Internal Revenue Service's future exercise of its rights to setoff and recoupment.

Relivant portions of the Decision …

VI. Recoupment and Setoff

 

The final dispute at issue in this appeal is whether the Bankruptcy Court had jurisdiction to enjoin the IRS from the future exercise of any right to setoff or recoupment against the Trustee.  

"The right of setoff (also called 'offset') allows entities that owe each other money to apply their mutual debts against each other, thereby avoiding the absurdity of making A pay B when B owes A." Citizens Bank v. Strumpf, 516 U.S. 16, 18, 116 S. Ct. 286 (1995) (internal quotation marks omitted). Setoff is a longstanding common law defense that provides a defendant with the right not to part with one's funds. See id. at 21; In re Chateaugay Corp., 94 F.3d 772, 777-79 (2d Cir. 1996). It is also granted to the Federal Government by several statutes, including 26 U.S.C. § 6402, which provides that when a taxpayer has made an overpayment, the Secretary of the Treasury may, within the "applicable period of limitations," credit that overpayment against any tax "liability" owed to the IRS by that taxpayer. See 26 U.S.C. § 6402(a). 

Recoupment, on the other hand, involves a special subset of setoff that applies in cases in which the factual basis for the claim and the setoff defense are related. See Reiter v. Cooper, 507 U.S. 258,264, 113 S. Ct. 1213 (1993). The benefit of recoupment over setoff is that recoupment rights survive even if the defending party could not bring an affirmative claim due to the expiration of the applicable statute of limitations. This is true, however, only if the original suit, to which the recoupment is lodged as a defense, is timely. See id.; Davidovich v. Welton (In re Davidovich), 901 F.2d 1533, 1537 (10th Cir. 2001).

 The Bankruptcy Court held that because the IRS failed to object to the provision of the plan barring the exercise of setoff and recoupment rights prior to confirmation, it is barred from objecting after the fact according to principles of res judicata. 

 

That is not to say, however, that the IRS is free to exercise its rights to setoff or recoupment against each of the potential liabilities of the Trustee it identifies in its papers.

Specifically, the IRS notes that it will seek approximately $140,000 in unpaid taxes that the

Trustee allegedly owes from 2002, notwithstanding the fact that the Bankruptcy Court, and now

this Court, has held that the Trustee was discharged from this liability pursuant to the procedures

set forth in 11 U.S.C. § 505(b )(2). Trustee argued below that there is no right to setoff as a result of this discharge, which argument the Bankruptcy Court elected not to address in light of its conclusion that res judicata was sufficient to expunge the IRS's rights.

 Because I do not agree with the Bankruptcy Court on this issue, I address the implication of Section 505(b) with regard to the IRS's setoff rights here.

Thus, the breadth  of cases holding that the setoff of prepetition debts trumps the discharge provisions found in other sections of the Bankruptcy Code are not particularly helpful to the IRS's position. 

For the foregoing reasons, the final order of the Bankruptcy Court is hereby affirmed in part and reversed in part.That part of the order enjoining the IRS from exercising any future right to setoff or recoupment is vacated.

 

 

US V. EDWARD P. BOND, Liquidating Trustee, 18, 116 S. Ct. 286 (September 17, 2012).