IN RE WALSH, (Bankr.D.Colo. 2003)

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Docket Number

Case No. 03-12843 HRT

Advocates

Andrew L. Cameron, Denver, CO, for Debtor.

Acts

Bankruptcy — Creditors, The Debtor, And The Estate — Debtor’S Duties And Benefits — Exemptions
Internal Revenue Code — Income Taxes — Normal Taxes And Surtaxes — Determination Of Tax Liability — Credits Against Tax — Refundable Credits — Earned Income
Internal Revenue Code — Income Taxes — Normal Taxes And Surtaxes — Determination Of Tax Liability — Credits Against Tax — Nonrefundable Personal Credits — Adoption Expenses

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Smart Summary

Factual and Procedural Background

This opinion addresses the Trustee's objection to the Debtor's claim of exemption regarding a 2002 income tax refund and the Trustee's motion for turnover of non-exempt property. The Debtor, Therese Ann Walsh, claimed an exemption for a tax refund received from the 2002 tax year, asserting it was exempt under Colorado law as an earned income tax credit refund. The Trustee challenged this claim, asserting the exemption was improperly claimed. The Court considered the Trustee's objection and the Debtor's response and proceeded to rule on the matter.

Legal Issues Presented

Whether the 2002 income tax refund received by the Debtor qualifies as exempt property under Colo. Rev. Stat. § 13-54-102(1)(o), which exempts "[t]he full amount of any federal or state earned income tax credit refund."
Whether a tax refund based on a non-refundable adoption expense credit can be considered an "earned income tax credit refund" under the Colorado exemption statute.

Arguments of the Parties

Trustee's Arguments

The Trustee argued that the Debtor's claimed exemption for the 2002 tax refund was improper because the refund was not an earned income tax credit refund as defined by the statute.
The Trustee maintained that the adoption expense credit is a non-refundable credit and thus does not qualify for exemption under the statute.
The Trustee bore the burden to prove the exemption was improperly claimed, which the Court found was met.

Debtor's Arguments

The Debtor claimed the entire 2002 tax refund was exempt under Colo. Rev. Stat. § 13-54-102(1)(o) as an earned income tax credit refund.
The Debtor argued that since earned income is an element of qualifying for the adoption expense credit, the refund should qualify as an earned income tax credit refund.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
11 U.S.C. § 522(1)	Establishes that a debtor's claim of exemption will not be disturbed absent a timely objection by an interested party.	Supported the principle that the Trustee must timely object and bear the burden to prove the exemption claim improper.
Taylor v. Freeland Kronz, 503 U.S. 638, 112 S.Ct. 1644 (1992)	Clarifies the burden of proof on the objecting party regarding exemption claims.	Affirmed that the Trustee must demonstrate improper exemption claim.
Finance Acceptance Company v. Breaux, 419 P.2d 955 (Colo. 1966)	Exemption statutes should be construed broadly in favor of debtors to protect exempt property from coercive processes.	Guided the Court's interpretation to favor debtor exemptions but constrained by clear statutory language.
Rutter v. Shumway, 26 P. 321 (Colo. 1891)	Supports liberal construction of homestead and exemption laws.	Informed the Court’s approach to statutory interpretation.
Jones v. Olson, 67 P. 349 (Colo.Ct.App. 1902)	Homestead law should be liberally construed to protect debtors.	Reinforced the principle of liberal construction in favor of exemption claims.
United States v. Ron Pair Enters., Inc., 489 U.S. 235, 109 S.Ct. 1026 (1989)	Statutory language must be given its clear and plain meaning.	Prevented the Court from extending the exemption beyond the statute’s explicit language.

Court's Reasoning and Analysis

The Court began by acknowledging the Trustee's burden to prove the exemption was improperly claimed and noted the general principle that exemption statutes are construed broadly in favor of debtors. However, the Court emphasized that it must adhere to the clear language of the statute and cannot distort its meaning to benefit the Debtor.

The Court analyzed the nature of the tax credits involved. It distinguished the Earned Income Credit (EIC), a refundable credit based on earned income, from the adoption expense credit, which is non-refundable and limited to the taxpayer's tax liability. The Debtor’s refund was primarily attributable to the non-refundable adoption credit and withheld taxes, not to any earned income credit refund.

The Court found that the statutory exemption applies solely to refunds of earned income tax credits, which are unique in being refundable and targeted at low-income taxpayers. The Debtor’s adoption credit did not qualify as an earned income tax credit because it is based on adjusted gross income, which can include unearned income, and is non-refundable.

The Court rejected the Debtor’s argument that the presence of earned income as an element of the adoption credit qualification equated the adoption credit with the earned income tax credit. It held that the statute’s language must be interpreted narrowly and precisely, limiting the exemption to the specific earned income tax credit refund.

Consequently, the Court concluded that the Debtor's claimed exemption was improper and ordered the turnover of the non-exempt property to the Trustee.

Holding and Implications

Holding: The Court sustained the Trustee's objection to the Debtor's claim of exemption and granted the Trustee’s motion for turnover of the non-exempt property.

Implications: The decision directly affects the parties by requiring the Debtor to turn over the portion of the 2002 income tax refund not properly exempted under Colorado law. The ruling clarifies that the Colorado exemption statute for earned income tax credit refunds is limited to the specific refundable earned income credit and does not extend to other tax credits such as adoption expense credits. The Court did not establish new precedent beyond interpreting the statute's clear language and applying existing legal principles.

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In re: THERESE ANN WALSH, Chapter 7, Debtor

ORDER RE: TRUSTEE'S OBJECTION TO CLAIM OF EXEMPTION AND MOTION FOR TURNOVER OF NON-EXEMPT PROPERTY

HOWARD R. TALLMAN, Bankruptcy Judge

This case comes before the Court on Trustee's Objection to Claim of Exemption and Motion for Turnover of Property of the Estate and the Debtor's Response thereto. The Court will sustain the Trustee's objection and grant the motion for turnover.

A court will not disturb a debtor's claim of exemption unless a timely objection is made by an interested party. 11 U.S.C. § 522(1); see also Taylor v. Freeland Kronz, 503 U.S. 638, 642, 112 S.Ct. 1644 (1992). It is the Trustee's burden in this case to demonstrate that the exemption is improperly claimed. F.R.Bankr.P. 4003(c). The Court construes the exemption statutes broadly in favor of debtors, so that the statutes may achieve their purpose. Finance Acceptance Company v. Breaux, 419 P.2d 955, 957-58 (Colo. 1966) ("The whole spirit of these acts is such that it was intended to protect the exempt property from all manner of coercive process of the law . . ."); Rutter v. Shumway, 26 P. 321, 323 (Colo. 1891); Jones v. Olson, 67 P. 349, 350 (Colo.Ct.App. 1902) ("The homestead law should be and is liberally construed . . ."). Nonetheless, the Court is constrained by the clear language of the statute, United States v. Ron Pair Enters., Inc., 489 U.S. 235, 240-41, 109 S.Ct. 1026, 1029-30 (1989), and it cannot pound a square peg in a round hole to attain the objective which the Debtor is hoping for in this case.

The Court finds that the Trustee has met her burden to prove that the exemption claimed by the Debtor in this case is improper.

At her § 341 meeting, the Debtor disclosed to the Trustee that she had received an income tax refund for the year 2002 in the amount of $3,816.00. She modified her claim of exemptions to include that refund and claimed it to be exempt under Colo. Rev. Stat. § 13-54-102(1)(o) which allows a debtor to exempt "[t]he full amount of any federal or state earned income tax credit refund." Colo. Rev. Stat. § 13-54-102(1)(o). The actual amount of credit claimed for adoption expenses on Debtor's 2002 income tax return is $3,431.00.

The issue for the Court is whether the $3,816.00 income tax refund received by the Debtor for the tax year 2002 is exempt property where the Debtor claimed an adoption expense credit on her tax return in the amount of $3,431.00 and where Colorado's exemption statute provides an exemption for a refund of state or federal earned income tax credit.

In 2000, the legislature amended Colo. Rev. Stat. § 13-54-102 to, among other changes, include an exemption for those debtors who receive a refund of their claimed earned income credit. The Earned Income Credit is a particular program "for certain people who work and have earned income under $34,178." INTERNAL REVENUE SERVICE, DEP'T OF THE TREASURY, PUBLICATION 596, EARNED INCOME CREDIT (EIC) at 1 (2002). The tax credit available to certain taxpayers under this program is based upon the amount of earned income and is calculated as a percentage of that income. 26 U.S.C. § 32. The Earned Income Credit is unique. It is a refundable credit that may result in a refund that is greater than the amount of withholding tax paid by the worker during the tax year. CONGRESSIONAL RESEARCH SERVICE, THE EARNED INCOME TAX CREDIT: A GROWING FORM OF AID TO LOW — INCOME WORKERS at 1 (1993) ("The [Earned Income Tax Credit] is the only tax credit that yields a grant when a filer's credit exceeds income tax liability").

Since this report was written, another refundable credit has been added. That is the $600.00 additional child tax credit.

In contrast to that program is the credit for adoption expenses which is available to taxpayers with a modified AGI [adjusted gross income] of less than $190,000.00 and the credit is based upon the amount of certain expenses relating to the adoption of a child. INTERNAL REVENUE SERVICE, DEP'T OF THE TREASURY, INSTRUCTIONS FOR FORM 8839 at 1 (2003). Importantly, the credit available for adoption expenses, like most other credits, is limited to the amount of the taxpayer's tax liability. 26 U.S.C. § 23(b)(4). Thus, it is not refundable.

The very structure of the Debtor's tax form bears this out. Lines 45 through 53 of the form relate to various credits which may be applied against Debtor's tax liability. Debtor claimed her adoption credit on line 51. The Earned Income Credit appears in an entirely different place, in the "Payments" section on line 64 where no credit is claimed because Debtor does not qualify for that credit. As a function of including a refundable credit such as Earned Income Credit in the "Payments" section of the form, it is possible to get a refund of that credit even when tax liability is $0 or there was no withholding tax paid during the year.

For the purposes of this decision, it is not necessary to parse the language of the statute too finely. However, the Court does observe that the statute exempts an "earned income tax credit refund." But under no circumstances can the Debtor even get a refund of her adoption expense credit. The only function of a non-refundable credit such as the adoption expense credit is to reduce the taxpayer's tax liability. In Debtor's case, after application of her adoption credit and a child care credit, she was able to reduce her tax liability to $0. Consequently, Debtor's tax refund consists solely of refunded withholding tax and the new refundable additional child tax credit. Had the Debtor qualified for an Earned Income Credit, it would have been claimed on her tax form under the "Payments" section along with the amount of taxes withheld, other tax payments made and the other refundable credit. Thus, it seems to the Court, the only amounts that a taxpayer can actually get a refund of would have to be the amounts listed under that "Payments" section of the tax form.

Debtor's position is that since earned income is an element of qualifying for the credit for adoption expenses, it must be an earned income tax credit which qualifies for exemption under the statute. But, contrary to Debtor's position, earned income is not an element of eligibility for the adoption expense credit at all. The income eligibility for that credit is based on AGI. 26 U.S.C.A. § 23. A taxpayer's AGI need not include any earned income whatever and could be comprised entirely of unearned income sources such as interest, dividends, and capital gains. INTERNAL REVENUE SERVICE, DEP'T OF THE TREASURY, FORM 1040, U.S. INDIVIDUAL INCOME TAX RETURN at 1, (2002).

The Court must conclude that the statutory language in Colo. Rev. Stat. 13-54-102 means precisely what it says and refers to the very unique tax credit program which is based upon earned income. It does not create a generic exemption for all tax credits which use income as a qualifying factor. To accept Debtor' construction of the statute would create an anomaly within the exemption statute. It would greatly expand the exemption to include taxpayers with very substantial income. The Court believes that, if the state legislature had intended such a result, it could have easily provided an exemption for all refunds based upon any state or federal tax credit. It did not do so. It chose the use the far more limited language of "earned income tax credit refund." At the federal level, there is only one Earned Income Credit. Consistent with the remainder of the exemption statute, that credit is targeted at persons of modest means. The Court would be stretching the statutory language of Colo. Rev. Stat. 13-54-102(1)(o) beyond all recognition to try to include within that language a credit such as the credit for adoption expenses. Consequently, it is

ORDERED that Trustee's Objection to Claim of Exemption is hereby SUSTAINED; it is further

ORDERED that Trustee's Motion for Turnover of Property of the Estate is hereby GRANTED. Debtor shall turn over to the Trustee the non-exempt property detailed in Trustee's Motion.