THINNES, Bankruptcy Judge.
A setoff which was validly effected may not be avoided under Section 553. The Internal Revenue Code permits the IRS to credit overpayments against tax liabilities of the taxpayer, and Section 553(a) permits setoff for mutual obligations. Therefore, the trustee was unable to avoid a setoff by the IRS of overpayments against tax liabilities of the debtor. See Sec. 542(b) at ¶ 9514 and Sec. 553(a) at ¶ 9556.
[Opinion of the Court]
The matter before the Court is a Complaint filed by Donald Joe and Lorna Claire Baugh (Debtors) pursuant to 11 U.S.C § 542 seeking turnover of funds set off by the Internal Revenue Service (Defendant). Attorneys W. H. Gilliam and Helen L. Duncan represented the Debtors and the Defendant, respectively. Pursuant to F.R.B.P. 7052, the Court now makes the following Findings of Fact, Conclusions of Law and Order.
The Debtors' Complaint did not detail the factual circumstances surrounding the transaction in question. From the Defendant's Answers to the Debtors' Interrogatories, the following facts may be deduced. The Debtors were delinquent in their 1977 income tax. On April 15, 1982, the Defendant applied the Debtors' overpayment for the 1981 tax year to the 1977 delinquency. A bankruptcy petition was filed on behalf of the Debtors on May 5, 1982. The instant complaint seeks a turnover of the overpayments applied against the 1977 delinquency.
11 U.S.C. § 542(a) states that "an entity . . . in possession, custody, or control, during the case, of property . . . that the debtor may exempt under section 522 . . . shall deliver to the trustee . . . such property." In their Complaint, the Debtors essentially alleged that if turnover was ordered, they would claim the overpayments exempt.
The operative language in 11 U.S.C. § 522(b)(1) provides that "an individual debtor may exempt from property of the estate" property that is allowed under the applicable state or federal exemption law.' The first question, therefore, is whether the 1981 overpayments constituted property of the estate.
11 U.S.C. § 541(a)(3) provides that the bankruptcy estate includes "[a]ny interest in property that the trustee recovers under section . . . 533." The first issue, therefore, is whether the trustee may recover the property under § 553. In essence, § 553(a) provides:
Except as otherwise provided in this section and in sections 362 and 363 of this title,
this title does not affect any right of a creditor to offset a mutual debt owing 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. . . .
(Emphasis added). The emphasized language has been interpreted to mean that "a setoff is not a transfer for purposes of preference law." 2 W. Norton, Bankruptcy Law Practice § 33.01, at 33-3 (1981). Moreover, there does not appear to be any fraud or defect in the Defendant's applicaton of the overpayments such that 11 U.S.C. § 544 or 548 would apply. In other words, the trustee may not attack the transfer under any of the powers granted him by the Bankruptcy Code if the setoff was validly effected. The question therefore becomes whether the setoff was proper under § 553.
Section 553(a) contains three exceptions to the creditor's right of setoff. See 11 U.S.C. § 553(a)(1)-(3). None of these exceptions applies to the Complaint at bar.
There are two steps with which the Defendant must have complied in order to be entitled to set off the Debtors' income tax refunds. First, the Defendant must have the "right" to engage in the setoff. Under the Internal Revenue Code, the Defendant is authorized to apply a debtor's income tax refund to reduce or extinguish that debtor's delinquent tax liabilities.
26 U.S.C. § 6402(a) provides:
In the case of any overpayment, the Secretary . . . may credit the amount of such overpayment, including any interest allowed thereon, against any liability in respect of an internal revenue tax on the part of the person who made the overpayment.
Clearly, this statute gives the Defendant the power to unilaterally credit a taxpayer's overpayments against his tax liabilities. Acker v. United States, 519 F. Supp. 178 (D.C. Ohio 1981).
The second requirement is that there be mutual debts. 11 U.S.C. § 553(a). "The basic test is mutuality, not similarity, of obligation — something must be `owed' by both sides." 4 Collier on Bankruptcy, ¶ 553.04, at 553-15 to -16 (15th ed. 1983). The Defendant does not dispute the fact that prior to the filing of Debtors' petition, they had a valid claim against it for a refund of at least $1,252.00 arising out of the overpayment of 1981 taxes. Thus, the Debtors owed the Defendant a debt. Similarly, the Court finds that the Debtors admitted in Schedule of Assets and Liabilities that they owed $1,250.00 to the IRS for delinquent taxes. Thus, mutual debts were owing between the Debtors and the Defendant.
In sum, the Defendant validly effected a setoff against the Debtors. See also n. 1 supra. The Trustee therefore may not attack the transfer under § 553. More importantly, a valid transfer is not subject to turnover:
Except as [otherwise] provided,
an entity that owes a debt that is property of the estate and that is matured, payable on demand, or payable on order,
shall pay such debt to, or on the order of, the trustee,
except to the extent that such debt may be offset under section 553 of this title against a claim against the debtor.
11 U.S.C. § 542(b) (Emphasis added).
The above conclusion is not altered even if one were to consider the overpayments property of the estate under 11 U.S.C. § 541(a)(1). This is so because assuming that the Debtors possessed a "legal or equitable interest" in the overpayments at the time of commencement of the case, § 542(b), supra, excepts the overpayments validly offset from turnover.
IT IS THEREFORE ORDERED that the Turnover Complaint filed herein by the Debtors be denied and dismissed.