The IRS has filed an amended proof of claim for $38,429.14. The debtor claims he is entitled to an offset for various credits which he is due, and that the correct amount of the claim is $3,745.08 as of June 30, 1994.

The dispute centers on whether the debtor is time-barred from asserting the offset. 5 ABR 45      The IRS's proof of claim was filed while the statute of limitations was still open for the debtor to have sought a refund which became available when earlier tax years were adjusted.

I hold that the debtor is barred from claiming the offset because he did not file for a refund within the statutory time allowed. Had the claimed refund arisen from the same transaction, the ruling would have been for the debtor.

     2. FACTS - Richard E. Wagner filed a voluntary chapter 11 on March 11, 1988.

The IRS filed Proof of Claim No. 1 on April 26, 1988, for $442,014.29. This was amended by Proof of Claim No. 17 filed on April 8, 1994, for $38,429.14 for 1982 and 1984 taxes.

The debtor claims he is entitled to an offset (or refund) due to amended tax returns, which gave him certain credits which he could apply to the 1979, 1980, and 1981 taxes to reduce the obligation of debtor to the IRS to less than $4,000.00. The amended tax returns giving arise to the credits and offsets were filed in 1993.

The IRS alleges that, pursuant to 26 USC § 6511(d)(2), the debtor is not entitled to claim the offset or refund because he has not acted in a timely fashion to state this claim. According to the IRS, the time to claim the refund or offset expired in 1989, about a year after the case was filed.

The right to a tax refund arose as follows:

• The debtor suffered a net operating loss in 1985. He carried the loss back to reduce prior year tax liabilities for 1982, 1983, and 1984. These years were then overpaid, and debtor filed a timely refund request, which the IRS honored. The 1985 NOL is not in dispute.

• The 1985 NOL carryback also resulted in Investment Tax Credits (ITCs) utilized 5 ABR 46      in 1982, 1983, and 1984 being freed up so these ITCs could in turn be carried back to the tax years 1979, 1980, and 1981. These credits are the source of the dispute.

The IRS alleges there are only two ways for debtor to get a refund for the ITCs which were freed up. One was filing a Form 1045 and the other was filing an amended return. The IRS states that the last date under the law and regulation for filing: (a) a Form 1045 request for a refund was December 31, 1986, and (b) an amended return was April 15, 1989. No Form 1045 has been filed, and an amended return was filed in 1993, about 4 years late.

     3. ISSUES - (a) Under what conditions is sovereign immunity waived by the federal government? (b) What time extensions to file a tax refund are available to a trustee or debtor-in-possession under 11 USC § 108? (c) In order to claim a direct refund, must the debtor comply with the conditions precedent of 11 USC § 505(a)(2)(B)? (d) Can the debtor offset the IRS's proof of claim with an untimely refund claim?

     4. LEGAL ANALYSIS -

     4.1. Sovereign Immunity Framework- In October, 1994, the Bankruptcy Reform Act of 1994 amended the laws governing the waiver of sovereign immunity in 11 USC § 106. This section applies retroactively to cases pending at the time. See, 2 Collier on Bankruptcy, ¶ 106.1, fn4 (15^th ed 1997).

Section 106(a) of the amended section abrogates sovereign immunity to the extent set forth in about 60 separate Bankruptcy Code sections, including 11 USC § 505, the section that allows a bankruptcy court to determine certain tax issues.

Section 106(b) relates to counterclaims:

(b) A governmental unit that has filed a proof of claim in the case is deemed to have waived sovereign immunity with respect to a claim 5 ABR 47      against such governmental unit that is property of the estate and that arose out of the same transaction or occurrence out of which the claim of such governmental unit arose.

The IRS has filed a proof of claim in this case. FRCivP 13(a), governing compulsory counterclaims, is the standard for application of § 106(b). Id at ¶ 106.5.

Finally, § 106(c) deals with offsets:

c) Notwithstanding any assertion of sovereign immunity by a governmental unit, there shall be offset against a claim or interest of a governmental unit any claim against such governmental unit that is property of the estate.

The treatment of setoffs is generally governed by 11 USC § 553. Id at ¶ 106.6. Unlike § 106(b) counterclaims, setoffs under § 106(c) need not arise out of the same transaction. Id at ¶ 106.6[ 2] [ a] .

     4.2. The Time to File A Refund Claim Was Limited Under 11 USC § 108- The filing of a bankruptcy often preserves the status quo and freezes pending or anticipated actions against the debtor. 11 USC § 108(a) extends the time for a trustee to file an action which had not expired when the bankruptcy was filed to the later of 2 years after the order of relief or the date on which the statute of limitations expires by its terms. Does it extend the time for a trustee to file an action for a refund after a bankruptcy is filed?

Section 108(b) provides that, where the time limit has not expired prepetition, the trustee has the later of 60 days after the time expires or the stated time limit to "file any pleading, demand, notice, or proof of claim or loss, cure a default, or perform any other similar act." Several of the relevant cases hold that the filing of a tax refund is controlled by § 108(b), not § 108(a). TLI, Inc. v United States, 100 F3d 424, 426-27 (5^th Cir 1996) and In re Howard Industries, Inc., 170 BR 358, 361-62 (Bankr SD Ohio 1994).

The Wagner bankruptcy was filed in 1988. The time to claim a refund by filing an 5 ABR 48      amended return was April 15, 1988. The amended return was not filed until 1993. Thus, under § 108(b), and even under § 108(a), the refund request was untimely.

     4.3. The Requirement That The Debtor Comply With The Condition Of Properly Requesting A Refund Is A Prerequisite To The Debtor Seeking A Refund Under 11 USC § 505 -

11 USC § 505 provides, in part:

§ 505. Determination of tax liability.
(a)

(1) 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.

(2) The court may not so determine--

(A)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 before the commencement of the case under this title, or

(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.

If Wagner's claim is treated as a straight request for a "refund," i.e., without attempting to use it as an offset, he has failed to meet this threshold requirement of "properly requesting" the refund from the IRS. It is not disputed that, but for the bankruptcy, Wagner has not properly 5 ABR 49      sought a refund within the time allowed. The question is whether the intervention of bankruptcy makes a proper request for a refund superfluous.

There is a split of authority about the interpretation of § 505(a)(2)(B) regarding refund claims. One line of cases is illustrated by In re Graham, 981 F2d 1135 (10^th Cir 1992); In re St. John's Nursing Home, Inc., 169 BR 795, 801 (D Mass 1994); In re Camacho, 184 BR 807, 813 (Bankr D AK 1995), rev on other grounds 190 BR 895 (D AK 1995), rehrg den 195 BR 114 (D AK 1996); In re Penking Trust, 196 BR 389, 396 (Bankr ED Tenn 1996). These cases hold that a bankruptcy court has no jurisdiction to address a refund claim where there has not been a prior claim for a refund under applicable law.

The other line is represented by the more liberal approach of In re Piper AirCraft Corp., 171 BR 415, 418 (Bankr SD Fla 1994); and, In re Ledgemere Land Corp., 135 BR 193, 198 (Bankr D Mass 1991) [ apparently overruled by St. John's Nursing Home] which downplay the requirement of a proper request, and focus more on the broad grant found in § 505(a)(1) allowing a bankruptcy court to hear and determine a tax matter "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."

The Graham line of cases reflect the better view regarding the proper treatment of refund claims under § 505(a)(2)(B). Penking, at 395-96, points out the weakness in the contrary authority, most of which rely as authority on cases which do not involve refunds.

Since Wagner has not "properly requested" a refund under § 505(a)(2)(B), the bankruptcy court does not have jurisdiction to make a freestanding judgment that a refund is appropriate. A proper request is a timely request under the requirement of the taxing statute. See, Penking, at 396, holding that:

5 ABR 50      This court agrees with the general proposition espoused by those cases that the failure of a debtor to seasonably contest an assessment of a tax does not preclude the bankruptcy court from determining the tax liability of the debtor or estate. That is exactly what § 505(a) provides for, a determination of the amount or legality of any tax, whether previously contested or not. This case, however, involves a determination of a request for a tax refund, which is subject to the additional requirement of section 505(a)(2)(B) that the Trustee properly request a refund. A "proper request" under § 505(a)(2)(B) connotes correctness and dictates conformity with the pertinent taxing authority's mechanism for seeking a refund. In re St. John's Nursing Home, Inc., 154 B.R. at 125.

To the extent that my prior decision in In re Ryan Air Service, Inc., 3 ABR 375 (Bankr D AK 1994) holds otherwise, I will no longer follow it.

Although sovereign immunity is waived under 11 USC § 106(a) with respect to proceedings under § 505, the waiver is only to the extent permitted by the section. Wagner has not complied with the prerequisite of filing a refund claim to be entitled to a straight refund under § 505.

In other situations, exhaustion of administrative remedies is overlooked in the bankruptcy context. The 9^th Circuit, in In re Town & Country Home Nursing Services, Inc., 963 F2d 1146, 1154-55 (9^th Cir 1992), held that a trustee need not exhaust administrative remedies under such federal laws as the Medicare Act or the Federal Tort Claims Act as a threshold to bankruptcy court jurisdiction. This is based on the court's interpretation of 28 USC § 1334(b) which provides:

(b) Notwithstanding any Act of Congress that confers exclusive jurisdiction on a court or courts other than the district courts, the district courts shall have original but not exclusive jurisdiction of all civil proceedings arising under title 11, or arising in or related to cases under title 11.

Where, however, the condition precedent is in the bankruptcy statute itself, such as the requirement that the "trustee properly requests such refund" in § 505(a)(2)(B), Town & Country does not apply. The parties agree that neither the trustee nor the debtor sought a refund in the 5 ABR 51      manner proscribed by federal tax law, so he cannot recover one under § 505(a)(1).

So if Wagner cannot get a direct refund, can he get the same benefit by way of an offset or counterclaim?

     4.4.  Debtor's Claim For A Refund Arose Out Of A Separate Transaction And Is Not Entitled To Be Offset Against The IRS's Claim- Even though Wagner did not go through the preliminary steps of making a "proper" request and waiting 120 days before seeking relief, he may still be entitled to an offset or recoupment against the IRS's claim if the offset arose out of the same transaction and the IRS's claim is timely.

The legislative history indicates that a claim to an offset is to be treated differently under § 505(a)(2)(B) than a direct claim for a refund. The House and Senate Reports to the 1978 Bankruptcy Reform Act, state with respect to this section:

The House amendment adopts the rule of the Senate bill that the bankruptcy court can, under certain conditions, determine the amount of tax refund claim by the trustee. Under the House amendment, if 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 would not first have to file an administrative claim for refund with the tax authority.

However, if the trustee requests a refund in other situations, he would first have to submit an administrative claim for the refund. Under the House amendment, if 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.

4 Collier on Bankruptcy, ¶ 505 LH[ 2] [ a] (15^th ed 1997). St. John's Nursing Home, Inc. at 797, 799 eschewed the reference to legislative history in favor of a plain construction of § 505(a)(2)(B). The history does in fact reflect, in part, a recognized exception to the requirement of filing a timely refund request. The exception is known as the doctrine of "equitable recoupment" discussed below.

The waiver of sovereign immunity for offsets is found in 11 USC § 106(c). Offsets do not have to come from the same transaction as the claim sought to be offset. The right to an offset is interpreted under 11 USC § 553. There are no bankruptcy directed offsets under § 553. The trustee or debtor look to applicable state or federal law. See, discussion in Part 4.1. of this Memorandum and Newbery Corp. v. Fireman's Fund Ins. Co., 95 F3d 1392, 1398 (9^th Cir 1996) (Section 553 "is not an independent source of law governing setoff; it is generally understood as a legislative attempt to preserve the common-law right of setoff arising out of non-bankruptcy law." [ citations omitted] ). Thus, in determining if Wagner is entitled to a setoff in this case, we must look to nonbankruptcy law.

The waiver of sovereign immunity under 11 USC § 106(b) for compulsory counterclaims are restricted to matters arising out of the same transactions.

The cases delimiting the scope of the doctrine of "equitable subordination" in tax matters discuss the concepts of: offset, recoupment, statute of limitations, and the effect of whether or not the offset or recoupment arises from the same transaction. As such they are useful, by analogy, in applying 11 USC §§ 106(b) and 106(c) in the present case. These equitable recoupment cases discuss the issues of untimely tax refunds in the context of whether or not they arise from the same transaction, address the effect of the statute of limitations and differentiate offset from recoupment.

In 1935, the Supreme Court adopted a theory of "equitable recoupment" to allow a taxpayer to alleviate the injustice of a double payment for the same tax. Bull v United States, 5 ABR 53      295 US 247, 262, 55 SCt 695, 701 (1935) held:

If the claim for income tax deficiency had been the subject of a suit, any counter demand for recoupment of the overpayment of estate tax could have been asserted by way of defense and credit obtained, notwithstanding the statute of limitations had barred an independent suit against the government therefor. This is because recoupment is in the nature of a defense arising out of some feature of the transaction upon which the plaintiff's action is grounded. Such a defense is never barred by the statute of limitations so long as the main action itself is timely. [ footnote omitted]

See, also, Stone v White, 301 US 532, 57 SCt 851 (1937).

The doctrine is limited to a recoupment or offset arising out of the same transaction. In facts analogous to the present case, the Supreme Court limited the equitable recoupment doctrine in tax cases to cases in which the recoupment arises from the same transaction. Rothensies v Electric Storage Battery Co., 329 US 296, 67 SCt 271 (1946). These facts are concisely stated in West's Head Note 2:

Where taxpayer obtained refund in 1935 for excise taxes paid for years 1922 to 1926, inclusive, taxpayer could not recoup amount of excise taxes paid for years 1919 to 1922, against additional tax caused by inclusion of refund as income for year 1935, since refund of excise taxes paid for years 1919 to 1922 was barred by statute of limitations for over 16 years.

The court said in 67 SCt at 273:

The essence of the doctrine of recoupment is stated in the Bull case; 'Recoupment is in the nature of a defense arising out of some feature of the transaction upon which the plaintiff's action is grounded.' 295 U.S. 247, 262, 55 S.Ct. 700, 79 L.Ed. 1421. It has never been thought to allow one transaction to be offset against another, but only to permit a transaction which is made subject of suit by a plaintiff to be examined in all its aspects, and judgment to be rendered that does justice in view of the one transaction as a whole.

Under the holding of these cases, a timely proof of claim might support an equitable recoupment claim even though a refund has not been timely sought otherwise, provided that the offset arises from the same transaction. If it arises from a different transaction, the offset is only allowable if it is itself timely claimed.

In the present case, the refund arises from a different transaction and was not timely claimed. Compare, Rothensies v Electric Storage Battery Co. Therefore, it cannot offset the IRS's proof of claim.

DATED:    August 29, 1997

HERBERT A. ROSS
U.S. Bankruptcy Judge