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#2335 signed 7-23-97



In Re:



CASE NO. 95-40923-7


ROBERT L. BAER, Trustee,


v. ADV. NO. 96-7058




This proceeding is before the Court on the plaintiff-trustee's motion for summary judgment. The trustee appears by counsel John T. Houston. Defendant Jerry D. Hurlbert appears by counsel Frederick R. Smith. The Court has reviewed the relevant pleadings and is now ready to rule.


The parties have stipulated to the following facts.

While he was still married to the debtor, the defendant received about $75,000 from his employer which the parties have called a "buyout." About $35,000 was deposited into a joint bank account with the debtor, and the rest was deposited into an individual retirement account that was apparently either tax-exempt or tax-deferred. When she filed a divorce petition, the debtor withdrew $25,000 from the joint bank account. The debtor and the defendant later reached a property settlement agreement in which the debtor agreed to reimburse the defendant for a portion, based on the $25,000 she took, of the income taxes he would owe on the $35,000. Their divorce became final in December 1994, and they filed separate 1994 tax returns as single individuals. The defendant reported the $35,000 as income on his federal and state returns, which were filled out around April 4, 1995, and paid the resulting taxes. According to calculations which the parties have not disputed, the taxes attributable to the $25,000 the debtor took totaled a little over $11,400.

On April 11, 1995, the debtor withdrew $8,500 from an individual retirement account and paid it to the defendant for her "share of 1994 income tax liability." The debtor has never paid him the remaining amount attributed to the $25,000. Less than 90 days after paying the defendant, the debtor filed for bankruptcy. The defendant has made no attempt to rebut the presumption, found in 11 U.S.C.A. §547(f), that the debtor was insolvent when she paid him, and her bankruptcy schedules show her liabilities exceeded her assets when she filed for bankruptcy.


The trustee contends the debtor's $8,500 payment to the defendant is an avoidable preference. With certain exceptions not applicable here:

(b) . . . the [bankruptcy] trustee may avoid any transfer of an interest of the debtor in property--

(1) to or for the benefit of a creditor;

(2) for or on account of an antecedent debt owed by the debtor before such transfer was made;

(3) made while the debtor was insolvent;

(4) made--

(A) on or within 90 days before the date of the filing of the petition;

. . . ; and

(5) that enables such creditor to receive more than such creditor would receive if--

(A) the case were a case under chapter 7 of this title;

(B) the transfer had not been made; and

(C) such creditor received payment of such debt to the extent provided by the provisions of this title.

11 U.S.C.A. §547(b). The defendant does not dispute that subsections one, three, and four are satisfied here. He does, however, contend the trustee may not avoid the debtor's payment because: (1) the debtor's obligation to pay part of the defendant's tax liability would be nondischargeable under §523(a)(15), so the payment did not enable the defendant to receive more than he would receive in a chapter 7 liquidation; (2) the money came from an asset, the debtor's IRA, which would have been exempt if she had retained it until she filed for bankruptcy; (3) the payment was not for or on account of an antecedent debt because the amount of the debt was not known until his tax liability was calculated in April 1995; and (4) the earmarking doctrine should be applied since the debtor gave the defendant the money to help him pay his tax liability. Each of these claims must fail.

The dischargeability of a debt the debtor paid within the 90-day preference period has no effect on the trustee's ability to avoid the payment. Certainly, the defendant received more by getting money from the debtor than he would by being allowed to continue to try to collect from the debtor after she obtains a bankruptcy discharge. The nondischargeability of a claim does not guarantee it will ever be paid. Furthermore, a debt covered by §523(a)(15) is discharged unless the creditor files a complaint asking the Court to determine dischargeability. See §523(c); Fed. R. Bankr. P. 7001(6). The defendant has not filed a dischargeability complaint, and the time for doing so has expired in this case. See Fed. R. Bankr. P. 4007(c).

The defendant correctly asserts that the debtor could have exempted the money she paid him if she had instead retained it in her IRA until after she filed for bankruptcy. See K.S.A. 60-2308(b). However, when the debtor withdrew the money and paid it to the defendant, rather than converting it to some other exempt asset, the money lost its exempt status under Kansas law. See International Harvester Credit Corp. v. Ross, 217 Kan. 683, 686-88 (1975). The trustee may avoid as a preference a prepetition transfer of property even though the property was exempt before the debtor transferred it. Covey v. United Federal Savings & Loan Ass'n (In re Owen), 104 B.R. 929, 931-32 (C.D.Ill. 1989). While some property can be exempted after a trustee recovers it, the debtor cannot exempt the $8,500 if the trustee recovers it since she voluntarily paid it to the defendant. See 11 U.S.C.A. §522(g) & (h).

The taxes which the defendant wound up owing on the $25,000 which the debtor took from their joint account resulted from his employer's buyout payment to him. Citing no authority about the accrual of tax liability, the defendant contends that the debtor had no obligation to him until his taxes were computed and that the debtor's payment to him was not for an antecedent debt because she paid him as soon as his taxes were computed. The Court declines the defendant's request to apply dicta from a case concerning a real estate contract to the accrual of the taxes in question here. See Sullivan v. Willock (In re Wey), 854 F.2d 196, 200 (7th Cir. 1988). A more plausible argument could be made that the defendant's tax liability arose as soon as he received the money from his employer and used it in a way that ensured it would be taxed as ordinary income. In fact, his tax return shows he not only incurred ordinary income tax on the $35,000 but also a 10% tax on early distributions for withdrawing it from a qualified retirement plan; this special tax would almost certainly have accrued as soon as he withdrew the money. By including the provision in their property settlement which made the debtor liable for some of the defendant's taxes based on the $25,000 she took, the parties indicated they knew or at least thought taxes would result from their use of the retirement money. The Court believes the defendant's tax liability arose no later than December 31, 1994, the end of his tax year, and could have been computed and paid as of the next day. The debtor's obligation to pay a portion of those taxes could also have been computed then, so her debt to the defendant similarly arose no later than that day.

The defendant concedes this case does not satisfy the "earmarking doctrine," but asks the Court to apply the "rationale" of the doctrine to prevent the trustee from recovering the debtor's payment to him. He fails to explain the doctrine, however, and so fails to recognize why it does not apply here. As explained by a leading bankruptcy treatise, the doctrine applies when a third party loans money to the debtor to enable the debtor to pay the claim of a specified creditor, "earmarking" the proceeds so that the debtor is not entitled to control their use. 5 Collier on Bankruptcy, ¶547.03[2] at 547-24 to -25 (15th ed. rev. 1997). The rationale is that the payment to the specified creditor does not diminish the debtor's bankruptcy estate, and simply substitutes one unsecured creditor for another. Coral Petroleum, Inc., v. Banque Paribas-London, 797 F.2d 1351, 1356 (5th Cir. 1986). While the defendant does suggest he gave the debtor the money that wound up in the IRA which she liquidated to pay him, his transfer to her was apparently part of their property settlement, not a loan. Indeed, it would have made little sense for him to loan her money with instructions to pay it back to him. Next reverting to his exemption argument, the defendant again asserts that the debtor's estate was not diminished by the payment because it came from her exempt IRA. However, as explained above, the money ceased to be exempt when she withdrew it from the IRA and paid it to him.

For these reasons, the Court concludes that the debtor's obligation to pay a share of the defendant's income taxes was an existing (or antecedent) debt when she paid him the $8,500 and that her payment enabled him to receive more than he would receive in a chapter 7 liquidation of her assets. Consequently, the trustee has shown that his summary judgment motion should be granted.

Summary judgment is hereby granted. The trustee is entitled to recover the $8,500 payment from the defendant.


Dated at Topeka, Kansas, this _____ day of July, 1997.





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