Bankruptcy Cases Involving Evasion of Payment and Classification of the Failure to File Penalty

A pair of recent bankruptcy cases deserve some mention. Conard v. IRS and In re Colony Beach & Tennis Club take a look at IRS claims from two perspectives and provide some insight on whether a bankruptcy petition will prove beneficial in certain circumstances. In the Conard case, the husband gets no relief but his wife will get the opportunity to fully litigate the issue of discharge. In Colony Beach, a defunct partnership’s liability gets classified in a way that will help other creditors of the debtor if not the debtor itself; however, in fashioning the equitable remedy that subordinates the IRS claim, the bankruptcy court loses sight of the true party to blame for the problem and creates an inequitable result at odds with earlier precedent and good sense.

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Evasion of Payment

Conard involves the application of facts to BC 523(a)(1)(C). This bankruptcy code section excepts from discharge tax debts incurred through evasion of a tax debt either in the filing or a return or the payment of the tax. The Conrads’ case involves evasion of a tax debt though efforts taken not to pay the tax. The amount of the liability was not in dispute and the IRS did not argue that the Conards did anything to keep the IRS from knowing the correct amount of the liability. Instead, the IRS seeks to deny the Conards a discharge because they have attempted to evade payment of the debt prior to filing their bankruptcy petition. The IRS must prove by a preponderance of the evidence that the Conards did not pay their taxes in an improper effort to avoid doing so. Guest blogger Lavar Taylor discussed this issue previously here and here. I wrote about it here, in a case involving evasion of the creation of the liability and not evasion of payment but the post has links to a couple of earlier discussions of the issue.

Mr. Conard operated a life insurance agency in Northern Virginia. The case caused me to notice that in the district where I practiced bankruptcy law while representing the IRS a new bankruptcy judge had been appointed, Judge Keith Phillips, who I knew and liked as a practitioner. Judge Phillips describes Mr. Conard as someone who “chose to put his federal tax obligations ‘on the back burner’ in favor of paying business expenses ‘to keep the business … afloat’ and expanding his business to generate more income.” Mr. Conard placed his federal taxes so far on the back burner that by the time he arrives in bankruptcy court he owed the IRS almost $700,000 for the years 2004-2009.

Of course, as is common in these types of cases, he made purchases that make it very difficult to have sympathy for him. He bought an $86,000 Mercedes Benz, a $47,000 BMW, a $50,000 Buick Lacrosse, and a $4,000 Harley motorcycle. In addition, he spent $48,000 on his son’s tuition as well as a litany of other goods and services that did not reflect the lifestyle of someone scuffling to get by. Judge Phillips found Mr. Conard’s case so straightforward that he ruled for the IRS on a motion for summary judgment. He finds, citing cases from the 3rd, 5th, 6th and 10th Circuits, that the IRS need to meet the criminal standard of beyond a reasonable doubt for evasion of payment.  The IRS needs to prove that Mr. Conrad attempted to evade the payment of his taxes – essentially the same, if not the same, proof as in a 7201 evasion of payment case; however, the proof does not need to be beyond a reasonable doubt or even clear and convincing in order to have the taxes determined to be excepted from discharge under BC 523(a)(1)(C).  The IRS can have the taxes excepted from discharge if they can prove the attempt to evade payment by a preponderance of the evidence.

However, the Court determined that the IRS had not shown that Mrs. Conard was sufficiently willful in not paying her taxes. It refused to rule on summary judgment with her and will hold a trial to determine her role in the non-payment. I do not know enough about the case against her to have an opinion. With respect to Mr. Conard, he presents the classic case of someone excepted for discharge for seeking to avoid the payment of taxes. If you are not going to pay your taxes, try not to purchase expensive cars and other big ticket items during the period of non-payment.

Reasonable Cause and Equitable Subordination

The Colony Beach case involves a situation in which the IRS seeks to have a penalty claim elevated to administrative claim status. If the claim achieves that status, it will get paid before all other unsecured claims. The debtor, a limited partnership, filed its chapter 11 bankruptcy petition in October, 2009, but by August of 2010 it followed the path of many businesses that start in chapter 11 and converted to a chapter 7 liquidation. It was a fiscal year taxpayer whose year ended on April 30. The return for the year ending in 2011 was initially due July 15 and the extended due date, had it requested an extension, would have been due on January 15, 2012. The trustee filed the return on January 7, 2012 apparently operating under the mistaken impression that his accountant had requested an extension. Because neither the trustee nor his accountants requested an extension, even though they could have done so, and because this penalty applies at the partnership level, the IRS filed a proof of claim for a penalty of $356,695.46.

The trustee, the same person who filed the return late, objected to the claim arguing that reasonable cause existed for late filing. Additionally, the trustee argued that it would be inequitable to allow the IRS to have a priority claim for the penalty and get paid ahead of all other unsecured creditors of the bankruptcy estate. (I do not know exactly how much money was in the estate but it is possible that the penalty claim made the estate “administratively insolvent” which would have meant the trustee would not receive his full fees.)

The first sentence of the reasonable cause portion of the opinion contained a citation to Boyle, which I have noted before is almost always a signal that things will not go well for the party arguing reasonable cause. My use of Boyle as a predictor on this point proved accurate again. The trustee argued that he was involved in “complex litigation which required his full attention.” He also argued that the business was in disarray impeding his ability to reconcile accounts. These all seem like reasons for requesting an extension of time to file which would only have taken a few moments and would have bought the trustee the time he needed to put things together. The court pointed out that the trustee did not file an application to employ accountants to prepare and file the 2011 return until five days before the extended deadline for filing the return. He testified that he thought the debtor’s former accountants would take care of requesting an extension though he never checked on whether they had done so. Consequently, the court had little trouble turning back his reasonable cause claim.

“Nevertheless, it is appropriate in this case to deny the United States’ claim as an administrative expense under 503(b) and to equitably subordinate it.” So, losing the reasonable cause argument in this case does not have any apparent negative impact on the trustee or most of the creditors of the estate. The court notes that penalties can achieve administrative claim status; however, to do so they must relate to a tax incurred by the estate. Here, the taxes related to the late file return are the responsibility of the partners and not the partnership in bankruptcy. So, the claim does not qualify for administrative claim status under section 503((b)(1)(C).

The IRS wants this money so it argued even if the penalty claim does not qualify under (b)(1)(C) it should qualify as a “generic” administrative expense, citing In re 800Ideas.com, Inc., 527 B.R. 701, 702 (Bankr. S.D. Cal. 2015). That case involved a late filed S Corporation return which had the same tax passthroughs as the partnership return and the same late filing penalty application at the corporate level. The bankruptcy court here, acknowledging the appropriateness of the citation, declines to accept the reasoning of that case concluding that “it is appropriate to give meaning to the exclusion of penalties that are unrelated to taxes owed by the bankruptcy estate.” The court also points out the real elephant in the room which is the impact of allowing the penalty claim as an administrative claim on the unsecured creditors who had no hand in the late filing of the return.

Here is where I disagree with the court. It states that in the 800ideas.com case “the impact of the penalty fell on the trustee because the claim, as an administrative expense, reduced the trustee’s compensation.” The court further states that in this case “the trustee will be paid in full, regardless of the United States’ claim receiving administrative status or not….” That makes no sense. The court could have the IRS claim for the late penalty paid in lieu of the trustee’s payment and subordinate the trustee’s payment, to the extent of the penalty claim to general unsecured status. The trustee in this case need not be paid in full while the IRS gets stiffed on its penalty claim that arose because of the trustee’s failure. I totally agree with the court that this penalty should not be borne by the other unsecured claimants but allowing the trustee to take ahead of the IRS cannot be reconciled with equity.

Conclusion

The bankruptcy court in 800ideas.com understood how to fashion an equitable remedy in this situation. I hope the IRS appeals the case to a district judge who has a similar understanding of equity. If the trustee in a situation like this receives his full fee, he learns that filing late has no consequence. That should not be the lesson learned from filing late. This court loses sight of how to fashion an equitable remedy no matter how sorry one feels for a busy trustee.

 

 

Avoiding the Federal Tax Lien Securing Penalties in a Bankruptcy Case

The case of Hutchinson v. United States [No. 17-01076] (E.D. Cal. 2017) involves an effort by taxpayers in bankruptcy to avoid a federal tax lien securing the payment of penalties. The bankruptcy court denies the effort by the taxpayers to avoid the lien while acknowledging that the bankruptcy trustee could have avoided the lien had the trustee sought to do so. As discussed below, the reason that the bankruptcy court allows one party, the trustee, to avoid a federal tax lien securing penalties but not another party, the debtor, results from the benefit Congress sought to confer in allowing avoidance of the federal tax lien securing penalties in a chapter 7 case.

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The taxpayers owed $162,690 in penalties at the time they filed their bankruptcy petition. Prior to the filing of the petition, the IRS had filed a notice of federal tax lien in the city or county in which their residence was located. In their bankruptcy schedules, taxpayers indicated that the value of their home was $185,000 and that it was encumbered by a first deed of trust in the amount of $87,000. They claimed a personal exemption of $100,000. Because they lived in California, which has a generous exemption provision for personal residences, this was possible. Not all states have such a large exemption for personal residences.

Taxpayers’ problem with the exemption was that it removed the property from the bankruptcy estate allowing them to keep the property and the home equity; however, the federal tax lien continued to attach to the property after bankruptcy putting them in the position of going through the bankruptcy only to find that on the other side they had not obtained the relief they needed. Because the federal tax lien still attached to the home, the IRS had/has the ability to sell the home either administratively or through a foreclosure proceeding. The taxpayers presumably sought to avoid the lien in their case in a post bankruptcy discharge action in order to keep the IRS from taking their home and using the equity in excess of their first mortgage to satisfy the tax debt.

Before discussing the Hutchinsons’ case further I stop to note that the IRS is generally very reluctant to take taxpayers’ homes. Before 1998 it did not take taxpayers’ home frequently, but after the Restructuring and Reform Act of 1998 the IRS very rarely takes taxpayers’ homes or other tangible property. The situation gets a little stickier for the IRS in the post bankruptcy situations. Absent bankruptcy, the IRS can simply take no collection action operating under the fiction that the statute of limitations on collection is still open and it might collect from the taxpayers through some mechanism other than seizure and sale of property. No one at the IRS is forced to make a decision concerning collection and the general practice of only seizing tangible assets in rare circumstances usually results in a decision to do nothing which is different than an affirmative decision to walk away from the only property that could satisfy the liability.

When a taxpayer obtains a bankruptcy discharge and before the filing of the bankruptcy petition the IRS  a filed federal tax lien for the discharged taxes discharged, someone at the IRS must make an affirmative determination whether to pursue collection from any assets the taxpayer brought into the bankruptcy estate to which the federal tax lien attached. The equity available in a debtor’s property such as the home equity available in the Hutchinsons’ case is the only thing from which the IRS can collect to satisfy the discharged liability because the bankruptcy discharge turned what was an in personam liability into an in rem liability.  The rem, or the thing securing the debt, in the Hutchinsons’ case, their house, is the only asset the IRS has from which it can satisfy the liability. Someone at the IRS must make an affirmative determination to release the lien.  In this situation the IRS employee assigned to the case cannot rely on the fiction that the IRS might later collect the liability from future earnings or a voluntary payment. The IRS employee knows that if they release the lien they are walking away from $100,000 in equity and that the only way to collect the $100,000 is to enforce the lien on the property. Here, it becomes more likely that the IRS will take action against the property to obtain the equity to which its lien attaches than if the taxpayer had not sought bankruptcy relief.

So, the Hutchinsons would like to eliminate the IRS lien in order to eliminate the possibility that the IRS would take their home. Because the lien at issue here is a lien in which the underlying liability is a penalty and not a tax and because the taxpayers filed a chapter 7 petition, the trustee could have avoided the lien using the powers available in Bankruptcy Code sections 724(a) and 726(a)(4). The Hutchinsons brought this action to avoid the penalty under Bankruptcy Code section 522(h). Section 522 is the section that addresses exempt property. The IRS responded to the action by arguing that 522(c)(2)(B) specifically allows it to assert its lien against exempt property and that only the trustee has standing to assert the lien avoidance provisions of 724(a).

The court acknowledged that the trustee could have avoided the tax lien and then found that if the trustee does not do so debtors can avoid liens under section 522(h) but not tax liens. Citing the earlier Ninth Circuit case of In re DeMarah, 62 F.3d 1248,1250 (9th Cir. 1995) the court holds that “where the lien sought to be avoided secures back taxes, 522(c)(2)(B) eviscerates the debtors’ 522(h) powers.” The court noted that the fact that the debtor could exempt property from the estate does not mean that the debtor can remove the lien “or that portion of it which secures the penalty.” The purpose for allowing the trustee to avoid the tax lien securing penalties in a chapter 7 case is to allow the trustee to obtain a greater recovery for the benefit of the other creditors of the bankruptcy estate. The purpose of the provision allowing avoidance was not to allow the debtor to gain relief.

This case does not break new ground but presents a bankruptcy issue we had not previously discussed on the blog. The penalty avoidance powers in chapter 7 are strong and represent an effort by Congress to clear up some equity for other creditors who should not be penalized themselves by the debtors’ bad tax behavior. The provision allows the removal of the lien on penalties as an impediment to the payment of a creditor with no lien interest or an inferior lien interest and avoids having limited estate funds go to satisfy a debt based on bad behavior towards the IRS.  Those avoidance powers were not intended to allow the debtor to use bankruptcy to escape from their bad tax behavior. In the absence of a filed federal tax lien and if the penalty is not for fraudulent behavior, bankruptcy serves as an excellent mechanism for discharging penalties more than three years old but the existence of the filed federal tax lien changes the game and gives the IRS the opportunity to pursue available equity in a debtor’s property to collect penalty claims if it has the desire to do so.

 

 

Collection from Retirement Accounts Part 3 – IRS Pushes Hard to Collect from F. Lee Bailey

The bankruptcy court in Maine has granted relief from the automatic stay to allow the IRS to collect from Mr. Bailey’s pension accounts and Social Security benefits. While the IRS has the power to go after these accounts, its exercise of this power is governed by the issues discussed in the first two parts of this series. This is another defeat for Mr. Bailey in his efforts to protect his assets from the collection of federal taxes. I wrote previously about Mr. Bailey’s filing of the bankruptcy petition after suffering a massive loss in Tax Court.

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In my earlier post regarding Mr. Bailey’s Tax Court loss, I speculated that Mr. Bailey might achieve relief in bankruptcy because his Tax Court case resulted in the imposition of an accuracy related penalty rather than the fraud penalty. That may still be true; however, the type of penalty does not stop the IRS from pursuing his assets and that is what it is doing with a vengeance. The bankruptcy court starts off the opinion stating “This bankruptcy case is another chapter in the decade long struggle between the Internal Revenue Service and Mr. Bailey over taxes.” We have not previously written much about the ability of the IRS to take a taxpayer’s social security payments and pension accounts. In addition to the first two posts in this series, I briefly touched on it recently in a post about military pensions where I discussed the federal payment levy program. Mr. Bailey’s case provides the opportunity to discuss how and when the IRS will take these assets as the policies apply to a specific individual rather than the group of individuals studied by TIGTA.

Based on the pursuit of these assets in the bankruptcy case, it seems clear that the IRS has determined that Mr. Bailey meets its definition of having committed flagrant conduct regarding the payment of his taxes. I discussed, and linked to, the IRS definition of flagrant conduct in the first post in this series. Cases where the IRS makes the determination that the taxpayer’s conduct is flagrant are the ones in which you see the IRS using its collection tools to their full effect. You should always seek to have your clients behave in a way that keeps them from fitting into the flagrant criteria or, should their conduct fall into the flagrant criteria, have them work quickly to mitigate that behavior because that type of behavior can cause the IRS to use some tools at its disposal that it might otherwise keep holstered.

The IRS will routinely go after 15% of a taxpayer’s social security payments through the federal payment levy program. As discussed in the post referenced above, the IRS has filters that it applies, thanks to the National Taxpayer Advocate, which exclude from the FPLP taxpayers whose income appears to be less than 250% of poverty. Section 6343 requires that the IRS not levy on taxpayers when the levy would put the taxpayer into a hardship situation and the filters the IRS applies in the FPLP program recognize that a high percentage of the individuals with income below 250% of poverty would end up in a hardship situation if the IRS levied on 15% of their Social Security payments. Of course, individuals whose income exceeds 250% of poverty can come into the IRS and show that the levy places them in hardship status if the IRS takes 15% through this program. For a detailed description of FPLP, see part two of this series.

The IRS need not limit itself to 15% of a taxpayer’s Social Security payments and it can levy on the entire amount of the payments if it chooses and if doing so does not place the taxpayer into hardship status. The opinion does not say whether the IRS plans to take only 15% of his Social Security payments or all of them; however, I would be surprised if it is not planning to take them all. When it seeks to take all of a taxpayer’s Social Security payments, the discussion in the last part of part two of this series becomes important. Mr. Bailey’s case is or was prior to bankruptcy in the hands of a revenue officer. Now that he is in bankruptcy, there will also be a bankruptcy specialist working on his case and probably an attorney at the Office of Chief Counsel. These individuals will apply the policy decisions set out in the manual in deciding to take his social security payments. The only legal impediment, aside from the automatic stay, is IRC 6343 setting out the hardship exception to levy.

As discussed previously, taking social security payments does not stop when the statute of limitations on collection ends. The IRS lien attaches to the taxpayer’s right to the stream of payments. Because the taxpayer’s right to this stream is fixed, once the IRS levies on the taxpayer’s interest in the social security payments the levy attaches to the right to receive all of the payments. So, as long as the taxpayer lives and the tax debt remains outstanding, the IRS can continue to receive the social security payments.

From part one of this series you know that the IRS can also levy on interests that taxpayers have in IRAs or pension plans. Even though ordinary creditors cannot reach assets in pension plans because of restrictions put in place by ERISA, these restrictions do not apply to the IRS. The IRS has policies that cause it to pause and obtain approvals and certain levels within the agency in order to levy on pension plans but the law places basically no restrictions that prevent the IRS from levying on these plans. A levy on a pension plan does not accelerate payment from the plan, but just like the levy on the taxpayer’s Social Security payments, the levy on the pension plan does attach to all of the rights the taxpayer has in the plan even if those rights include future and not present payments. I can only assume that prior to seeking to lift the stay in Mr. Bailey’s bankruptcy case, the IRS and its lawyers have already made a determination that neither the policies in the manual or the provisions in IRC 6343 prevent levies upon his pension plan or social security payments.

These IRS rights to pursue Social Security and pension plan payments play out in Mr Bailey’s bankruptcy case in the context of the automatic stay. The automatic stay comes into existence the moment a debtor files a bankruptcy case and works to prevent creditors from taking most assets of the debtor and of the estate. Bankruptcy code section 362(a) lists eight separate matters covered by the automatic stay; however, creditors can apply to the bankruptcy court to lift the automatic stay to permit the creditor to go after an asset otherwise protected by the stay. That is what the IRS has done in Mr. Bailey’s case. The bankruptcy court must then determine whether to lift the automatic stay to permit the IRS to collect from these assets while the bankruptcy case proceeds.

The concern of the IRS is that if Mr. Bailey receives these payments he might spend them. Each time he spends the payments from Social Security and the pension plan, he dissipates an asset on which the IRS has a lien interest and allowing him to receive the payments can only occur if he provides adequate protection to the IRS that its lien interest will not be harmed by his receipt of these payments. The bankruptcy court notes that he has the burden of proof on all issues connected with the motion of the IRS to lift the stay except on the issue of the equity in the Social Security and pension benefits. The IRS must show these assets have equity to which the federal tax lien has attached. Showing that equity exists in social security and pension plan payments is very simple.

By the time the IRS filed the motion to lift the automatic stay, Mr. Bailey had already received his chapter 7 discharge. The discharge lifted the automatic stay with respect to collection against him personally but the stay would continue with respect to assets of the bankruptcy estate until the estate was closed. The claims of the IRS survived the discharge in the chapter 7 case according to the bankruptcy court but the court does not provide specific information as to why they survived. It appears that even if some or all of the IRS claims were not excepted from discharge under bankruptcy code 523, the federal tax lien continued to attach to property belonging to Mr. Bailey which he kept after the chapter 7. After the conclusion of the chapter 7 case, Mr. Bailey filed a chapter 13 bankruptcy case. This maneuver is sometimes called a chapter 20.

The court finds that the IRS lien interest in the Social Security and pension payments is not adequately protected. Mr. Bailey said he needed to use the payments from these sources to fund his chapter 13 case and therefore he should get to keep them; however, that is exactly what the IRS fears since in using them to fund the plan he will spend the money from these plans and as he does so he destroys the lien interest of the IRS. The court points out that though it rules for the IRS in this summary type proceeding, Mr. Bailey can challenge the lien claim of the IRS in another proceeding should he seek to do so.

Mr. Bailey continues in his second bankruptcy case to do what many taxpayers before him have tried to do and use bankruptcy to wriggle free from federal tax debt. While it is possible to do that in certain circumstances, where the IRS has perfected its lien, debtor has assets to which the lien attaches, and the IRS is diligent in protecting its rights, the debtor will basically always lose. That does not mean the IRS will ultimately collect the $5 million dollars owed to it, but it does mean that while some or all of that debt remains due and owing, the IRS will continue to have open season on his assets including his Social Security and pension assets.

 

Priority Status of Transferee Liability in Bankruptcy

Two types of claims exist in bankruptcy – secured and unsecured. Every creditor wants to be a secured creditor. In theory, secured creditors pass through bankruptcy unaffected. That theory has many notable exceptions but, nonetheless, it is best to be a secured creditor.

If you cannot be a secured creditor, the next best thing is to be a priority creditor. Congress has looked at the type of debts that exist in the United States and decided that certain of those debts, about ten, deserve recognition above all the rest. It lists these special “priority” debts in section 507 of the bankruptcy code. If your debt makes it onto this list, your debt gets paid before general unsecured claims receive payment. The higher you are on the list, the better you are. Think of the list of priority debts as a cruise ship with the best cabins at the top and the worst at the bottom. Then think of general unsecured claims as steerage existing in the hold of the ship below all of the priority claims. Depending on when the money in the estate runs out, only certain creditors get paid. All of the creditors in the first priority must be paid before any payments go to the next level down, and so on through each level. Wherever the money runs out, the creditors in the group where it runs out get paid pro rata and any creditors below that level go home empty handed.

It is in this context that the fight in In re Kardash, No. 8:16-bk-05715 (September 21, 2017) takes place. The IRS convinced the Tax Court to hold in T.C. Memo 2015-51 and T.C. Memo 2015-197 that he owed about $4.3 million as a result of fraudulent transfers, and the 11th Circuit affirmed the Tax Court’s decisions at 866 F.3d 1249 (11th Cir. 2017). For more background on the Tax Court aspect of this case see Steve’s prior post here and a subsequent post about the case by Peter Reilly here. The IRS seeks to have the transferee liability of Mr. Kardash treated as a priority claim in his bankruptcy case (although he is married Mr. Kardash filed a chapter 11 bankruptcy individually and his wife did not file). Mr. Kardash objected to treating the transferee liability as a priority claim. Usually, it is the trustee who cares more than the debtor, but there is a second importance to priority status for tax claims because any tax claim entitled to priority status is excepted from discharge if it does not get paid in the bankruptcy case. Tax debts not entitled to priority status can also be excepted from discharge but the rules for those debts are more restrictive. So, the classification of the claim makes a big difference both to the other creditors of the estate and, potentially, to Mr. Kardash.

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Mr. Kardash was an employee and minority shareholder with an 8.65 share of a company that was defunct by the time of the bankruptcy case. He managed the operations of the company but was not a responsible person under IRC 6672. (If he did owe any money as a responsible person, such a debt would always be entitled to priority status under bankruptcy code 507(a)(8)(C)). During the relevant period, the company had revenue in excess of $450 million but paid no income taxes. The IRS subsequently audited the company and determined that it owed over $120 million for these years. The two controlling shareholders siphoned substantially all of the cash out of the company. Mr. Kardash received about $3.5 million during the years 2005-2007, and he reported the distributions as dividends and paid tax on it.

The IRS sent him a notice of transferee liability regarding these dividends as well as bonuses he received in 2003 and 2004. He petitioned the Tax Court, which ruled that the dividends paid to him in 2005-2007 were fraudulent transfers under applicable Florida law because they were not made in compensation for his services and the company was either insolvent at the time it paid him or became insolvent as a result of the payments.

The IRS can file a priority claim under bankruptcy code 507(a)(8)(A) for unsecured claims for “a tax on or measured by income or gross receipts for a taxable year ending on or before the date of the filing of the petition….” The bankruptcy court states that the transferee liability under IRC 6901(a) (the basis for Mr. Kardash’s liability) does not by its terms impose a tax. While this is a true statement, the transferee liability provisions seek to provide the IRS with a basis for collecting tax that has otherwise gone unpaid. The bankruptcy court quotes from the Tax Court’s description of the case:

“Section 6901(a) is a procedural statute authorizing the assessment of a transferee liability in the same manner and subject to the same provisions and limitations as in the case of the taxes with respect to which the transferee liability was incurred. Section 6901(a) does not create or define a substantive liability but merely provides the Commissioner a remedy for enforcing and collecting from the transferee of the property the transferor’s existing liability.”

The bankruptcy court points to an 11th Circuit decision in Baptiste v. Commissioner, 29 F.3d 1533 (11th Cir. 1994), holding that “any liability to which section 6901(a) applies is not a tax liability, but rather an independent liability.” The 11th Circuit found that IRC 6901(a) is purely a procedural statute. The Baptiste case was not a bankruptcy case; however, in In re Pert, 201 B.R. 316, 320 (Bankr. M.D. Fla. 1996), a bankruptcy court in the same jurisdiction as the court deciding Mr. Kardash’s case relied upon Baptiste in determining that a transferee liability was not entitled to priority status. The bankruptcy court states that the Baptiste and Pert decisions control the decision here. I do not necessarily agree with that statement as the Circuit Court decision addresses a different aspect of a transferee liability and a bankruptcy court is not bound by decisions of bankruptcy judges at the same level. Nonetheless, these cases provide support for the decision that the transferee liability is not entitled to priority status.

The Court disagrees with the decision of the 10th Circuit in McKowen v. Internal Revenue Service, 370 F.3d 1023 (10th Cir. 2004). The McKowen case involved the issue of discharge and not directly the issue of priority status, though the two can be linked. The McKowen case adopted a functional approach to the classification of the transferee liability claim which is the approach sought by the IRS. A middle ground here would be to treat the debt as non-priority but excepted from discharge similar to debts where a fraudulent return has been filed. Such treatment would allow other creditors of the estate to take before the payment of the derivative liability created by 6901(a), but would also allow the IRS to have the opportunity to collect on a debt that the actions of the company owing the debt has prevented the IRS from collecting. Neither the priority provision of bankruptcy code section 507 nor the discharge provisions of bankruptcy code section 523 neatly address the circumstances of a transferee liability. It is surprising that almost 40 years after the passage of the bankruptcy code, an issue of this type remains unresolved.

In arguing that the court should apply a functional analysis in determining whether the transferee liability receives priority status the IRS cited to United States v. Reorganized CF&I Fabricators of Utah, Inc., 518 U.S. 213 (1996) in support of its position that a bankruptcy court must look to the basis for a liability in determining the liabilities status. In CF&I the Supreme Court determined that a liability labeled a tax was really a penalty just as in Sotelo v. United States, 436 U.S. 268 (1978)(in a case involving the trust fund recovery penalty) the Supreme Court found a liability labeled a penalty was really a tax. See a post by Bryan Camp discussing this issue for further details. As you can see from the fact that cases have twice gone to the Supreme Court to classify tax claims, this is a serious issue. The parties’ briefs are excellent and set out the issue in great detail if you are seeking more understanding of the issue. See Debtor’s Response and Opposition to the IRS’S Motion for Summary Judgment and the Reply to Debtor’s Response and Opposition to the United States’ Motion for Summary Judgment.

Conclusion

I look for the IRS to appeal this decision unless it determines that the 11th Circuit precedent controls the issue. The decision here does not directly address discharge but only the priority of the IRS claim. Depending on the amount of money in the estate, the priority status of the claim may not matter as much as the discharge issue. From the pleadings it appears that the efforts of the IRS to collect from Mr. Kardash partially involves its ability to reach property held as tenancy by the entireties based on the decision in United States v. Craft, 535 U.S. 274 (2002) and a subsequent 11th Circuit case, United States v. Offiler, 336 F. App’x 907, 909 (11th Cir. 2009) interpreting Craft. I wrote about the Craft case here.

A part of the fight in the bankruptcy case involves use of the proceeds of a house that the taxpayer and his wife jointly owned. The IRS objected to certain uses of those proceeds because the debtor’s proposed use would reduce its recovery. The debtor is 75 and now on social security. The prospects for recovery here will come from existing property and not future income but the IRS may determine that its ability to collect from Mr. Kardash is less important than establishing the principle regarding the classification of transferee liabilities in bankruptcy cases. If it does, Mr. Kardash will not only have selected bad business partners but also a bad issue to litigate since the IRS may push the litigation without his concern for the cost vs. benefit.

 

 

 

 

Getting Convicted of Tax Evasion Means No Discharge of the Tax in Bankruptcy

I wrote last spring about how a conviction for filing a false tax return, IRC 7206(1), provided a basis for denying a bankruptcy discharge on the basis of collateral estoppel. The recent decision in United States v. Wanland provides an example of a conviction for tax evasion, IRC 7201, which creates the same result.

At issue in the Wanland case is only the unpaid taxes and not the fraud penalties. The civil fraud penalty, like all tax penalties, can be discharged in a bankruptcy case when it becomes three years old, as discussed here. The IRS does not argue that anything keeps the fraud penalty from discharge but it does make good use of an argument regarding its levy to extend the years in which Mr. Wanland was charged with criminal behavior to earlier years to also prevent their discharge.

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Mr. Wanland was an attorney. The recently decided case seeks to obtain a judgment against him for $1,065,493.30. He is representing himself in this litigation. On September 26, 2013, he was convicted of 28 counts of criminal tax violations. One count of 7201 evasion of payment, 24 counts of concealment of property subject to levy and three counts of 7203 failing to file tax returns.

Before he was convicted of the criminal tax violations, Mr. Wanland filed bankruptcy and received a discharge of his debts on June 8, 2011. Because of the bankruptcy discharge, Mr. Wanland argues that the IRS is collaterally estopped from raising the issue of his liabilities since it did not bring an action in the bankruptcy case to except his liabilities from discharge. The issue presented is one of first impression in the 9th Circuit though other courts have addressed it. Must the IRS affirmatively seek a determination regarding the discharge of taxes or does the exception to discharge of 523(a)(1), except the described taxes from discharge without the need for affirmative action.

The IRS takes the position that it does not affirmatively need to bring an action in each bankruptcy case to have the bankruptcy court make a determination regarding which taxes are and which taxes are not discharged. At the conclusion of each bankruptcy case the IRS makes its own determination regarding the impact of the discharge on the taxpayer’s liabilities. If the IRS determines that the taxes or penalties, were discharged, it will write them off its books and the taxpayer does not need to do anything to request that the IRS do so. If the IRS determines that the taxes are not discharged, it sends them back into the collection stream. If a taxpayer thinks that the IRS decision to send the taxes back into the collection stream is wrong, the taxpayer can sue the IRS for violating the discharge injunction and cause the write-off of the taxes if it wins.

Here, the IRS has gotten to the point in the collection of the liabilities against Mr. Wanland that it is bringing a suit to reduce the liabilities to judgment. That will cause the liabilities to hang around his neck basically forever, as we have discussed here. In his effort to ward off the suit, he argues that the IRS missed the time to object to the discharge of his tax liabilities and it cannot seek to collect them at this point.

The district court rejects his arguments citing to the decisions of other courts that have faced this issue.

“Debts listed in sections 523(a)(2), (a)(4) and (a)(6) are automatically discharged in bankruptcy unless a creditor objects to their dischargeability by fiing an adversary proceeding. Fed. R. Bankr. P. 4007 (advisory committee notes). A creditor who wishes to object to the dischargeability of a debt under sections 523 (a)(2), (a)(4) or (a)(6), must file a complaint within sixty (60) days of the first scheduled meeting of creditors. Fed. R. Bankr. P. 4007(c)… Those debts excluded from discharge not listed in sections 523 (a)(2), (a)(4) or (a)(6), including certain tax debts, are automatically excepted from discharge… As a result, a complaint to determine the dischargeability of a debt, other than a debt listed in sections 523(a)(2), (a)(4) or (a)(6), may be filed at any time. Fed. R. Bankr. P. 4007(b)”

Quoting In re Walls, 496 B.R. 818, 825-26 (N.D. Miss. 2013)(citation omitted); see also In re Range, 48 Fed. App’s 103 at 5 & n.2 (5th Cir. 2002)(unpublished).

There are 19 subparagraphs of Bankruptcy Code section 523. Only three of them have been singled out in the Bankruptcy Rules to require the creditor to affirmatively bring an action early in the case to determine discharge. The first two deal with types of fraudulent activity by the debtor and the third with willful and malicious action that causes harm. Because the particular provision that prevents Mr. Wanland’s discharge is a type of fraud, there is some basis for looking at taxes excepted from discharge under 523(a)(1)(C) to determine if they create a different situation that “ordinary” taxes. It would create an enormous burden on the IRS and the bankruptcy court to have the IRS objecting to discharge in every bankruptcy case in which the debtor’s taxes are excepted from discharge because the volume would be enormous. The IRS has historically been a creditor in about 40% of all bankruptcy cases meaning that these types of motions would be filed in hundreds of thousands of cases each year.

The number of cases in which the IRS excepts the taxes from discharge under 523(a)(1)(C), however, is quite small. It would not place a big burden on the IRS or the bankruptcy court if the IRS were required to come into those cases with a motion similar to the motion made in the cases of the three provisions cited. Nonetheless, the general rule regarding tax debts prevails here and the district court finds with the other courts looking at the issue that the IRS need not affirmatively file an objection to the discharge of this debt.

The decision does not surprise me. Once the IRS gets past the issue of whether it should have raised the issue during the proceeding, the court has no trouble finding that the debtor’s conviction serves to estop the debtor from arguing that the liability is excepted from discharge for the years of the 7201 criminal conviction which were 2000-2003. The court finds it a closer question whether the IRS can use offensive collateral estoppel to the 1996-1998 tax liabilities which were not included in the criminal case. The IRS presented evidence that it served a levy to collect taxes for 1996-1998 and 2000-2003. That levy was the levy upon which the criminal case was based because he concealed his assets to keep the IRS from receiving payment on that levy. Under the circumstances, the court finds that affirmative collateral estoppel works to prevent Mr. Wanland from arguing that the taxes for all of the years are not excepted from discharge. This is an interesting extension of the collateral estoppel effect of the bankruptcy case. The court could have reached the same conclusion without the need for collateral estoppel if it found that he was trying to evade the payment of his taxes for the non-criminal years.

 

Trying to Limit a Federal Tax Lien through Confirmation of a Chapter 13 Plan

A Chapter 13 plan usually gets confirmed with 60 to 90 days after a debtor files bankruptcy. It often involves fairly boilerplate language, but it is binding on the debtor and the creditors. Because of the relatively high volume of these plans and their relatively routine nature, the IRS does not always pay sufficient attention to these plans. In Nomellini v. United States, the debtor pointed to his plan language and argued that it limited the federal tax lien filed against him. The district court affirmed a bankruptcy court determination holding that the plan did not disrupt the federal tax lien. The decision does not break new ground but does point to the potential power of confirmation to impact tax debts even if the discharge does not eliminate them.

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Mr. Nomellini owed taxes for several years and the IRS filed a notice of federal tax lien before he filed bankruptcy. In the bankruptcy case, the IRS filed a claim listing only $10,000 of its almost $200,000 claim as secured because the IRS adopted the values listed in debtor’s schedules showing his property and his secured creditors. The plan stated that “the valuations shown above will be binding unless a timely objection to confirmation is filed. Secured claims will be allowed for the value of the collateral or the amount of the claim, whichever is less…. The remainder of the amount owing, if any, will be allowed as a general unsecured claim paid under the provisions of paragraph 2(d).”

The plan made no mention of the IRS lien nor did it state that the IRS lien would be avoided. Although the debtor filed motions to value and avoid the liens of two other creditors, he did not do so with respect to the IRS lien. The plan provided that the real property owned by the debtor would re-vest to him at the time of the discharge or dismissal of the case. At the time of filing the bankruptcy case, the debtor valued his property at $950,000. Two years into the plan, the debtor asked for permission to employ a real estate agent and list the property for $1,800,000. Not long thereafter, the debtor obtained a contract for $2,175,000. I pause here to mention that this has never happened to me and I am jealous.

The debtor proposed that after paying off other debts based on their priority, over $1M of the sale proceeds would come back to the debtor. At this point, the IRS amended its claim to file a fully secured claim for $214,552 based on the NFTL it filed prior to the bankruptcy petition. The debtor objected to this amendment, arguing that the IRS was stuck with the plan language quoted above which limited its lien interest in the property.

The court found that the plan did not alter the lien rights of the IRS. While the plan binds the parties, the issue of what the plan covers still exists. It stated that a plan “should clearly state its intended effect on a given issue. Where it fails to do so, it may have no res judicata effect for a variety of reasons: any ambiguity is interpreted against the debtor, any ambiguity may also reflect that the court that originally confirmed the plan did not make a final determination of the matter at issue, and claim preclusion generally does not apply to a claim that was not within the parties’ expectations of what was being litigated, nor where it would be plainly inconsistent with the fair and equitable implementation of a statutory or constitutional scheme.” Citing In re Brawders, 503 F.3d 856, 867 (9th Cir. 2007).

The court also found that the debtor should have brought an adversary proceeding in which the IRS would receive adequate notice of the attempt to limit its lien if that was the debtor’s intention. Because the debtor did not make clear that his intention was to limit the IRS lien, the court would not allow him to limit the in rem rights of the IRS with respect to the property to which its lien had attached. Creditors should receive adequate notice of efforts to limit their liens. Putting cursory language in the plan is not an adequate method for providing notice. The court pointed to the court rules that the debtor should have followed if he wanted to limit the lien. These types of rules not only protect creditors with large numbers of claims like the IRS, but also protect creditors who only occasionally have a matter in bankruptcy.

The debtor also argued that the court valued the secured claim of the IRS at confirmation in order to determine the feasibility of the plan. The court finds that the claim was valued but not the lien interest and rejected this argument as well.

This case demonstrates that in the 9th Circuit, and I think in most circuits, debtors will not be allowed to attack a lien without giving a creditor specific notice of the attack. This is good news for creditors, and especially creditors like the IRS who have a lien interest on all of the debtor’s property and will not have a realistic mechanism for valuing all of that property within the tight time frames of a chapter 13 confirmation. If a debtor puts the IRS on notice that it wants to attack its lien interest, then the IRS can gear up for a fight in an adversary proceeding and decide whether the fight is worth the effort. Losing a lien interest based on the language of a plan puts the IRS and many other creditors in a tough spot.

The case also shows that sometimes debtors can come out of bankruptcy in good shape. This is certainly unusual, but I have seen other cases in which the value of debtor’s property jumped or was improperly valued at the outset. Here, the bankruptcy allowed the debtor some breathing room with respect to his property and he reaped the benefit of appreciation rather than a foreclosing lienholder. Even though the debtor lost the fight with the IRS, the debtor still made out very well in this case.

 

Clawback from IRS of Payment by Ponzi Schemers

In the case of Zazzali v. United States, the 9th Circuit has affirmed a lower court decision allowing the trustee in a bankruptcy of company that ran a Ponzi scheme to require the IRS to pay the money paid to it for taxes back to the bankruptcy estate for distribution to other creditors of the estate. The case involves Idaho’s Uniform Fraudulent Transfer Act as applicable through Bankruptcy Code section 544(b)(1), as well as the sovereign immunity provision of Bankruptcy Code section 106(a)(1). To win, the trustee needed to show that outside of bankruptcy an unsecured creditor could avoid the same transfer and that the sovereign immunity provision in the bankruptcy code did not prevent the ordering of a repayment from the government.

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The company that engaged in the Ponzi scheme was set up as an S Corporation. While operating and while running the Ponzi scheme, it made tax payments on behalf of its shareholders. It paid the IRS over $17 million during the years of the scheme and the primary beneficiaries of the payments were the two principal officers of the corporation. The IRS ultimately refunded to these two men over $3.6 million in claimed overpayments on their individual returns.

When the corporation filed bankruptcy and a trustee was appointed, the trustee began bringing fraudulent transfer actions to bring money into the estate for the benefit of the unsecured creditors. In addition to pursuing the company insiders, the trustee went after the IRS and 25 states to whom taxes were paid. The appeal only involves the IRS.

The trustee used both the fraudulent transfer provisions of Bankruptcy Code 544(b)(1) and 548. Section 548 is broader in scope but more limited in time. Under that provision, the trustee recovered $58,000 from the IRS paid within two years of the filing of the petition and the IRS did not contest that claim. Section 544(b)(1), which relies on the state provision for fraudulent transfers, allows the trustee to go back four years from the petition, and that was where the high dollar transfers occurred.

The IRS argued that Congress had not waived sovereign immunity with respect to the 544(b)(1) claim. The Seventh Circuit, in an almost identical case, ruled for the IRS in the case of In re Equipment Acquisition Resources, Inc., 742 F.3d 743 (7th Cir. 2014). The 9th Circuit reaches a different conclusion.

Section 106 lists the bankruptcy code sections for which sovereign immunity is waived. Section 544 is one of those sections. The 9th Circuit holds that the waiver in section 106 is absolute and gets past the IRS concern that the type of fraudulent conveyance at issue here is one derived from a state statute. The view of the IRS is that because the trustee here relied on 544(b)(1), and through it Idaho’s Uniform Fraudulent Transfer Act, the government’s sovereign immunity precludes a claim based on state law. To get past the IRS argument, the 9th Circuit, affirming the decisions of the district court and bankruptcy court below, looks at the bankruptcy code as a whole and how the two provisions at issue here fit into the overall scheme.

The sovereign immunity provision at issue here was enacted after the enactment of section 544. This suggests that Congress knew what it was doing when it put 544 into the list of provisions for which sovereign immunity was waived and did not back into this situation.

The 9th Circuit also found that the IRS interpretation of section 106 and the interplay of the sovereign immunity provision there with the fraudulent transfer provision in 544 would nullify a portion of the statute. Using a rule of statutory construction, the 9th Circuit found that this interpretation should be avoided if possible, and here it is possible if the waiver of sovereign immunity is read broadly.

The 9th Circuit acknowledged that its opinion is at odds with the only other circuit court opinion and it writes further to explain why its interpretation is the better one. (Perhaps anticipating that the circuit split will result in Supreme Court review.) The 7th Circuit rests its opinion in the Equipment Acquisition case, upon the ground that private creditors could not use the state fraudulent conveyance statute to pry money out of the federal government. It viewed the trustee as standing in the shoes of the state creditors and did not believe that the broad statement in section 106 was intended to change non-bankruptcy law in such a way that allowed the trustee to have state law powers no private creditor had outside of bankruptcy.

The 9th Circuit finds that this is exactly what Congress intended when it passed the broad waiver of sovereign immunity. It recognized the unique position of the bankruptcy trustee and the need to recover money for the bankruptcy estate in a federal proceeding, albeit one based upon state law.

In addition to the argument regarding sovereign immunity, the IRS also argued, in line with the reasoning of Equipment Acquisition, that the 9th Circuit’s interpretation ran afoul of the Appropriations Clause and the Supremacy Clause. These provisions would potentially stop a private creditor outside of bankruptcy even if sovereign immunity did not. The 9th Circuit says no Appropriation Clause violation exists because the trustee is not taking money out of the Treasury but rather recovering money where a transfer is “voidable under applicable law.” With respect to the Supremacy Clause concerns, the 9th Circuit finds that because bankruptcy is a federal cause of action, this situation is not a state wielding power over the federal government.

I do not know if the IRS will pursue this issue into the Supreme Court but would not be surprised if it did. There is a fair amount of money in this case and these types of cases sadly come up with some regularity. The result here is not one that bothers me from an equitable standpoint. It does not seem right for the IRS to keep money stolen from individuals where the tax is essentially a tax on the ill-gotten gains. I feel better if the money goes back to the individuals who suffered the loss and the IRS does not receive what amounts to a type of windfall. Sometimes victims or agencies representing the victims make constructive trust arguments in these types of situations. Whatever the argument, it makes sense to try to get the money back to the victims if possible. I hope that the litigation does not cause all of the money to end up in the hands of the lawyers to the exclusion of the victims.

 

Late Filed Return Issue Overlooked in Recent Collection Due Process Case

On July 28, 2017, in the Collection Due Process (CDP) case of Conway v. Commissioner, Docket Number 6204-13S L, the Court issued an order determining that petitioner did not discharge her tax liabilities for several years.  The Tax Court has the authority Washington v. Commissioner, 120 T.C. 114, 120-121 (2003) to determine discharge issues in CDP cases.  The case is interesting for what the IRS did not argue, what it conceded, the standard of review of a CDP case in the 1st Circuit and how timing plays into the outcome.

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Ms. Conway failed to timely file returns for the years 2002 and 2006-2010.  This familiar story lands her in bankruptcy court for the District of Massachusetts on February 10, 2012 where she received a discharge of her chapter 7 case on May 8, 2012.  Regular readers of this blog know that someone living in the First Circuit who does not timely file their income tax return can never discharge the liability on that return because of the decision in Fahey v. Massachusetts Department of Revenue, _ F.3d _ (1st Cir. February 18, 2015).  See blog posts here, here and here discussing the issue.

The funny thing about the Conway decision is that even though Ms. Conway failed to timely file her returns for all of the years at issue and even though controlling circuit law, under the Golsen rule, made the outcome of her case a slam dunk victory for the IRS, the Fahey case never gets mentioned.  This could be because the people involved were not carefully reading PT, or for other reasons, or a combination of both.

After Ms. Conway received her discharge, the IRS did not abate her liabilities for the years mentioned above.  At that time, almost three years before the Fahey decision, a decision with which the IRS does not yet agree, the IRS decision to keep open her liabilities for these years was not based on her late filing but on the timing of the assessments for the years 2006-2010 and on a mistake as to 2002.  In August, 2012 the IRS filed a notice of federal tax lien against her for her outstanding liabilities and sent her the required CDP notice.  She timely filed a CDP request and sought relief, inter alia, because the tax debts were discharged in her recently completed bankruptcy case.  In February, 2013 the Settlement Officer (SO) issued a notice of determination sustaining the NFTL.

Ms. Conway filed a CDP Tax Court petition on March 15, 2013 raising, inter alia, the bankruptcy discharge as a reason for removing the NFTL.  The IRS filed a motion for summary judgment on November 29, 2013.  In that motion, the IRS conceded that the SO made a mistake as to 2002 and should have written off that liability; however, the IRS argued that as to the remaining years the exception to discharge in Bankruptcy Code 523(a)(1) prevented the discharge.  (The IRS attorney pledged to fix the 2002 year and make sure it was abated.) The IRS argued that the “SO did not abuse her discretion under the standard of review adopted by the United States Court of Appeals for the First Circuit in Dalton v. Commissioner, 682 F.3d 149 (1st Cir. 2012), rev’g 135 T.C. 393 (2010).”  On January 6, 2014, petitioner filed an objection to the motion for summary judgment.  At that point, the case stood ready for decision and at that point Fahey was just a glimmer in the eye of the Massachusetts Department of Revenue.

The Court decides in Conway that the 2006-2010 taxes are excepted from discharge because they were assessed within 240 days of the date of filing the bankruptcy petition.  If taxes were at all a factor in the decision to file bankruptcy, and I have no idea, I fault taxpayer’s bankruptcy lawyer for filing during this 240-day window because it prevents them from discharge under 523(a)(1)(A) since these taxes still had priority status; however, even in the pre-Fahey world, she would have had to wait two years after filing her late returns in order to avoid the exception from discharge under 523(a)(1)(B).  The Tax Court had ample reason to find her taxes excepted from discharge here and was correct in doing so.  At the time the IRS filed its summary judgment motion, it was correct to concede 2002 and it was correct not to argue Fahey.

Because the Tax Court took over three and ½ years to decide what appears to be a relatively simple discharge case, the IRS had the opportunity to supplement its summary judgment motion with the intervening Circuit authority.  Based on the docket sheet of the case and the Court’s opinion, it appears that it did not do so; however, the IRS did file a request to file a status report earlier this year and I cannot see what was in that request.  I thought that the IRS, even though not agreeing with the one-day late discharge rule of Fahey and two other circuits, was making the argument in the three circuits with controlling authority on the one day late rule.  So, I do not know if the failure to point Fahey out to the court here was a decision representing a change in position that it would argue the one-day late rule in those circuits, or a failure to recognize the opportunity to make this argument, or simply a decision that it was going to win anyway and why add yet another reason when the opinion should come out at any second.  I bring it up for those watching the one day rule and the IRS reaction to it.  Because of the decision in the Fahey case, the IRS decision to concede 2002 could have been reversed.  I do not know how the Tax Court would have reacted to an effort by the IRS to withdraw its concession because the law of the circuit changed while the Tax Court was working on its opinion.  Because the IRS did not attempt to withdraw its concession, we will never know.

The case also raises the application of the First Circuit’s decision in Dalton.  In Dalton, the First Circuit reversed the Tax Court and held that the findings of law in CDP determination are only tentative and so the Tax Court does not need to give deference to the SO’s legal conclusions.  The IRS argued in its motion that despite the SO’s legal mistake as to the dischargeability of 2002, the Court should sustain the notice of determination because the SO did not abuse her discretion under the standard of review adopted in DaltonDalton seems to stand alone in its view of the deference accorded to SOs.  This issue deserves attention and may get litigated further in other circuits.

Ms. Conway was going to lose her case even before the Fahey decision because of the timing of her late filed returns and her bankruptcy petition.  She benefits here by filing her case before the Fahey decision came out because of the IRS concession with respect to 2002.  She loses most of her case because of late filing.  Somehow taxpayers need to understand the benefits of filing on time even if they cannot pay.  In circuits like the First, it is now critical because it is a lifetime bar on discharge.  Even in other circuits, late filing will create the types of problems Ms. Conway faced here and will not allow debtors to obtain the full measure of the benefits of bankruptcy.