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

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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.

 

Comments

  1. I wonder how things would have worked out for the debtor if he just paid out his payments for the life of the plan?

    I remember being involved as a Supervisory R/O 30 years ago and discovering that, due to the fact that IRS’ BK unit filed a proof of claim for the incorrect amount (I believe in the $20k range instead of the $120k owed), the remaining taxes were discharged after the Taxpayer fulfilled his plan’s payments.

    In the Nomellini case cited, had he just paid the IRS and all other creditors over the plan timeframe, I suspect that he would have had a different result- and more cash in his pocket!

  2. Lavar Taylor says:

    The result in Nomellini clearly turns on the fact that inadequate notice was given to the IRS. In the Ninth Circuit, if adequate notice is given, it is possible to “strip” an IRS tax lien off of an asset through confirmation of a plan. In a Chapter 11 case I was involved with many years ago, the Appellate Section of DOJ Tax confessed error on this point. See Taffi v. United States (In re Taffi), 68 F.3d 306 (9th Cir. 1995), aff’d on another issue, 96 F.3d 1190 (en banc)(1996). So if you are going to try something like this, be very clear in the language of the plan what you intend to do.

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