Remembering Dale Kensinger

On January 15, 2020, Dale Kensinger passed away leaving a big hole at the Tax Clinic at Harvard Law School.  You can find his obituary here.  Until very recently Dale put in a few days a week doing volunteer work at the tax clinic, where he had his own dedicated office as part of the supervising team.

I first met Dale on March 14, 1977, when I started working for Chief Counsel, IRS in Branch 3 of the Refund Litigation Division.  Dale was one of nine attorneys in the branch and was the second most senior.  As a newly minted law school graduate, I remember thinking Dale, who was about 35 at the time, was really old.  He was also extremely knowledgeable, generous with his time and kind.  I was fortunate to start my legal career in a small branch of attorneys that included someone like Dale.

Dale moved on to the Kansas City office of Chief Counsel only nine months after I arrived.  I moved on after just 18 months because of a reorganization that sent all of us to field offices across the country or to other National Office divisions.  Dale worked in the Kansas City office from 1978 to 1999 where he became the Assistant District Counsel.  Other than seeing him at the occasional training program, our paths essentially did not cross during these years though we both worked for the same large organization.

He retired in 1999 and founded the low income taxpayer clinic at University of Missouri – Kansas City.  He also became active in the ABA tax section and quickly rose to leadership in the low income taxpayer committee.  When I retired in 2007 and began teaching at Villanova, I reconnected with Dale through the ABA Tax Section.  Then Dale retired again in 2009 to move from Kansas City to Boston to be near his daughter, Elizabeth.  Following his retirement from the UMKC clinic, Dale became less active with the ABA but he was not finished helping low income taxpayers. 

My colleague at the Legal Services Center at Harvard, Dan Nagin, arrived in 2012 to start a veteran’s clinic and quickly found that he had many clients who needed tax assistance.  Dan searched around for someone who could help these clients and connected with Dale.  Dale worked with volunteer students from Harvard to service the veteran clients until Dan could convince the Harvard faculty to formally start a tax clinic.  When the tax clinic formally started in 2015, I came to Harvard as a visitor to get it going and had the incredibly good fortune to have Dale there already to guide me once again.

Dale served three years in the air force during the Vietnam War.  His time as a veteran, his kind and patient nature as well as his deep knowledge of tax practice, allowed him to fix the tax problems of many veterans, and others, during the five years I worked with him in the tax clinic at Harvard.  He not only handled a substantial docket but he mentored students, fellows and me.  The tax clinic misses him on many levels.  His clients miss him deeply and several have commented to me over the past two months how much he helped them and how much they hoped and prayed for his recovery.

Because of his extraordinary service to low income taxpayers in his retirement, Dale was selected in 2018 as the co-recipient of the Janet Spragens Pro Bono Award which is the only annual award given by the Tax Section.  The ABA Tax Section describes the award and the selection criteria as follows:

This award was established in 2002 to recognize one or more individuals or law firms for outstanding and sustained achievements in pro bono activities in tax law. In 2007 the award was renamed in honor of the late Janet Spragens, who received the award in 2006 in recognition of her dedication to the development of low income taxpayer clinics throughout the United States.

Throughout the 50+ years of his career as a tax lawyer, Dale provided a model of caring about finding the right answer through his legal skills and caring about his clients with his interpersonal skills.  At the tax clinic we are reminded daily of Dale’s work as we try to finish what he started with the clients he was representing.  We were very fortunate to have him as a colleague and a role model for so many years.  I will miss our regular talks about baseball, politics, difficult clients, difficult IRS employees and wonderful granddaughters.  Our thoughts and condolences go out to his family at this time.

Designated Orders Review

Almost three years ago Procedurally Taxing began a (mostly) weekly feature of the designated orders from the Tax Court.  We did this because it became increasingly clear over the years of blogging on procedural issues that orders generally and designated orders specifically contained a treasure trove of important information that largely went ignored.  Because of the fantastic search feature for orders that the Tax Court created in 2011 and the system for designating orders that the court subsequently created, the opportunity to focus on the orders the court thought most important provided an opportunity to expand PT’s coverage of procedural information into an area not otherwise receiving attention on a regular basis.

A team of four authors was recruited – Caleb Smith, Patrick Thomas, Samantha Galvin and William Schmidt.  The four authors have remained constant since the start of this feature.  Two of the four authors, Caleb Smith and Patrick Thomas are going to present at the ABA Tax Section meeting next week in Boca Raton on what they have learned in the past three years as they have written about designated orders.  The panel will take place on Friday, January 31 at 9:30 AM as part of the Individual and Family Committee Programing.  In addition to Caleb and Patrick, the panel includes Rich Goldman, the procedural guru from IRS Chief Counsel’s Office and Special Trial Judge Diana Leyden, a frequent user of designated orders since joining the Tax Court.  I have the pleasure of moderating this panel.

Patrick and Caleb have created some interesting material for the panel which I will reveal here.  I think this material will entice you to hear the panel and provide you with a good background on what can be learned by following the designated orders.  The PowerPoint slides provide a detailed look at the use of designated orders by topic and by judge.  The written handout provides a great discussion of lessons to be learned from these orders.

Because we have gotten behind a bit in publishing our designated order weekly reviews, we are going to use the days leading up to the panel to catch up on designated orders over the past couple of months and to wet your appetite for an excellent panel.  For those of you who have not already made your plans to spend a few winter days in the Florida sunshine, I hope the designated order panel will motivate you to join us.

The Tax Court Has Updated Its Procedures for Non-Attorney Admission

I wrote a blog post a few years ago on non-attorney admission to the Tax Court that has become one of the most popular blog posts written on our site.  Because of the interest in the subject, I wanted to provide this short update because the Tax Court has recently updated its procedures.  You can find the updated procedures here.  The Tax Court admits non-attorneys for historical reasons.  You can read about the history behind this in the Court’s authorized and terrific biography, which was updated a few years ago by Dean Brant Hellwig of Washington and Lee Law School.  There are some non-attorney Tax Court practitioners in the Boston area I know who use it as an adjunct to their practice as enrolled agents.  If you are interested in taking the test, I suggest reading about the updated provisions.

Should Bankruptcy Trustee Be Paid When Taxes Exceed Assets in the Estate?

The case of In re: Patrick Hannon and Elizabeth Hannon; No. 12-13862 (Bankr. D. Mass. 2019) presents a situation in which the IRS argues that the bankruptcy trustee and law firm representing the trustee should not receive compensation from the estate assets, because the trustee should have abandoned the assets since the trustee could not bring value to the unsecured creditors of the estate.  The bankruptcy court rejected the argument of the IRS and allowed the trustee and the law firm to take their fees from assets that would otherwise go to satisfy outstanding debts due to the IRS.  The case brings to light the sometimes tricky determination regarding assets and lienholders in a bankruptcy case.

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The Hannons owed money to the IRS but at the outset of their bankruptcy case the amount owed to the IRS had yet to be conclusively determined.  The Hannons originally filed their bankruptcy case as a chapter 11 seeking to reorganize their debts, they converted the case to chapter 7 in 2013 recognizing that reorganization would not work and they needed to liquidate their assets.  In a chapter 11 case debtors generally control their assets without a trustee.  In a chapter 7 the bankruptcy court appoints a trustee to liquidate the assets.  When a case converts from chapter 11 to chapter 7 the fluidity of the financial situation can make it quite difficult for the incoming trustee to know exactly what the debtor owes and exactly what the estate owns (or the value of what it owns.) 

In this case it appears that both the amount of debt and the value of the assets were, at least somewhat, in question.  If the trustee could determine that the amount owed to lienholders would prevent any property from reaching general unsecured creditors, the trustee should have abandoned the assets of the estate so that the secured creditors could use their lien interests to dispose of the properties, while the estate became a no asset estate with nothing available to unsecured creditors.  Trustees serve unsecured creditors and secured creditors generally take care of their own interests.  If a trustee administers property encumbered by a lien, the trustee brings no value to the estate for the benefit of unsecured creditors, while potentially reducing the amount that the lienholder could otherwise obtain upon the sale of the liened property.  Essentially, the IRS argues here that the trustee should have known that the estate did not have any property available for unsecured creditors and should have turned over the property of the estate to the lienholders and quietly backed out of the case.  The bankruptcy court must decide if the trustee acted properly under the circumstances or acted in a manner that negatively and improperly harmed the interests of the secured creditor.

Although the bankruptcy court in Massachusetts handled the bankruptcy aspect of the case, the litigation between the Hannons and the IRS took place in Maine for reasons not explained in the opinion.  When the conversion from chapter 11 to chapter 7 occurred in January of 2013, the litigation between the Hannons and the IRS had not concluded.  So, the amount owed to the IRS in the case remained unknown.  The Hannons and the IRS reached an agreement in July of 2013 resulting in a final judgment entered in November of 2013.  At the time of the agreement, paragraph 8 of the document contained the following provision:

The Trustee shall continue to sell or otherwise liquidate the Estate’s personal and real property in the ordinary course.

Additionally, the bankruptcy court noted:

In December of 2013, the IRS assented to a motion filed by the trustee in the IRS Lien Avoidance Action to suspend all deadlines in the proceeding until the trustee completed his liquidation of the estate’s assets. The assented-to motion states: “[T]he parties have recently conferred regarding the within Adversary Proceeding and have agreed that it will be most cost-effective to allow the trustee to complete his liquidation of all Estate assets before expending additional resources in this matter.”

From the perspective of the IRS, having the trustee liquidate the estate assets can provide good value.  The trustee does the work of cleaning up title and selling the assets.  These acts can take considerable time and effort.  The IRS does not always do a good job of this and does not always bring the maximum value.  The trustee can sometimes handle estate assets much more efficiently and cost effectively.  So, agreements between the IRS and the trustee allowing the trustee to administer property that might be fully encumbered can make sense.  The assets also could be wasting assets where having the trustee administer them during a period of dispute concerning the scope of a lien makes additional sense.  On the other hand, if the assets of the estate are entirely encumbered with the federal tax lien, perhaps the IRS feels that it can obtain the best value without having someone in the middle.

Despite the language of the agreement, the IRS objected to the trustee’s fees and the attorney for the trustee’s fees.  The bankruptcy court denies the motion of the IRS to reduce or eliminate the fees allowing them to be paid by the estate, which means that less assets in the estate remain with which to satisfy the IRS debt.  The failure to pay the IRS debt in full or as fully as possible also has implications for the debtors if the tax debts were non-dischargeable.  The debtors would prefer to see the IRS paid and eliminate a debt the IRS will pursue after the bankruptcy estate.

Although the court allowed most of the trustee’s fees, it did trim them with respect to action taken after the extent of the debt due to the IRS and the value of the property became clear.  This caused a small reduction in the amount of the trustee’s fees and the legal award.  Without much more information about who knew what when, I have no basis to conclude that the decision incorrectly allowed the fees.  Twice the IRS agreed to allow the trustee to continue working with assets of the estate.  The IRS should have known when it made those agreements that the trustee deserved compensation for those efforts.  The question I would have concerns the reasonableness of those efforts under the circumstances but not whether the trustee should receive some compensation.  The case points out the difficulties all parties face when uncertainty exists concerning the amount owed and the value of assets and the need to immediately control the assets.  Both the IRS and the trustee in this situation need to carefully document their interactions if they want to show that action was properly taken or not taken.

Offset of Tax Refund to Satisfy Unpaid Child Support

We are entering peak offset season as federal tax refunds serve to satisfy many state and federal obligations of individuals who anticipated a check from Uncle Sam.  The recent case of Blue v. United States Department of Treasury, No. 1:19-cv-01926 (N.D. Ohio 2019) serves as a reminder not only of the ability of the Treasury Department to take a federal tax refund and send it to a government creditor but of the inability to challenge the offset by suing Treasury.

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Mr. Blue brings his case against Treasury pro se in the state court.  In some ways this makes sense because he will ultimately need to bring an action in state court to obtain the relief he seeks but the defendant will differ.  The Department of Justice removes the case to federal court and then immediately files a motion to dismiss for lack of subject matter jurisdiction.  You might think it odd to remove a case only to dismiss it but doing so is normal and makes sense.  The government does not want to make the jurisdictional argument to a state court judge who might find jurisdiction exists.  Better to remove the case to federal court, which the government has the absolute right to do, and dispose of it there in a setting where the government has more comfort in the outcome.

The district court dismisses the case with a short order first discussing sovereign immunity and the failure of Congress to authorize a suit such as this and then citing to IRC 6502 and the specific prohibition against a suit such as this:

Congress has not waived sovereign immunity for this type of suit against the Treasury Department. In fact, Congress has explicitly barred such suits, stating, “No Court of the United States shall have jurisdiction to hear any action, whether legal or equitable, brought to restrain or review a reduction authorized by subsection (c), (d), (e), or (f).” 26 U.S.C.A. §6402(g). Subsection (c) cited above authorizes a reduction of an individual’s federal income tax refund for “any past-due [child] support . . . owed by that person.” 26 U.S.C. § 6402(c). Under the terms of the statute, this Court lacks jurisdiction over any claims against the Treasury Department pertaining to offsets of income tax refunds for child support arrearages.

If Mr. Blue wants to get his tax refund, he needs to go to the state court that issued the child support order and convince that court that no outstanding order existed that should have caused the Treasury Department to send his federal tax refund to the child support agency.  The system does not allow attacking the offset by suing Treasury.  His only remedy lies in getting the child support order declared incorrect or fully satisfied.  It’s not surprising that Mr. Blue thinks he should go after the Treasury Department and the offset program.  Many clients of the clinic come in with the same view – that they have a tax problem not a problem with whatever agency has used the Treasury Offset Program to grab the tax refund.  The Blue case shows the futility of suing Treasury.  Taxpayers seeking to obtain a refund must always go to the part of the state or federal government requesting the offset and work out the issue there.  Assuming that the state or federal agency properly certified a debt to Treasury, Treasury will always win with the defense that it simply offset as contemplated in the federal statutes.

Because he brought the suit against the wrong party, we do not know if he really owes the child support to which the refund was offset.  The court did not need to get into the merits of his liability in order to dismiss his case.  Assuming that he has a valid argument that he does not owe the child support, the dismissal here does not prevent Mr. Blue from making that argument in a case against the child support agency.

Because it is the season for offset, here are links to prior blog posts on the offset issue that might be of benefit if you are dealing with an offset issue:

Offset of an overpayment where taxpayer designated the payment

Defense to Payment as a basis for stopping offset of student loans

Offset to satisfy student loans and general discussion of offset program operation

When is an offset an offset

TIGTA report explaining offset program

Illegal exaction – offset against a criminal fine

Requesting a bypass of the offset against prior federal taxes

Man Bites Dog – Estate Wins Penalty Case Regarding Late Filed Return

In the case of Estate of Agnes R. Skeba v. United States; No. 3:17-cv-10231 (D. N.J. 2020), the court reconsidered and vacated an earlier opinion concerning the late filing penalty and determined both that the IRS wrongly interpreted the statute in imposing the penalty on these facts and that the estate had reasonable cause for filing the return late.  Several years ago I wrote that, when you see a citation to United States v. Boyle, 469 U.S. 241, 246 (1985) in an opinion, expect the worst if you are a taxpayer.  This case throws out that convention along with others.  I’m not sure that we have seen the last of this case, but I am sure that many taxpayers will start citing this opinion as they seek to avoid the late filing penalty.

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The facts of the case show an estate that was pretty diligent about trying to pay its taxes and, in fact, one that overpaid its taxes — which is why this case ends up in district court rather than the Tax Court.  The decedent had an estate valued at close to $15 million, much of which was farm land and equipment.  The estate had a liquidity problem with respect to the payment of taxes.  (This raises a question concerning IRC 6161 which is not answered by the opinion and which I cannot answer.)  The estate also had other problems because of will contests.  It used available funds to pay the inheritance taxes due in New Jersey and Pennsylvania and to partially pay the taxes due to the IRS.  It made an initial payment to the IRS of $725,000.  It knew that it was not paying enough to the IRS and was actively trying to borrow money to make the balance of the payment it calculated the estate would owe.  Closure on the loan was delayed, causing the estate to pay the balance of the anticipated liability, $2,745,000, a little more than nine months after the decedent’s date of death.

Because of uncertainty created by the litigation, the estate requested an extension of time to file the estate tax return.  The IRS granted the estate a six month extension; however, the estate did not file the return during the extension period and filed it almost nine months after the extended period had ended.  During this period there were delays in the state court litigation caused by the illness of the named executor and the attorney for the estate.  Once the estate filed the return, the IRS assessed the reported liability, which turned out to be about $900,000 less than the estate had paid in estimated payments.  This seems like a happy ending for the estate; however, the IRS imposed a late filing penalty on the estate arguing that the estate had not fully paid its liability at the time the return was due and that it did not timely file the return.  It calculated the penalty based on the difference between the timely payment of $725,000 and the estate tax liability of $2,528,838.  Because the return was filed more than five months late, the IRS multiplied 25% times the difference between the liability and the timely payment ($1,803,838) resulting in a penalty of $450,959.50 and a net “Overpayment” of $488,719.34 which it cheerfully refunded to the estate.  The estate, however, was not cheerful over this result.

The estate brought a refund suit seeking to recover the penalty amount.  The district court initially held for the estate; however, the IRS argued that the court applied the wrong standard in its initial opinion.  The IRS asserted that the de novo standard of review is appropriate for assessing the issue of whether the estate demonstrated reasonable cause and not willful neglect in failing to timely file its estate tax return; whereas the Court’s original memorandum used the arbitrary and capricious standard.  The Court vacates its prior memorandum and files this superseding memorandum in its place.

The court starts its analysis by giving a nod to Boyle:

[T]he law has evolved in estate tax matters to acknowledge that the estate bears the burden in proving that it has exercised ordinary business care and prudence in the event it filed a late return. United States v. Boyle, 469 U.S. 241, 246 (1985) (quoting 26 CFR § 301.6651(c)(1) (1984)).


In Boyle, Chief Justice Burger addressed “whether a taxpayer’s reliance on an attorney to prepare and file a tax return constitutes ‘reasonable cause’ under § 6651(a)(1) of the Internal Revenue Code, so as to defeat a statutory penalty incurred because of a late filing.” Id. at 242. According to 26 CFR § 301.6651-1(c)(1), a taxpayer filing a late return must show that he or she exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time. Id. at 243. Chief Justice Burger reasoned there was an administrative need for strict filing requirements.

Having given the obligatory nod to Boyle, the court then sets off on its own analysis of the statute and how, in the facts of this case the late filing of the return does not trigger the penalty:

In the Court’s view, the resolution of this matter hinges on an interpretation of a section of the IRS Code (26 C.F.R. § 6651) called “Failure to file tax return or to pay tax.” . . .

Generally, § 6651 addresses the assessment of penalties for late filing of a return, and late payment of taxes due. More specifically, the penalty under § 6651(a)(1) addresses the failure to file a timely return:

In case of failure (1) to file any return on the date prescribed therefor (determined with regard to any extension of time for filing), unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the amount required to be shown as tax on such return 5 percent of the amount of such tax if the failure is for not more than 1 month, with an additional 5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate. . . . 26 U.S.C. § 6651(a)(1). . . .

The calculation of the penalty imposed for failure to timely file a return (subsection (a)(1)) and failure to timely pay the tax (subsection (a)(2)) is clarified in § 6651(b). It declares:

(b) Penalty imposed on net amount due. For purposes of —

(1) subsection (a)(1), the amount of tax required to be shown on the return shall be reduced by the amount of any part of the tax which is paid on or before the date prescribed for payment of the tax and by the amount of any credit against the tax which may be claimed on the return,
(2) subsection (a)(2), the amount of tax shown on the return shall, for purposes of computing the addition for any month, be reduced by the amount of any part of the tax which is paid on or before the beginning of such month and by the amount of any credit against the tax which may be claimed on the return[.]
§ 6651(b).

The parties disagree on how to construe these provisions. Plaintiff proffers two arguments in support of its position. First, Plaintiff argues that § 6651(a)(1) should be read together (in pari materia) with § 6651(b)(1). In reading these subsections together, Plaintiff concludes that the late filing penalty is calculated by using the formula set forth in subsection (a)(1), incorporating the “net amount due” on the “the date prescribed for payment” as set forth in subsection (b)(1). Since the estate tax was overpaid on March 18, 2014 and the extension ran until September 10, 2014, there was no net amount due on the September deadline; and hence, no penalty may be imposed.

Secondly, and in the alternative, Plaintiff argues that the phrase “such failure is due to reasonable cause not due to willful neglect” in subsection (a)(1) protects the taxpayer from a penalty if the return was filed late due to a reasonable cause.

The Government disagrees with the taxpayer’s arguments. The Government proffers that the requirements of § 6651(a)(1) and (b) must be construed with another statute (26 U.S.C. § 6151) entitled “Time and place for paying taxes shown on returns.” . . . More specifically, § 6151 reads in pertinent part:

(a) General rule. Except as otherwise provided in this subchapter [26 USCS § 6151 et seq.] when a return of tax is required under this title or regulations, the person required to make such return shall, without assessment or notice and demand from the Secretary, pay such tax to the internal revenue officer with whom the return is filed, and shall pay such tax at the time and place fixed for filing the return (determined without regard to any extension of time for filing the return).
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(c) Date fixed for payment of tax. In any case in which a tax is required to be paid on or before a certain date, or within a certain period, any reference in this title to the date fixed for payment of such tax shall be deemed a reference to the last day fixed for such payment (determined without regard to any extension of time for paying the tax).

Id. Based on § 6151, the Government cleverly reasons that the last day for payment was nine months after the death of Agnes Skeba — March 10, 2014; because no return was filed by that date a penalty may be assessed. Applying the rationale to the facts, the Government contends only $750,000 was paid on or before March 10, 2014, when $2,528,838 was due on that date. Referring back to § 6651(a)(1), a 25% penalty on the difference may therefore be assessed because it was not paid by March 10, 2014. As such, the full payment of the estate tax on March 18, 2014 is of no avail because the “last date fixed” was March 10, 2014. Accordingly, the Government argues that the imposition of a penalty in the amount of $450,959.00 is appropriate.

The IRS’s arguments miss the mark. First, both §§ 6651(a)(1) and (a)(2) designate the specific day on which penalties will be assessed for both late filing and payment of the estate tax return. Both paragraphs specify that the “date prescribed” is to “be determined with regard to any extension of time for filing.” The language of the statute in dispute is the one which is given precedence over a more generic statute like § 6151. See La Vallee Northside Civic Asso. v. V.I. Coastal Zone Mgmt. Com., 866 F.2d 616, 621 (3d Cir. 1989); see also Meyers v. Heffernan, No. 12-2434 (MLC), 2014 WL 3343803, at *8 (D.N.J. July 8, 2014).

After finding that the statutory language does not support the application of the penalty in this situation, the court goes on to find that the estate had reasonable cause for its late filing:

In this case, Mr. White [the estate’s attorney] submitted his August 17, 2015 letter explaining the rationale for not filing. For example, in Mr. White’s letter, he indicated that certain estate litigation was delayed due to health conditions suffered by the executor. Additionally, Mr. White refers to the Hoagland law firm and one of the attorneys assigned to the case as having been diagnosed with cancer. The Hoagland firm is a very prestigious and professional firm and based on same, Mr. White’s letter shows a reasonable cause for delay.

In addition, Mr. White’s prior letter of March 6, 2014 notes that there was difficulty in “securing all of the necessary valuations and appraisals . . . caused by the contested litigation.” Drawing from my professional experience, such appraisals often require months to prepare because a farm located in Monroe, New Jersey will often sit in residential, retail, and manufacturing zones. To appraise such a farm requires extensive knowledge of zoning considerations. Thus, this also constitutes a reasonable cause for delay.

Both aspects of the opinion will get cited by estates seeking to avoid the heavy hand of the late filing penalty when applied to significant estate tax liabilities.  As I mentioned above, I will be surprised if the IRS does not appeal this decision.  While I may have my doubts that the opinion will stand, it is one of many cases that points out the harshness of the application of Boyle.  The estate here made a significant effort to pay the tax.  The legal basis for the ruling could be a game changer for estates that make full payment before an extended due date.  I realize not every estate can meet that criteria.  Certainly, the case is worth following.

Volunteers Needed at Upcoming Las Vegas Calendar Calls

Several years ago the ABA Tax Section undertook the project of covering all Tax Court calendar calls to make sure that unrepresented taxpayers had an attorney to whom they could ask questions and obtain guidance at the calendar call.  The project was a success and volunteers were secured for calendar calls in all of the cities in which the Tax Court sits; however, life is dynamic rather than static.  Recently, both low income taxpayer clinics in Las Vegas have closed.  While there is hope that one or both or a new one may reopen in the future, at the moment the Tax Court will hold calendars on January 13 (next week; this is a mixed regular and small case calendar) and February 24 (this is a regular calendar).  Volunteers are needed for both calendars in order to provide coverage for any unrepresented taxpayers who may appear.

When a similar coverage hole occurred in Honolulu six years ago, Andy Roberson jumped into the breach and covered the calendar.  The Pro Bono and Tax Clinic committee of the Tax Section hopes that one or more tax controversy specialist will quickly jump in to cover the upcoming calendars in Las Vegas.  If you are willing to help cover one of the upcoming calendars in Las Vegas, please contact the Tax Section’s Chief Counsel, Meg Newman at Megan.Newman@americanbar.org or by phone at (202) 662-8645.

Limited Ability to Offset Tax Refunds

The case of U.S. Dept. of Housing and Urban Development v. Larry Edward Wood et ux.; No. 5:19-cv-00302 (S.D. W. VA. 2019) shows a limitation on the government’s right to set off a tax claim against a debt owed to another federal agency.  The outcome here did not surprise me (except maybe that HUD was not required to pay something for offsetting a prepetition debt in violation of the automatic stay.)  The law has evolved to allow the IRS to offset an income tax refund against another income tax liability, but there is no exception in the automatic stay allowing the offset of a tax refund to satisfy the liability of another government agency (or even another type of tax.)

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Mr. and Mrs. Wood bought a mobile home in 2008.  They borrowed almost $40,000 to make the purchase.  The Department of Housing and Urban Development (HUD) guaranteed the loan.  Unfortunately, the Woods defaulted in 2014 causing HUD to cover the debt and then to come after them to satisfy the outstanding debt which by that point totaled about $23,000.  In December of 2015, HUD certified the debt to Treasury so that it could benefit from the Treasury offset program (TOP).  This paid off in early 2017 when HUD scooped up over $9,000 of a federal tax refund that would otherwise have gone to the Woods.  Perhaps because of the loss of this refund or perhaps because of other causes, or both, the Woods filed a bankruptcy petition on March 21, 2018.

Their 2017 tax refund of over $6,000 was scheduled for payment after they filed their return on March 26, 2018, but instead was sent to HUD to continue paying off the debt on the mobile home.  The Woods brought an adversary proceeding in bankruptcy court arguing that the offset of their 2017 was barred by the bankruptcy laws.  They made two arguments in support of their position.  I will discuss both below.  The argument regarding the automatic stay surprises me, as the law clearly bars offset in this situation.  The bankruptcy court held for the Woods and in this decision, the district court sustains the decision of the bankruptcy judge.

Outside of bankruptcy, the TOP offset presents no problem for HUD.  At issue here is the difference, if any, brought about by the bankruptcy code once the Woods filed their petition.

Exempt Property Argument

Bankruptcy allows debtors to claim certain property of the estate as exempt from creditors.  As a threshold matter the court looks at whether the refund is property of the bankruptcy estate.  It cites a split in the circuits in situations in which the refund is less than the amount owed to the government and decides to follow the majority rule that in all situations the refund is property of the estate.  Just because property comes into the estate, however, does not mean that it is available for creditors and Congress allows debtors to exempt certain property in order to protect that property and provide debtors with some amount of assets moving forward after bankruptcy.

BC 522 sets out the rules for claiming these personal exemptions.  BC 522 has its own exemption provisions but also allows states to opt for their own exemption rules which almost all states have done.  Some states have very generous exemption rules while others, typically states in the east heavily reliant on common law, provide more miserly exemptions for debtors.  In West Virginia the Woods could claim this refund as exempt and they did so.  The bankruptcy court determined that the exempt trumps the offset provisions in 553.  As such, the debtors could recover the refund taken from them by offset.  This does not mean that their liability to HUD is forgiven or forgotten, but only that HUD cannot take this refund while the Woods remain in bankruptcy to satisfy the outstanding debt.

Automatic Stay Argument

The court next looks at the automatic stay and its impact on the taking of the refund.  BC 362 sets out the automatic stay in paragraph (a) where there are eight separate provisions providing coverage from creditors once the debtors file their bankruptcy petition.  Subparagraph (7) stays offset during the bankruptcy case.  This provision came into the law in 1978 with the enactment of the current bankruptcy code.  It caused major headaches for the IRS because it had to turn off its computers to avoid violating the stay.  Finally, in 2005 the IRS succeeded in convincing Congress to provide some relief from this provision.  As with the relief it provided in 1994 with respect to the stay on assessment found in subparagraph (6), that really threw a wrench into the tax system, Congress did not change BC 362(a)(7) but instead added an exception to the list of exceptions found in 362(b).  In this case it added subparagraph (b)(26).  The fact that there are 26 subparagraphs in the section dealing with exceptions to the automatic stay says Congress has lots of actions it wants to continue despite the stay.

BC 362(b)(26) allows offset despite the prohibition on offset in (a)(7) but the allowance only allows offset in a narrow circumstance.  The exception “constrains the reach of the automatic stay by excepting from violating the automatic stay, the setoff under applicable nonbankruptcy law of an income tax refund . . . against an income tax liability.”  This exception to the automatic stay does not allow the IRS to offset an income tax refund against an outstanding trust fund recovery penalty or against any other type of tax debt.  Furthermore, it does not allow the offset of the income tax refund against any other type of federal debt.  Aside from the narrow allowance made plain in the statutory language, prior case law also made clear that the income tax refund could not be offset against other federal debt.  I have trouble understanding what the DOJ lawyers representing HUD thought they could argue here.  I did not pull the briefs filed to see if they had some terrific argument that does not leap out from a reading of the opinion or of the statute.

HUD also argued that equity should allow it to offset the debt based on a retroactive annulment of the automatic stay.  The bankruptcy court took only a few sentences disposing of this argument.

The case demonstrates the limited scope of the exception to the automatic stay regarding offset.  While the exception provides a significant benefit to the IRS, it provides no benefit to other federal agencies.  If they want to use TOP while an individual’s bankruptcy case exists, someone will need to go back to Congress and get (b)(26) expanded.  I don’t expect that to happen anytime soon.