Last week I wrote about the case of Lufkin v. Commissioner, T.C. Memo 2021-71, in which the Tax Court ruled on the impact of filing bankruptcy on the statute of limitations. In that post, I mentioned that Bryan Camp wrote about the case as part of his Lessons from the Tax Court series, which alerted me to the decision. In that same post Bryan also wrote about Barnes v. Commissioner, T.C. Memo. 2021-49, which Judge Lauber decided on May 4, 2021. As with the Lufkin case, Bryan has a good write-up, and he provides good bankruptcy background information. I will try to add a little additional color to the case.
The Barnes case shows what happens when a taxpayer goes into bankruptcy while still contesting a liability. As taxpayers learn, the result does not favor the taxpayer in a situation in which the unresolved liability gets resolved after the bankruptcy filing and the resolution allows the IRS to assess an additional amount. The Tax Court must work through the bankruptcy provisions to get to the correct result which it does as it demonstrates again that bankruptcy discharge issues can find their way into Tax Court decisions requiring the Tax Court judges to understand bankruptcy law as they rule on tax collection issues.
When Mr. and Mrs. Barnes entered bankruptcy, they were still waiting for the Tax Court to make a decision on their 2003 liability. They filed the Tax Court petition in 2008 and tried the case in June 2009. They had submitted their briefs in the case when, on July 26, 2010, before the issuance of an opinion, they filed a chapter 11 petition. The filing of the bankruptcy petition stayed the Tax Court proceeding and would have caused the Tax Court judge working on the opinion in their case to hold onto the opinion. While the automatic stay stops the Tax Court proceeding, I don’t know if Tax Court judges interpret it as stopping them and their clerks from working on the case, or if it just stops them from issuing an opinion. My guess is the latter, but I have not spoken with a Tax Court judge about how strictly the Tax Court interprets the stay. Perhaps the Tax Court judges interpret the stay to require them to completely stop working on the opinion until the stay lifts, or perhaps there is a split among the judges regarding how they interpret the stay when it comes into existence during the opinion-writing stage of a case.
In any event, the existence of the unresolved Tax Court case means that as to the liability at issue in the Tax Court, the debt in the bankruptcy court for that unresolved liability would receive priority status under BC 507(a)(8)(A)(iii) because the liability was not yet assessed but was assessable. Here, the Barnes filed a chapter 11 case, which requires in BC 1129 that they commit in their plan to fully pay all priority claims. The IRS participated in the plan and filed a proof of claim; however, it failed to include in its claim the 2003 liability. The Barnes could have filed a claim on behalf of the IRS for 2003 or could have included 2003 in their plan, but the plan did not include the 2003 liability. It’s hard to know whether this was oversight by one or both of the parties or a calculated decision. The Barnes may not have wanted to commit to paying the $50K or so the IRS thought was due and may have been stretched to come up with a plan that would have paid it over time. The IRS may have preferred to collect outside of bankruptcy and not lose the interest it would lose if paid through bankruptcy. In any event, 2003 was not addressed.
Note that chapter 11 cases for individuals occur relatively infrequently. If this were a chapter 11 filed by an entity, an oversight of this type could have ended the IRS’s hopes for any recovery on 2003 because of the super discharge available in chapter 11 to entitles. That super discharge is not, however, available to individuals who must look to BC 523(a) for the discharge provisions and that’s where the Barnes lose their case with respect to the tax.
The chapter 11 plan, silent as to 2003, was confirmed. The Tax Court says the automatic stay remained in place while the debtors made their plan payments. In November 2011, the IRS filed a motion to lift the stay to allow the Tax Court case to move forward, which the bankruptcy court granted. On April 2, 2012, the Tax Court entered its opinion. Although the Barnes appealed the Tax Court opinion to the D.C. Circuit, they, like 99.9% of Tax Court petitioners who appeal, did not post a bond to stay assessment. The IRS assessed on August 1, 2012. The IRS eventually filed a notice of federal tax lien which allowed the Barnes to make a collection due process (CDP) request, which eventually led to the second Tax Court opinion regarding 2003 – this one only 18 years after the tax year, though the delay was not due to the Tax Court, which had acted reasonably expeditiously in both cases.
The Barnes’ first argument in the CDP case was that the 10-year statute of limitations on collection had ended before the IRS filed the notice of federal tax lien. This argument makes absolutely no sense given that the assessment date for the 2003 liability is in 2012. The Tax Court was gracious in noting that the collection statute remained open.
Next, the Barnes made another argument that made no sense – that the 2003 liability was discharged by the bankruptcy case. Again, the Tax Court graciously pointed out that the liability was entitled to priority because it was not yet assessed but still assessable at the time of the bankruptcy petition. Since they were represented, I am surprised by both arguments.
The Barnes requested an offer in compromise, but the IRS determined they had the ability to fully pay the debt. Since they did not agree with that determination or did not want to pay the debt in full, the IRS determined the filing of the notice of federal tax lien was valid and the lien did not need to be released or withdrawn. The Tax Court sustained this determination by ruling for the IRS in response to a motion for summary judgment.
Tax and penalty liability do not travel on the same discharge path in BC 523. The penalty for late filing and the penalty for accuracy were discharged because they are governed by BC 523(a)(7) rather than 523(a)(1). The provision for penalties essentially allows their discharge if three years has passed from the due date of the return at the time of the bankruptcy filing. The Tax Court notes that these two penalties were discharged. The interest on the penalties would likewise be discharged just as the interest in the tax would not.
Note that if the Barnes had owed taxes based on their return and not their deficiency case, the taxes owed which were shown on their return would have been discharged subject to an argument regarding the one-day rule, which the IRS would not raise and which the D.C. Circuit has not decided. It’s possible for a taxpayer having liabilities that arise at different points in time to achieve different discharge results based on the timing of the liability vis a vis the timing of the filing of the bankruptcy petition.
If you have not read one of the many posts regarding the one-day rule, you can read one here which links to others. The late filing of the 2003 return could itself have posed a basis for losing the ability to discharge any taxes due on 2003 had they filed bankruptcy in the 1st, 5th or 10th Circuits. No one raised that argument in this case, and I mention it just because there was a late filing penalty assessed.