The Perils of Electing to Carry Forward a Tax Refund When Filing Bankruptcy

In Miller v. Wylie, No. 21-04012 (Bankr. E.D. Mich. 2023) the debtors elect to carry forward their tax refunds for returns filed shortly before bankruptcy and immediately after filing. Although the analysis for the pre- and post-bankruptcy elections turns out differently, the post-bankruptcy election causes the loss of their bankruptcy discharge under BC 727(b)(2)(B).  I have seen occasional cases with this issue over the past few decades but have not written about it previously.  The timing of bankruptcy filing versus return filing and the ability to elect on a return to carry a refund forward has tempted debtors to try this technique for preserving an asset that their creditors deserve.  The existence of both pre- and post-bankruptcy elections in this case provides a detailed look at the considerations undertaken by a bankruptcy court when debtors make this type of election.


The Wylies filed a joint chapter 7 petition on August 27, 2020.  To reach the decision in this case the bankruptcy court held a four-day trial – Wow.  The refund issue relates to both state (Michigan) and federal tax refunds.  I will focus on the federal refunds.

Like many other debtors the Wylie’s filed their tax returns late.  Unlike most debtors, they filed seeking a substantial refund rather than posting more debt.  Their 2018 return was filed almost one year late on March 31, 2020, just five months prior to the filing of their bankruptcy petition.  The return claimed a refund of $21,317.00 and their state return filed at the same time claimed a similar sized refund.  They elected to have the overpayments reflected on these returns applied to their 2019 income tax liabilities as estimated taxes.

There is nothing wrong or underhanded about making such an election as a general matter which is why the Internal Revenue Code permits such an election.  Because the returns were filed with five months of the filing of the bankruptcy petition, the trustee alleges that the election amounted to a transfer which concealed their property with the intent to hinder, delay or defraud a creditor within the meaning of BC 727(a)(2)(A).

The Wylie’s filed their 2019 returns on September 15, 2020, almost immediately after filing their bankruptcy petition.  Note that even though the return was filed after the bankruptcy petition the liability/overpayment for 2019 taxes was a prepetition liability or overpayment because the 2019 tax year ended on December 31, 2019, which date occurred prior to the filing of the bankruptcy petition.

The federal tax overpayment for 2019 on their return was $20,798.00 essentially resulting from the 2018 overpayment election with a similar result for their Michigan taxes resulting in over $40,000 in tax overpayments for 2019.  What did the Wylie’s do with this $40,000?  They elected to apply it to their 2020 tax liability.  The trustee alleges that this election sought to transfer and conceal property of the estate with the intent to hinder, delay, or defraud the trustee within the meaning of BC 727(a)(2)(B).  Because this election occurred after the filing of the bankruptcy petition it triggered a slightly different code section and it creates significantly more problems for the Wylies.

The court next turns to what the Wylies reported on their bankruptcy schedules.  Debtors who file bankruptcy must file extensive schedules disclosing their assets and do so under penalties of perjury.  The Wylies made at least two statements about their tax refunds which troubled the trustee whose job involves collecting all of the available assets for the benefit of the creditors.  First, the Wylies said the value of tax refunds owed to them was unknown.  More troubling they said:

Payment of $13,000 total, $10,000 to IRS and $3,000 to state of Michigan on October 2, 2019, towards estimated income tax liability. 2019 returns have not been filed. Payment amount was estimated to equal the tax liability.

Note the omission of information regarding the election to carry forward their 2018 overpayment.

The bankruptcy court notes the burden of proof here regarding the statute violation rests with the trustee.  It then goes over the elements the trustee must prove and the case law surrounding those elements.  Look to the case for a detailed discussion.

BC 727(a)(2)A) Discharge Denial Request

With respect to the pre-petition election to carry forward their 2018 overpayments the court found the election to be a transfer that concealed their property.  The trustee cited to several of the cases I had read over the past decades in which debtors tried to conceal tax refunds using essentially the same technique as the Wylies:

Case law on this subject, cited by the Trustee, supports the Court’s conclusion that the Debtors made a “transfer,” and the Debtors have cited no case law to the contrary. See United States v. Sims (In re Feiler), 218 F.3d 948, 955, 956 (9th Cir. 2000) (bankruptcy debtors’ pre-petition tax election to carry forward net operating loss (“NOL”) to offset future income, and to waive NOL carryback and resulting tax refund, was a “transfer” of a property interest to the IRS); Gibson v. United States (In re Russell), 927 F.2d 413, 418 (8th Cir. 1991) (same, regarding bankruptcy debtor’s post-petition NOL election); Kapila v. United States (In re Taylor), 386 B.R. 361, 369 (Bankr. S.D. Fla. 2008) (same, regarding bankruptcy debtor’s pre-petition NOL election).

The court decided, however, that the pre-bankruptcy election did not meet the intent element of the statute because the trustee could not prove that the’ Wylies election, made five months prior to bankruptcy, sought to hinder, delay, or defraud a future chapter 7 trustee in a future bankruptcy case.  The court viewed this election as a preference of the IRS over the Wylies other creditors.  This type of preference could cause the funds transferred with a period prior to bankruptcy to be clawed back into the estate but would not rise to the level of denying a discharge.  The court detailed at this point the severe health and financial problems facing Jason Wylie.

The court detailed the various businesses that Jason Wylie ran, his financial and health situation leading up to the bankruptcy, the timing of the hiring of the bankruptcy attorney, the reason for the delay in filing the 2018 return.  Four days of testimony would have flushed out these details which provide crucial background for the court’s decision on discharge.  Denying a discharge is a severe remedy the bankruptcy court would not take without care.

BC 727(a)(4)(A) Discharge Denial Request

The trustee sought to deny the discharge because of the false statements on the bankruptcy schedules.  The court agrees the statements in the schedules were false but finds that the trustee did not prove the Wylies made these false statements fraudulently.  So, as with BC 727(a)(2)(A) discharge denial request, the court turns away the trustee’s attempt to deny the discharge on this ground.  One of the deciding factors for the court was that the Wylies provided their 2018 return to the trustee before or shortly after the filing of the petition and their 2019 return shortly after filing it.  Because they were providing accurate information about the carry forward election at approximately the same time, the court determined that they did not intend to deceive the trustee with the false statements in the schedules.

BC 727(a)(2)(B) Discharge Denial Request

Here, the Wylies lose their discharge.  The bankruptcy petition had already been filed.  The 2019 refunds were clearly property of the estate.  The court finds the carry forward election sought to transfer property of the estate with the intent to hinder, delay or defraud the trustee.  By making the election the Wylies necessarily delayed the trustee since they could have received the refunds from the IRS promptly (a relative term during the pandemic) instead of forcing the trustee to unwind their election causing additional time and expense.  (Under the facts here and probably because of the pandemic, the court finds that the election did not actually hinder or delay the trustee in obtaining the refunds but that is not controlling since they intended to do so.)

Jason Wylie and Leah Wylie both admitted in their trial testimony that the purpose of making their 2019 Tax Refund Transfers was the same kind of purpose they had when they made their 2018 tax refund elections — to try to make sure that their 2020 taxes would be paid.89 As the Court has discussed in Part III.C.1.b of this Opinion, this purpose is essentially a purpose to prefer the Debtors’ two taxing authority creditors (the Internal Revenue Service and the State of Michigan) over their other creditors. That is, the Debtors wanted to insure that their taxing authority creditors were paid in full, for 2020 taxes, in preference to their other creditors, many or most of which could not be paid in full.

In the post-petition context, the Debtors making a transfer of estate property with this purpose is wholly inconsistent with the duties of the Chapter 7 Trustee. This means that in substance, the Debtors had, at a minimum, an intent to hinder the Trustee. In the Debtors’ Chapter 7 bankruptcy case, the Chapter 7 Trustee would not and could not give the Debtors’ intended preferential treatment to these taxing authority creditors for 2020 taxes.

So, the debtors lose their discharge and the refunds come into the estate to pay creditors which could include the IRS depending on the various priorities of the creditors.  The Wylies, unlike debtors in many of the previous cases I have read with this issue, do not appear to have the sneaky intent to use the carry forward to obtain the refund for themselves in a future year filing but rather appear genuinely desirous of making sure they covered their taxes.  While their intentions are more noble than others using this technique to keep property out of the estate, the trustee is right to pursue the refunds for the benefit of all creditors in order that the priority scheme of the bankruptcy code is preserved.  The bankruptcy court struggled with the decision to deny the discharge because of the intent issue.

Equitable Tolling and Bankruptcy Time Periods

Bankruptcy brings out equitable rulings in a way that tax issues do not, but as discussed at the end of the post, remembering the bankruptcy equitable rulings can prove helpful.  The leading case on equitable tolling and bankruptcy in the tax context is United States v. Young, 535 U.S. 43 (2002) where the IRS argued, and the Supreme Court held, that the time period for a tax to retain priority status based on BC 507(a)(8)(A)(i) was equitably tolled based on a prior bankruptcy filing.  In that case the debtor filed a chapter 13 petition and stayed in bankruptcy long enough for the tax period to age out of priority status.  The debtor then dismissed the chapter 13 bankruptcy petition and shortly thereafter filed a chapter 7.  After obtaining a discharge in the chapter 7, the debtor argued that the debt was no longer entitled to priority status and thus discharged due to its age and status.  The Supreme Court said that under these circumstances the IRS time period for having a priority claim was tolled by the first bankruptcy since that bankruptcy prevented the IRS from collecting on the debt.

In Rader v. Internal Revenue Service, No. 3:21-ap-90125 (M.D. Tenn. 2023) the debtor made a similar argument, but this time the parties argued about the period in BC 523(a)(1)(B)(ii) which governs the discharge of taxes for individual taxpayers who file their returns late.  As in the Young case, the IRS prevailed in its equitable tolling argument.


Mr. Radar filed a chapter 13 bankruptcy petition on March 11, 2014.  He successfully completed the bankruptcy using the five-year plan option and received his discharge on November 12, 2019.  Prior to filing his successful chapter 13 petition, Mr. Radar filed a chapter 13 petition on May 11, 2011, which was dismissed without a discharge on November 7, 2013.  During both bankruptcy cases the automatic stay arose at the time of filing the petition and lasted until the dismissal (first case) or the discharge (second case.)  While the automatic stay was in effect, the IRS could not take collection action against Mr. Radar and the collection statute of limitations was tolled; however, the time period in BC 523(a)(1)(B)(ii) makes no mention of the effect of a prior bankruptcy.

I have discussed BC 523(a)(1)(B)(ii) in numerous blog posts because this subparagraph comes into play for the courts interpreting the unnumbered paragraph at the end of BC 523(a) which gave rise to the “one-day rule” discuss here and in many preceding posts.  You can find an extensive discussion of the one-day rule in IRS Practice and Procedure at Chapter 16. 

The Radar case, however, involves a straight-forward interpretation of this provision.  BC 523(a)(1)(B)(ii) provides that a taxpayer who files a return late cannot discharge a tax liability related to that return without waiting for two years after the filing of the late return.  This exception to discharge ties back to the priority provisions and to the overall goal of the bankruptcy code to generally give the IRS adequate time to collect on a debt before allowing a debtor to discharge the tax debt in bankruptcy.

Mr. Radar, like many who file for bankruptcy as well as many who do not, failed to timely file his returns for many years.  For the years 2002-2009 he filed eight years of past due returns on Mach 15, 2011.  He filed his 2010 return on April 2, 2012.  He apparently filed the past due returns without remittance or with insufficient remittance.

The timing of the filing of these late returns is not a coincidence.  So many debtors were going into bankruptcy with unfiled returns that Congress addressed the situation in the 2005 extensive revisions to the bankruptcy code.  Debtors must file past due returns or face dismissal from bankruptcy.  In the 2005 legislation Congress enacted BC 1308 entitled “Filing of prepetition tax returns.”  This section requires the filing of the four returns due prior to the filing of the bankruptcy petition.  By March of 2011, Mr. Radar was probably consulting with a bankruptcy attorney in preparation for the filing of his first bankruptcy petition and knew he needed to file the past due returns.

By filing the past due returns less than two months before he filed his first bankruptcy petition, he did not give the IRS much time to process those returns and begin collection.  Because the IRS give past due returns low priority for processing during the filing season and because the past due returns must be paper filed, the returns filed in March of 2011 were probably not processed for several months.  Once processed, the IRS would have filed a claim in the bankruptcy case but done nothing else because of the stay.

When Mr. Radar was dismissed from the first bankruptcy case, the IRS could collect; however, only four months separated the first and second bankruptcy cases at which time the IRS had to stop collection and wait for payment through the bankruptcy process.  At the time of the second bankruptcy filing, the IRS had only six months of time to collect when the automatic stay did not prevent collection.

After noting that the two-year rule of BC 523(a)(1)(B)(ii) would allow the discharge of all of the years at issue except 2010 if equitable tolling does not apply, the bankruptcy court launched into its analysis of equitable tolling.  It stated:

There is a “rebuttable presumption” that equitable tolling applies to nonjurisdictional federal statutes of limitations. Holland v. Florida, 560 U.S. 631, 645-46, 130 S. Ct. 2549, 2560 (2010) (citation omitted). “It is hornbook law that limitations periods are ‘customarily subject to ‘equitable tolling,’’ unless tolling would be ‘inconsistent with the text of the relevant statute.’” Young v. United States, 535 U.S. 43, 49, 122 S. Ct. 1036, 1040 (2002) (citations omitted).

It is not immediately obvious that the two-year lookback period in §523(a)(1)(B)(ii) is a limitations period. However, in Young, the Supreme Court explained that a similar tax-related three-year lookback period in 11 U.S.C. §507(a)(8)(A)(i), as incorporated by §523(a)(1)(A), was a “limitations period because it prescribes a period within which certain rights (namely, priority and nondischargeability in bankruptcy) may be enforced.”3 Id. at 47.

The Supreme Court noted in Young that the IRS risked older taxes becoming dischargeable if not collected or if a tax lien is not perfected before the three years under that subsection have elapsed, so the IRS was encouraged to act quickly. Id. “Thus, . . . the lookback period serves the same ‘basic policies [furthered by] all limitations provisions: repose, elimination of stale claims, and certainty about a plaintiff’s opportunity for recovery and a defendant’s potential liabilities.’” Id. at 47 (quoting Rotella v. Wood, 528 U.S. 549, 555, 120 S.Ct. 1075 (2000)). The Supreme Court acknowledged that the lookback period was limited in nature since it only barred some, but not all, legal remedies (namely priority and nondischargebilty in bankruptcy), but it held it was, nonetheless, a statute of limitations. Id. at 47-48. So that point regarding the nature of the lookback period as a limitations period is settled by the Young decision.

After the Young decision, Congress amended BC 507(a)(8) in 2005 to specifically addressed, at least in part, the problem of prior bankruptcy cases on the priority of the tax claim by adding an unnumbered paragraph to the end of the section.  In making that change it did not alter BC 523(a).  The bankruptcy court noted that two prior bankruptcy court decisions had addressed the specific question at issue in Mr. Radar’s case: Putnam v. IRS (In re Putnam), 503 B.R. 656 (Bankr. E.D.N.C. 2014), aff’d sub nom. Putnam v. I.R.S., No. 5:14-CV-118-D, 2014 WL 8863125 (E.D.N.C. Sept. 24, 2014); Ollie-Barnes v. IRS (In re Ollie-Barnes), No. 09-82198, 2014 WL 5794866 (Bankr. M.D.N.C. Nov. 6, 2014).

 Mr. Radar argued that the failure of Congress to make a change to BC 523 to fix this problem at the time it changed BC 507 showed that the rebuttable presumption for equitable tolling should not apply.  The bankruptcy court turned around that argument finding that the change to BC 507 showed that Congress approved of the tolling of time periods such as this and doing so would close a loophole.

Mr. Radar made a second argument regarding equitable tolling based on the facts and circumstances of the case.  He argued:

vehemently and creatively that because equitable tolling is “equitable” relief, the totality of the circumstances should be considered in determining whether it would be equitable to toll the lookback period. Debtor argues for a case-by-case review of the actions of both the debtor and the IRS. If a debtor has acted in good faith and if the IRS perhaps has not, Debtor argues that the lookback period should not be tolled. Debtor contends some actions of the IRS reflect poor conduct or bad faith, such as the way Chapter 13 plan payments were applied to the IRS debt in the earlier case and the pursuit of dischargeable penalties. Accordingly, under Debtor’s approach, all actions of the parties throughout the bankruptcies and the collection process should be considered before imposing any equitable remedy.

Debtor misconstrues the equitable focus when a limitations period is tolled. The focus is on whether the applicable claimant has been prevented in some way from acting within the limitations period. See Robertson v. Simpson, 624 F.3d 781, 783 (6th Cir. 2010) (“The doctrine of equitable tolling allows courts to toll a statute of limitations when ‘a litigant’s failure to meet a legally-mandated deadline unavoidably arose from circumstances beyond that litigant’s control.’”) (citation omitted).

While rejecting this argument as a basis for preventing equitable tolling, the court noted that in the next phase of the trial the IRS behavior in the case could become relevant. 

The decision did not surprise me based on the Supreme Court’s analysis in Young and the equities of shielding yourself from collection but wanting the benefit of the ticking clock on IRS collection opportunities.  The case indicated that a fair amount of money was at issue.  So, an appeal may occur.

I like to see the IRS make equitable arguments and believe that it deserves to make those arguments.  It also deserves to be reminded that it argues in favor of equitable tolling when it benefits the IRS and against it when it favors taxpayers.  Bringing out the cases where it makes these arguments helps in the cases where it seeks to limit equitable tolling.

Timing Your Bankruptcy Petition to Obtain a Discharge of 2019 Taxes

The effect of the pandemic continues to play out with tax issues.  In yesterday’s post regarding the timing of filing a refund claim for 2019 Bob Probasco explained how the extension of time to file the 2019 return impacts the three year rule for timely filing a claim.

Another impact of the extension of time to file the 2019 return plays out for individuals waiting out the three year rule for income tax liability to transform from priority claims in bankruptcy to general unsecured claims eligible for discharge.  This post raises questions regarding the timing of bankruptcy filings in 2023 seeking to gain the benefit of what is normally a cut and dry time period.


Bankruptcy Code section 507(a)(8)(A)(i) provides that the IRS is entitled to priority claim status for

A) 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 –

i) For which a return, if required, is last due, including extensions, after three years before the date of the filing of the petition

 Ordinarily, this provision grants priority status to taxes owed when a person goes into bankruptcy for the periods in which the return due date fell less than three years before the filing of the bankruptcy petition.

For example, if an individual filed bankruptcy on April 10, 2023, the taxes for the years 2019 through 2022 would have priority status since the due dates for the returns for those years fell less than three years before the filing of the bankruptcy petition.

Why does this matter?  Unless the bankruptcy estate will fully pay the taxes for these years, the individual debtor will exit bankruptcy still owing the taxes for these years because of the operation of Bankruptcy Code section 523(a)(1) which excepts from discharge all taxes entitled to priority status.

So, a debtor with outstanding taxes who wants to rid themselves of a tax liability will wait until April 16 of the year three years after the due date of the return for the year of the tax liability to file their bankruptcy petition. (If they obtained an extension of time to file the return they will wait until October 16.)

Now, enter the pandemic and the global extension of time to file tax returns for 2019.  How does that global extension of time impact the debtor’s decision on when to file their bankruptcy petition in order to obtain the benefit of a discharge.  On the refund side the post by Bob Probasco argues that the global extension provides additional time for a taxpayer to file their refund claim for 2019.  Taxpayers who need debt relief want an earlier date to apply.  Unlike its pronouncement in Notice 2023-21 that seeks to provide guidance regarding the timing of refund claims for 2019, the IRS has issued no guidance on its view of when a tax claim turns from a priority claim into a general unsecured claim.  It must have internally issued this guidance because it will start filing claims taking a position on this issue almost immediately.

This question was recently posed to me by a tax clinician.  Like any good lawyer, I declined to answer the question and instead consulted someone else.  In this case I consulted Ken Weil who has written several bankruptcy posts for PT and to whom I bring all of my thorny bankruptcy questions.

Ken said he had given the issue much thought and he felt strongly that unless a taxpayer had filed for an extension of time to file their 2019 return, the three year rule for priority claims should cause 2019 taxes to turn into general unsecured claims on April 16, 2023. He also thought that since the IRS had not issued guidance on this issue taxpayers should wait until July 16, 2023 to file their bankruptcy petition out of an abundance of caution. I agree with Ken’s conclusion regarding the timing of the priority status and also with his advice to wait, if possible, until the sure thing.

He cited to IRM § (07-25-2022) and said  “I think it is pretty clear that the IRS issued its extension under the emergency rules.  IRS Notice 2020-18 (March 20, 2020).”  He also cited to Bryan Camp’s “Lesson From The Tax Court: Counting the Days,” TaxProf Blog (May 23, 2022).”

There will ways in which the pandemic extension impacts tax procedure other than refund claims and bankruptcy discharge but these are two obvious and immediate areas of concern raised by the special events in the spring of 2020.  Just as getting vaccinated can assist you in preventing the worst consequences of COVID, thinking about a planning the timing issues presented by the special extension of time to file in 2020 can keep you from an unpleasant tax result.

Avoiding the Federal Tax Lien in Bankruptcy

In United States v. Warfield (In re Tillman), No. 21-16034 (9th Cir. 2022) the Ninth Circuit reversed the lower courts and determined that the chapter 7 trustee could not avoid the federal tax lien on the debtor’s homestead.  The trustee filed a motion for rehearing en banc and the 9th Circuit has ordered a response from Appellant by December 4.  A copy of the response is attached here.  So, the discussion below may not be the end of the story.


Ms. Tillman purchased a house in Prescott, Arizona.  Prior to the filing of the bankruptcy petition the IRS filed a notice of federal tax lien on the property stemming from a penalty she owed.  Ms. Tillman claimed a $150,000 homestead exemption in the house under Arizona law.  The trustee sued to avoid the tax lien on the exempt property in order to obtain the benefit of the lien for the bankruptcy estate.  At the time of the bankruptcy, she had paid off the underlying taxes set out in the lien notice but owed about $25,000 in penalties.

The issue pits different bankruptcy codes sections against each other that deal with exemptions and with the treatment of penalties in chapter 7 cases.

BC 522 generally permits a debtor to claim certain property as exempt.  The amount of property is almost always dictated by the state in which the debtor lives at the time of filing bankruptcy.  Arizona has a generous homestead provision which Ms. Tillman claimed.  Under almost all circumstances a debtor gets to keep the exempt property which cannot be used to satisfy the claims of creditors in the bankruptcy case; however, claiming property as exempt protects it from the claims of unsecured creditors not those who have a security interest in the property claimed as exempt.

BC 522(c)(2)(B) holds that exempting property does not protect it from a tax lien where the IRS has properly filed the notice before the bankruptcy petition.  The notice of federal tax lien would not specifically mention a taxpayer’s real estate but attaches to all property and rights to property belonging to the taxpayer.  To perfect the lien against a taxpayer’s real estate, the IRS would need to file the lien in the locality in which the property was located.  If, prior to the filing of a bankruptcy case, the IRS filed the notice in the city or county in which the property was located and if the notice properly identified the taxpayer, the IRS would have a perfected lien that would survive the debtor’s attempt to claim the property as exempt.  It would not receive payment for its lien in the bankruptcy case but would have the ability to pursue the property after bankruptcy.  Because the IRS is reluctant to administratively or judicially take taxpayer’s homes, sometimes taxpayers get to keep their homes safe from other creditors because of the federal tax lien’s priority, and then the IRS never pursues the property allowing some lucky taxpayers to walk away from both their tax obligations and their other debts.

Chapter 7 trustees do not have the same reluctance or policies regarding debtor’s homes that the IRS does.  The trustees carefully review debtor’s schedules and other available information to determine if selling the debtor’s home or other assets would bring a benefit to the unsecured creditors of the bankruptcy estate (as well as a commission to the trustee.)  Here, the trustee sought to use the existence of the tax lien combined with BC 724 and 726(a)(4) to sell the property for the benefit of the unsecured creditors.

BC 724(a) says that a chapter 7 trustee can avoid a “lien that secures a claim of a kind specified in section 726(a)(4)” for the benefit of the estate.  BC 726 describes how property in a chapter 7 case should be distributed to creditors, providing first for claims listed in BC 507 which would include the unsecured claims to which Congress has given priority, second to unsecured claims with no priority, third to unsecured claims filed late, and fourth to claims for penalties, whether secured or unsecured.

The trustee reasoned that because the underlying tax had been paid, the IRS’s claim (secured by the notice of federal tax lien) was merely a claim for a “penalty” within the meaning of BC 726(a)(4), and therefore under BC 724 the lien could be avoided.  The bankruptcy code disfavors penalty tax claims allowing the avoidance of the liens for these claims through the procedures described in BC 724 and 726.

However, the trustee had one more hoop to jump through: under BC 551 the property preserved must be property of the estate. This requirement was key to the government’s argument.  Section 551 comes immediately after the bankruptcy code provisions allowing for the avoidance of certain transfers.  It seeks to preserve the property avoided for the bankruptcy estate unless the property would not have met the definition of property of the estate described in in BC 541.  In other words, the avoidance provisions cannot transform property that would otherwise have remained outside the estate into property of the bankruptcy estate.

The bankruptcy and district courts held that the trustee could avoid the federal tax lien, rejecting:

The government’s argument that the court’s holding would cause inequitable results for the Debtor, because the Debtor’s exemption could be reduced twice as a result of the same lien—first, as a deduction from the amount that Debtor could exempt, and then, again, when the Debtor is required to satisfy the value of the lien to the IRS. The Bankruptcy Court reasoned that the Debtor would not have to unfairly pay twice on the same lien because the IRS Tax Lien “never attached to the Debtor’s homestead exemption.” “[T]he value of the Debtor’s exemption was always subordinate to the Tax Lien” and “[w]hen the Tax Lien is avoided, the Trustee steps into that avoided position.” Therefore, the court explained, “[i]f it so happens that the IRS’s now unsecured claim is also nondischargeable, it is no different than any other nondischargeable claim which will need to be paid by the Debtor.”  

Essentially, the IRS argued that the debtor’s homestead exemption withdrew the exempt property from the bankruptcy estate which would mean it is unavailable for the unsecured creditors of the estate.  The Ninth Circuit finds that:

When a debtor properly exempts a property interest under § 522, the exemption withdraws that property interest from the estate and, thus, from the reach of the trustee for distribution to creditors….

In reaching our holding, we conclude that the Bankruptcy Court erred by overlooking the key question of first impression before us: whether a trustee may use § 724(a) to avoid a lien secured by a debtor’s exempt

property. The Bankruptcy Court did not analyze this question. Instead, the Bankruptcy Court appears to have assumed that the Trustee could use § 724(a) to avoid a lien on the Debtor’s exempt property.

The majority was especially concerned that its result kept the debtor from having to pay the debt twice.  The majority took pains to distinguish the decision in Hutchinson v. IRS (In re Hutchinson), 15 F.4th 1229 (9th Cir. 2021).  I wrote about the bankruptcy and district court opinions in that case here and here.  It’s difficult to find a light of daylight between the two opinions except that the government did not raise the issue in Hutchinson but merely conceded that the result the trustee sought could attach.

I agree with the majority in Tillman.  While it may look like the avoidance provision seeks to preserve property for other creditors, in this instance applying the law as was done in the lower court opinions puts debtors in the bad position of paying twice since the exempt property will now be used to pay unsecured creditors who would otherwise not have the opportunity to get paid from this property while the debt owed to the IRS is not extinguished and can be collected after the bankruptcy.  The existence of the tax lien should not create a benefit for the unsecured creditors.

The dissent looks to the powers of the trustee to avoid liens and to the position of the IRS when it has a lien claim.  It finds the majority’s concern with the consequence of avoidance of the lien to be a troubling result does not matter because what matters is the language of the bankruptcy code.  The defense finds that the plain text supports the position of the lower courts.

Contrary to the IRS and majority’s view, the trustee’s authority to avoid a federal tax penalty lien isn’t nullified because it encumbers exempt property. The majority incorporates § 726’s reference to the distribution of the “property of the estate” to bar a trustee’s avoidance authority. The IRS instead relies on § 551’s limitation of preservation of liens “only with respect to property of the estate.”

This issue will not go away easily and may soon result in a successful Supreme Court petition.

Ken Weil, who knows a lot more about tax issues in bankruptcy than me and who occasionally writes guest posts for PT, sent me this case.  When I sent him my draft, he offered these comments which provide a slightly different, and probably better, perspective on the case:

The IRS objected to the trustee’s use of BC 724(a), presumably because it determined that collection of the nondischargeable tax penalty would be more difficult without the NFTL attached to the property. The tax year at issue was 2015.  The taxpayer filed for bankruptcy in January 2019.  Tax penalties in Chapter 7 are dischargeable after three years from the due date of the return, including extensions, for the failure to file penalty, or three years from the payment due date for the failure to pay penalty.  BC 523(a)(7); and see United States v. Wilson, No. 15-1448, Docket entry No. 10 (N.D. Cal. 2016) (opinion withdrawn as parties settled) (tax year at issue 2008; petition filed July 2012; 2008 return filed on extension; parties agreed that failure-to-pay penalty was discharged; held, failure-to-file penalty not discharged).  One has to wonder why the bankruptcy filing was not delayed until after April 15, 2019, at the least. 

The IRS argued that exempt property is not property of the bankruptcy estate.  Schwab v. Reilly, 560 U.S. 770, 775-776 (2010).  For avoidance to be available to the trustee, BC 724(a) and 551 require that the property in question be property of the bankruptcy estate. 

More precisely, an exempt interest in property is not property of the bankruptcy estate.  Schwab v. Reilly, 560 U.S. 770, 794-795 (estate retained interest in property beyond the exempt amount) (2010).  In other words, while the value of the homestead left the bankruptcy estate, the rest of the house remained in the bankruptcy estate.  In that situation, what is the property of the estate?  Does the trustee have the authority to use BC 724(a) if the part of the real property against which the trustee can avoid the IRS lien is out-of-the-bankruptcy estate yet the property itself remains property of the bankruptcy estate?  Without diving into the Schwab v. Reilly issue, the Circuit Court found that the applicable property interest was not property of the estate, and BC 724(a) was not available to the trustee.  The dissent felt that the house was property of the estate, and, under the literal terms of the statute, the IRS lien could be avoided.

As a policy matter, the IRS argued, and the lower courts agreed, that allowing the trustee to avoid the lien as to the homestead would cause a double payment by the taxpayer.  This is a true statement, but also this argument is a red herring.  If the secured tax obligation is nondischargeable, there is always the potential for a double payment, regardless of whether the property at issue is exempt property.  The first payment is made from property that otherwise would have paid the tax debt, and that money is spread among all creditors.  The second payment potentially comes postpetition from the debtor to the taxing authority because the debtor’s tax obligation was not discharged.

Here, the trustee could have potentially avoided the issue at-hand by timely filing an objection to the homestead exemption.  Then, the argument as to whether the homestead interest had left the bankruptcy estate would not have been available.  Instead, the argument would be whether the trustee can object to the exemption because the trustee has rights in the property under BC 724(a).

Ken also offered the following fact pattern as a way to think about the problem:

Suppose, Taxpayer

>Files for bankruptcy;

>Taxpayer has a nice car;

>Taxpayer makes a claim of exemption in an interest in that car, which exemption claim does not cover the entire value of the car, and the trustee does not object; and

>The IRS only has a FTL and not a NFTL.

The claim of exemption would scrub the FTL from that interest in the car but the FTL would remain attached to the rest of the car, which is property of the bankruptcy estate and subject to the trustee’s control.

Don’t know that there is anything to come of this because the trustee can avoid the FTL.  But, I suppose the trustee could decide the car was not worth administering and abandon it.  Then, the debtor gets the car back, and it is partially lien-free and partially subject to the FTL.

Exempting the Earned Income Tax Credit from the Bankruptcy Estate

In In re Medina, No. 22-10233 (Bankr. D. N.M 2022) the bankruptcy court held that the portion of the debtor’s refund attributable to the earned income tax credit (EITC) was not exempt from the debtor’s bankruptcy estate.  The case points out a split in the outcome for debtors.  This split is not based upon a split in the interpretation of bankruptcy law but a split in how states approach exemptions.  Guest blogger Phil Rosenkrantz wrote about this several years ago in a post regarding the child tax credit. 

The bankruptcy code allows each state to decide which assets a debtor may choose to exempt from the bankruptcy estate.  Most states have exempted EITC refunds because the payments meet the state definition of payment for the welfare of the individual.  Similarly, most states have exempted the advanced child tax credit (ACTC); however, each state statute stands on its own.  Ms. Medina finds out to her sorrow that New Mexico has not drafted its statutory exemptions in a manner allowing for the exemption of the EITC.  As discussed below, this is an area where Congress should step in.  We should not require a state by state determination of whether to exempt federal anti-poverty payments.


Ms. Medina filed her bankruptcy petition on March 24, 2022, making her 2021 refund a pre-petition asset.  As she filed she claimed an exemption of her federal and state tax refunds for 2021 using New Mexico’s wildcard exemption which is capped at $500.  She chose to use the New Mexico exemptions rather than the federal exemptions provided in BC 522 because she wanted to protect the equity in her home and New Mexico, like most states with a Spanish rather than English colonial heritage, has a generous homestead exemption.

The wildcard exemption did not provide enough protection for her 2021 refunds:

Based on her filed tax returns, Ms. Medina was entitled to a 2021 federal tax refund of $4,845 — out of which $3,618 was due to the federal EITC — and a 2021 state tax refund of $1,016 — out of which $724 was due to New Mexico’s EITC (the Working Families Tax Credit). Ms. Medina’s total 2021 tax refunds were therefore $5,861. The tax preparer fees were 10% of the total refunds.

She did not receive the refunds until after filing her bankruptcy petition – though that fact is not legally significant.  She spent the refunds by April 21, 2022, making “important home repairs such as repairing her air conditioner and hot water heater.”  The trustee objected to exemption of the portion of her refund that exceeded the wildcard amount except that the trustee did not object to the portion of her refund based on the Child Tax Credit (CTC).

In most fights interpreting state law, the EITC has fared better than CTC because CTC is not exclusively an anti-poverty provision.  Taxpayer eligible for the CTC include middle class households as well as households falling into the poverty guidelines of most states.  Usually, the ACTC has a better chance than the CTC of exemption from the estate because of the most restrictive requirements for ACTC.  The trustee’s concession on CTC surprised me.

Although represented at the outset of the case, Ms. Medina was pro se at the time of the fight over the exemptions.  She raised four arguments but only the argument regarding the ability to exempt the EITC portions of the refund bears discussion.

The court describes the EITC and its anti-poverty purpose but ends the descriptive section by stating:

Despite its anti-poverty purpose, Congress has not enacted exemptions for EITC refunds similar to the protections for Social Security benefits under 42 U.S.C. §407 and veterans’ benefits under 38 U.S.C. §5301(a).

That statement might serve as a basis for seeking a change in the bankruptcy law to provide protection for the anti-poverty payments administered under the IRC.  These payments represent a significant portion of the federal anti-poverty payments.  They should be recognized with the other payments mentioned by the court without the requirement to litigate this issue state by state.

The court notes that many states have passed legislation exempting EITC from the reach of creditors, some states have broad exemptions for public assistance benefits generally and many courts have interpreted EITC to meet the exemptions for public assistance.  The case contains good citations for state laws and court decisions on this subject.  The court did a nice job of researching state law and case law in a pro se case where her submissions would have left big gaps in this research.  See it below in bonus material.

While the court finds that EITC payments are public assistance payments, it finds that New Mexico lacks a broad public assistance exemption.  It carefully analyzes the state statute and then notes that

Other courts have similarly held that an exemption under a public assistance act does not apply to EITC tax refunds where the exemption is limited to public assistance granted under the act because EITC tax refunds are granted under federal and state tax codes. In Nevada, the bankruptcy court held that the Nevada exemption for “assistance awarded pursuant to the provisions of this chapter,” which referred to chapter 422 of the Nevada Revised Statutes, did not include EITC because it was “not paid or payable pursuant to a state-administered public welfare program under Chapter 422.” In re Thompson, 336 B.R. 800, 802 (Bankr. D. Nev. 2005). Similarly, in Arizona, the bankruptcy court concluded that the Arizona exemption for “assistance granted under this title” and “money paid or payable under this title” did not include EITC, because EITC is granted by the federal tax code, not by Arizona’s public assistance statute. In re Builder, 368 B.R. 10, 11-12 (Bankr. D. Ariz. 2007).

So, Ms. Medina cannot exempt the EITC portion of her state or federal refunds, except to the extent of the $500 wildcard exemption, which were the largest portions of those refunds.  The court finds that spending the refunds for necessary expenses does not exempt them.  The court does not say what she must do now that she now longer has the money.  If she cannot repay the money to the estate, I expect that her bankruptcy will be dismissed without her receipt of the discharge of debts she sought in filing.  This is a tough result for her but not one for which the court should be blamed.

Bonus material

For those interested, I copy below the court’s research on the state of the exemption of EITC from both a state law and case law perspective.

State law:

Several states have passed statutes that expressly exempt EITC from the reach of creditors, including Colorado, Indiana, Kansas, Louisiana, Mississippi, Nebraska, and Oklahoma.5 New Mexico has not done so.

5Colorado: Colo. Rev. Stat. Ann. §13-54-102(1)(o) (exempting full amount of any federal or state income tax refund “attributed to an earned income tax credit”); Indiana: Ind. Code Ann. §34-55-10-2(c)(11) (exempting interest in a refund or credit “received or to be received” under federal and Indiana EITC provisions); Kansas: Kan. Stat. Ann §60-2315 (exempting “right to receive” federal and Kansas EITC); Louisiana: La. Rev. Stat. Ann. §13:3881(A)(6) (exempting federal EITC “except for seizure by the Department of Revenue or arrears in child support payments”); Mississippi: Miss. Code Ann. §85-3-1(i) (exempting an amount not to exceed $5,000 of “earned income tax credit proceeds”); Nebraska: Neb. Rev. Stat. Ann. §25-1553 (exempting “full amount of any federal or state earned income tax credit refund”); Oklahoma: Okla. Stat. Ann. tit. 31, §1(A)(23) (exempting “[a]ny amount received pursuant to the federal earned income tax credit”).

Case law:

Many courts hold that EITC tax funds are public assistance within the meaning of state exemptions applicable to public assistance grants generally.6 Such courts reason that “the clear purpose and effect of the earned-income credit is public assistance.” In re Brasher, 253 B.R. 484, 489 (M.D. Ala. 2000). “Economically, the earned-income credit does not function as ‘mere tax relief’ but rather is ‘in essence, a grant.’” Id. (quoting In re Longstreet, 246 B.R. 611, 614 (Bankr. S.D. Iowa 2000)). This view is consistent with the notion that exemptions are to be construed liberally in favor of the debtor. See In re Foah, 482 B.R. 918, 921 (10th Cir. BAP 2012); In re Bushey, 559 B.R. 766, 774 (Bankr. D.N.M. 2016); Hewatt v. Clark, 44 N.M. 453, 1940-NMSC-044, ¶ 15. Such liberal construction effectuates the humanitarian purposes of exemption provisions. Foah, 482 B.R. at 921 (citing In re Carlson, 303 B.R. 478, 482 (10th Cir. BAP 2004)). Generally, the “purpose of having exemptions is to permit a debtor to retain certain necessities . . . without fear of creditors taking them.” In re Warren, 512 F.3d 1241, 1249 (10th Cir. 2008); In re Bushey, 559 B.R. 766, 771 (Bankr. D.N.M. 2016) (quoting Warren). The New Mexico exemption statute in particular was “adopted as a humane policy to prevent families from becoming destitute as the result of misfortune through common debts which generally are unforeseen.” Hewatt v. Clark, 44 N.M. 453, 1940-NMSC-044, ¶ 13 (internal quotation omitted).

However, at least one court has held that EITC tax refunds do not fall within a broad state exemption for “public assistance” because an EITC tax refund is a “tax overpayment” and not a “welfare grant.” See In re Trudeau, 237 B.R. 803, 807 (10th Cir. BAP 1999). This Court disagrees.7 An EITC tax refund is not dependent on the amount of tax paid and is available even to a qualified taxpayer who pays no tax at all. The EITC is not a refund attributable to an actual tax overpayment.

6E.g., In re James, 406 F.3d 1340, 1343-45 (11th Cir. 2005) (holding that EITC was exempt under Alabama exemption for “public assistance for needy persons”); In re Corbett, No. 13-60042, 2013 WL 1344717, at *2-3 (Bankr. W.D. Mo. Apr. 2, 2013) (holding that EITC was exempt under Missouri exemption for “public assistance benefit”); In re Fish, 224 B.R. 82, 84-85 (Bankr. S.D. Ill. 1998) (holding that EITC was exempt under Illinois exemption for “public assistance benefit”); In re Tomczyk, 295 B.R. 894, 896-97 (Bankr. D. Minn. 2003) (holding that EITC was exempt under Minnesota exemption for “all relief based on need”); In re Moreno, 629 B.R. 923, 932-34 (Bankr. W.D. Wash. 2021), aff’d, No. WW-21-1124-LBS, 2021 WL 6140115 (9th Cir. BAP Dec. 23, 2021) (holding that EITC was exempt under Washington exemption for “assistance”); Flanery v. Mathison, 289 B.R. 624, 628-29 (W.D. Ky. 2003) (holding that EITC was exempt under Kentucky statute exempting “public assistance benefits”); In re Longstreet, 246 B.R. 611, 617 (Bankr. S.D. Iowa 2000) (holding that EITC was exempt under Iowa exemption for “public assistance benefit”); In re Jones, 107 B.R. 751, 751-52 (Bankr. D. Idaho 1989) (holding that EITC was exempt under Idaho exemption for benefits provided by “public assistance legislation”).

Freezing Refund Did Not Violate The Automatic Stay

In United States v. Waters (In re Waters), No. 21-1219, 2022 WL 17086310 (2d Cir. Nov. 21, 2022) the court sustains the decision of the lower court that holding onto the debtor’s refund did violate the automatic stay.  I thought this issue was settled almost three decades ago by the Supreme Court in Citizens Bank of Md. v. Strumpf, 516 U.S. 16, 21 (1995) but debtor’s arguments here put a slight twist to the matter.


When a taxpayer goes into bankruptcy owing money to the IRS, the IRS wants to collect the outstanding debt in a manner that provides the most certainty.  If the taxpayer has a pre-petition tax debt and a pre-petition refund, the most certain way to collect the money is to offset it.  Offsetting avoids the muss and fuss of filing a proof of claim and hoping the estate has sufficient assets to satisfy the claim.  Sending a refund to a taxpayer at a time when the taxpayer owes taxes does not sit well with the IRS nor with any creditor.

Prior to 2005 the automatic stay at BC 362(a)(7) specifically prohibited offset as part of the automatic stay.  The Strumpf case arose in the context of the statute as it existed prior to 2005.  Strumpf did not involve the IRS but rather a bank.  It came out of the Fourth Circuit which had previously held that the IRS violated the automatic stay when it froze a taxpayer’s refund after the filing of a bankruptcy petition.  In Strumpf the Supreme Court said that the bank could freeze a debtor’s account in the situation where the debtor had an outstanding liability to the bank.  It rejected the debtor’s argument that the freeze amounted to an offset which the automatic stay prohibited.  The Court stated:

In our view, petitioner’s action was not a setoff within the meaning of § 362(a)(7). Petitioner refused to pay its debt, not permanently and absolutely, but only while it sought relief under § 362(d) from the automatic stay. Whether that temporary refusal was otherwise wrongful is a separate matter-we do not consider, for example, respondent’s contention that the portion of the account subjected to the “administrative hold” exceeded the amount properly subject to setoff. All that concerns us here is whether the refusal was a setoff We think it was not, because-as evidenced by petitioner’s “Motion for Relief from Automatic Stay and for Setoff”-petitioner did not purport permanently to reduce respondent’s account balance by the amount of the defaulted loan.

That decision opened the door for the IRS to also freeze refunds.  The Strumpf case did not say, however, that a creditor could freeze the debtor’s money indefinitely.  It contemplated that the creditor freezing the funds would relatively promptly come to the bankruptcy court seeking a lifting of the automatic stay and showing the necessity to do so in order to adequately protect the interest of the creditor as a secured creditor in the amount of the debtor’s funds it held.

In 2019 a district court decision, Wells Fargo Bank, N.A. v. Weidenbenner (In re Weidenbenner), No. 15-CV-244 (KMK), 2019 WL 1856276, at *4 (S.D.N.Y. Apr. 24, 2019) showed the hazards facing creditors who froze funds and did not act promptly to resolve the account.

In the bankruptcy court, Mr. Waters argued that the freeze of his refund violated BC 362(a)(1)(2) & (6).  He did not argue that it violated BC 362(a)(7) perhaps because of Strumpf or for other reasons.  In a footnote the Second Circuit notes:

Here, the IRS never sought the bankruptcy court’s approval to put in place or maintain its approximately two-year freeze. On other facts, such a lengthy freeze — coupled with the IRS’s failure to seek court approval — might constitute a violation of the automatic stay. But we need not pursue that possibility here because, for the reasons stated in text, no such violation occurred in this case.

Maybe Mr. Waters could have succeeded in arguing for a stay violation had he pushed the issue under subparagraph (a)(7).  Instead, he correctly dropped his arguments about subparagraphs (a)(1) and (5) in the appeal before the Second Circuit.  His arguments on those subparagraphs could go nowhere because both of those subparagraphs needed the IRS to commence an action or proceeding against him or a lien creation.  That did not occur under these facts.

He moved forward arguing that the freeze violated subparagraph (a)(6).  Here the court finds that the freeze did not violate this paragraph saying:

The IRS’s administrative freeze also did not violate Section 362(a)(6) because, on the facts of this case, the freeze did not constitute an act to collect, assess, or recover a claim against Waters. To determine whether a creditor violates Section 362(a)(6), courts routinely look at two standards. Some, including the district court below, evaluate whether a creditor’s conduct was of a nature that “(1) could reasonably be expected to have a significant impact on the debtor’s determination as to whether to repay, and (2) is contrary to what a reasonable person would consider to be fair under the circumstances.”… Applying the first standard, the district court determined that the IRS’s conduct “merely maintained the status quo” and did not constitute an act to collect, assess, or recover a claim. In making this determination, the district court relied on undisputed facts that Waters’s amended tax return claiming refunds for most of the taxes he paid violated a 2002 bankruptcy court order and that the IRS’s freeze was necessary to prevent Waters’s circumvention of that order.

The Court’s decision makes sense and follows the finding in Strumpf.  The fact that Mr. Water’s violated a court order in filing his claim kept him from making something out of the delay by the IRS in seeking resolution of the freeze.  The violation of the order may also have been why the IRS did not feel the need to seek a speedy resolution of the freeze.

Today, the landscape is different.  In 2005 Congress amended the bankruptcy code.  It did not eliminate the automatic stay with respect to offset, leaving subparagraph (a)(7) in the code, but it added a subparagraph to 362(b) the section describing exceptions to the automatic stay.  BC 362(b)(26) now allows the IRS to offset a pre-petition refund against a pre-petition liability if the refund and the liability both result from the same type of tax, e.g., both derive from income taxes or both derive from employment taxes. 

In most cases today, the IRS does not need to freeze refunds because it can offset them.  Only where the refund results from a different type of tax does the IRS need to freeze it and go through the same type of steps it needed to follow prior to the changes to the bankruptcy code in 2005.  Because freezing is now relatively rare rather than routine, the possibility that the IRS would fail to move quickly to resolve the freeze would seem to be greater though I have not noticed cases suggesting that debtors have pursued the IRS for stay violations of this type.

The 2005 change does not allow the IRS to offset a post-petition refund against a pre-petition liability and neither would the Strumpf decision allow a freeze in this context.  So, there are still times where freezing could cause problems for the IRS but those situations occur much less frequently that the ones the 2005 change now permits.

First Circuit Looks at One Day Rule Again

I have written many times about the one day rule adopted by the First Circuit in the case of In re Fahey, 779 F.3d 1 (2015).  You can find earlier posts here and here (discussing the bankruptcy court decision in Kriss) with links in those posts to the many earlier ones.  This rule prevents a debtor from obtaining a discharge of taxes for a tax year if the debtor filed his taxes even one day late.  As I have written on many occasions, the rule makes no sense to me and could not have been what Congress intended.

Kriss v. United States (In re Kriss), No. 21-1206, 2022 WL 17100572 (1st Cir. Nov. 22, 2022) offers the First Circuit the chance to take another look at the issue.  On the brief for Mr. Kriss is John Pottow, a professor at Michigan Law School who has taken up the sword on this issue to try to get the law back on the right path.  Unfortunately, both the facts and prior history of the case prevent the reversal of First Circuit precedent sought in this case.  It did seem to me, however, that the First Circuit acknowledged that it may have gotten the law wrong in Fahey.


Mr. Kriss failed to timely file his 1997 and 2000 tax returns.  The IRS assessed a liability against him for 1997 in March of 2003 using the substitute for return IRC 6020(b) procedures and in September of 2003 did the same for the year 2000.  The IRS began unsuccessful collection efforts.  The opinion states that Mr. Kriss submitted Forms 1040 for the two years in 2007 but does not say what liabilities were reported or, if he reported less than the amount assessed by the IRS using the substitute for return procedure, whether the IRS abated the amount due down to the liability reflected on the late filed Forms 1040.  Some balance due remained after the filing of the Forms 1040.

In 2012 Mr. Kriss filed a chapter 13 petition.  He remained in bankruptcy for the five year life of the plan receiving a discharge in 2017.  The bankruptcy and district courts, no doubt following the decision in Fahey, held that his discharge did not discharge the 1997 and 2000 taxes.

The First Circuit acknowledges that it has decided the issue of discharge in a late filed return; however, it notes that its decision in Fahey involved the taxes owed to Massachusetts and not to the United States.  It acknowledges that unlike Massachusetts, the IRS interprets the statutory provisions differently and considers “many late-filed federal returns to be returns within the meaning of section 523(a)(*).”

This sidesteps the issue Professor Pottow sought to litigate though giving a tip of the cap to those arguments:

Ultimately, we need not decide whether Fahey entirely applies to federal returns just as it applies to Massachusetts returns. Nor need we consider the cogent arguments well marshalled by Kriss on appeal for rethinking Fahey. Rather, even if Fahey does not control, Kriss loses because his much belated filings did not qualify as returns under section 523(a)(*) even under the alternative test put forward by Kriss in the bankruptcy court. See United States v. Lara, 970 F.3d 68, 78 (1st Cir. 2020) (“We need not decide which standard applies in this case, as [appellant’s] challenge fails under either standard.”); United States v. Burgos-Montes, 786 F.3d 92, 105 (1st Cir. 2015).

Mr. Kriss argues that his late filed returns meet the Beard test.  We have discussed that test here.  In essence his arguments seek to push aside any impact of section 523(*) and take the case back to the pre-2005 debate which the amendment to the statute was designed, though poorly written, to eliminate.  He argues that his late filing of the returns coming long after the IRS had already created substitutes for return was an honest and reasonable attempt to satisfy the filing requirement.  This is the argument accepted by the 8th Circuit in In re Colson, 446 F.3d 836 (8th Cir. 2006).  In the courts below he argued for a rejection of the one day rule based on the three circuit court decisions rejecting that rule: In re Justice, 817 F.3d 738 (11th Cir. 2016), In re Giacchi, 856 F.3d 244 (3d Cir. 2017), and In re Smith, 828 F.3d 1094 (9th Cir. 2016), all of which rejected the Colsen objective test.

Mr. Kriss changed his argument because he not only needed a rejection of the one day rule but he needed a rejection of the majority view that after the IRS has prepared a substitute for return it is too late for a debtor to meet the Beard test.  It is unfortunate that the facts of this case did not involve a taxpayer who filed late but before the IRS filed a substitute for return.  That would have presented a clean case for the First Circuit to reconsider its decision in the Fahey case.

The First Circuit rules against Mr. Kriss because the cases he cited rejecting the one day rule also reject granting a discharge in his circumstances and because he did not argue Colson below.  The Colson decision creates a test that is virtually impossible for the IRS to administer.  It sought a change in the statute trying to get a legislative rule that once it had made an assessment based on an unagreed substitute for return, the debtor could not later file a Form 1040 and have that treated as a return.  Instead, the IRS got legislative language that is unclear and has caused problems for the past 17 years.  The IRS has succeeded in convincing almost all courts that the Colson test does not work and is not the proper test.  It has succeeded in convincing the most recent circuits addressing the one day rule that such a rule is an improper interpretation of section 523(*).  It would be nice to have the Supreme Court weigh in on the issue and settle it once and for all in order to eliminate both circuit splits that exist.  Unfortunately, Mr. Kriss did not have the right facts nor make the right arguments below to bring this issue to the Supreme Court. 

The language of the First Circuit stating “nor need we consider the cogent arguments well marshalled by Kriss on appeal for rethinking Fahey,” makes me think that maybe it would reconsider Fahey if presented with the right facts properly argued below.  That would be good.  Even better would be a Supreme Court decision sustaining the position of the Third, Ninth and Eleventh Circuits.

Chapter 11 Confirmation and Lifting of Automatic Stay

In Cochran v. Commissioner, 159 T.C. No. 4 (2022) the Tax Court decided in a precedential opinion that confirmation of a chapter 11 plan of reorganization of an individual does not lift the automatic stay imposed by BC 362(a)(8).  The decision reverses an earlier Tax Court decision issued before a crucial change in the law.  This decision will impact a small minority of individuals.  The situation has a fairly easy work around in most cases but still deserves some attention as a precedential opinion of the Tax court.


Each year debtors file a relatively tiny number of bankruptcy petitions under chapter 11 of the bankruptcy code. For the 12-month period ending Sept. 30, 2022, there were 4,762 chapter 11 bankruptcy filings. In contrast, there were 229,703 chapter 7 filings and and 149,077 chapter 13 filings. Individual chapter 11 filings make up only a fraction of the total number of chapter 11 cases. For the the 12-month period ending June 30, 2020, there were only 464 filings. Of that minuscule number of individual chapter 11 cases only a much smaller number will have a pending Tax Court case.  So, this decision has a limited universe of impacted individuals.

Individuals seeking to reorganize their debts typically file chapter 13 cases because it is easier and cheaper to do so; however, some individual debtors cannot file in chapter 13 because of the amount of debt they owe.  Chapter 13 places dollar limitations on the debtors who can seek relief under its provisions.  The individuals who do not qualify for chapter 13 because of debts in excess of the limits can nonetheless seek reorganization through chapter ll.  That’s what the Cochrans did here.

After filing their chapter 11 petition, the Cochrans took all of the actions necessary to obtain a confirmation of their chapter plan.  At issue in their Tax Court case is the impact of obtaining a confirmed plan.  While I mentioned at the outset that the case involves the automatic stay imposed by BC 362(a)(8), the relevant sections for determining the impact of the plan on this provision of the automatic stay are BC 1141(d)(5) addressing the effect of a chapter 11 confirmation and BC 362(c) addressing the termination of the automatic stay.

Starting with the central Bankruptcy Code section at issue, it’s helpful to understand that BC 362(a)(8) is a bit of an outlier in the list of eight things that the filing of a bankruptcy case brings to a halt.  The automatic stay seeks principally seeks to protect the bankruptcy estate.  Once a debtor files bankruptcy, the debtor has sent up large signal flares that severe financial troubles exist.  it would create havoc if these signals caused creditors to come in an start picking apart the debtor’s assets.  So, the automatic stay generally requires creditors to stand back in order to allow for an orderly disposition of the estate.  Subparagraph (a)(8) was a late legislative addition to the list of stayed actions and has a different tenor than the others.  The principle purpose of (a)(8) was to keep the debtor from abandoning a Tax Court case because of lack of financial concern for the outcome.  The stay gives the trustee time to come in and protect the interest of all creditors by pursuing the case or, alternatively, postponing the Tax Court case so that the outcome is of concern to the post-petition debtor and no other creditors of the estate.

The reason for the existence of the stay, I think, drove the arguments of the petitioner in this case.  The Tax Court describes their argument as follows:

Petitioners also broadly cite Kovitch v. Commissioner, 128 T.C. 108, 112 (2007), People Place Auto Hand Carwash, LLC v. Commissioner, 126 T.C. 359, 363 (2006), and 1983 Western Reserve Oil & Gas Co. v. Commissioner, 95 T.C. 51, 57 (1990), aff’d, 995 F.2d 235 (9th Cir. 1993), for the proposition that an automatic stay under 11 U.S.C. § 362(a)(8) “should not apply unless the Tax Court proceeding possibly would affect the tax liability of the debtor in bankruptcy.”

The Court responded by stating:

These cases are distinguishable on the basis that they were concerned with ascertaining which entities related to a debtor should fall within the scope of 11 U.S.C. § 362(a).

Both the Court and the petitioners are right.  The Court is technically right that it does make a difference whether the debtor is an individual or an entity because the discharge provisions and there for the provisions dealing with the end of the automatic stay differ.  The petitioners are right that the reason for the creation of the automatic stay makes no difference in this case.  Since moving forward with the Tax Court case at this point does nothing to preserve the assets of the case or protect the petitioners as debtors, there is no point to using the automatic stay to keep the Tax Court case from proceeding.  The decision here, however, follows a unbroken line of Tax Court decisions strictly limiting its ability to move forward due to (a)(8) until a technical lifting of the stay occurs even if the stay does nothing to protect the debtor or the estate in the specific context of the case.

So, we have a code section that the Tax Court strictly interprets and one that says Tax Court cases stop when the automatic stay exists.  The parties agree that the automatic stay came into existence with the filing of the bankruptcy petition.  The legal disagreement, aside from the policy disagree discussed above, is the impact of the confirmation of the petitioner’s chapter 11 plan on the automatic stay.  The Tax Court gets the impact precisely right in a relatively short opinion. 

Under the version of the Bankruptcy Code enacted in 1978, the plan confirmation lifted the stay.  That outcome was reflected in the Tax Court’s earlier decision on this issue in Moody v. Commissioner, 95 T.C. 655, 658 (1990).  However, in 2005, during the last major change to the bankruptcy laws, Congress amended the relevant bankruptcy code section regarding the effect of plan confirmation in individual chapter 11 cases because of other changes it made principally regarding discharge.  It amended BC 1141(d)(5) addressing the impact of plan confirmation of the plan of individual debtors.  The provision now says confirmation does not discharge the individual’s debts and that discharge will not occur until some later time.

The amendment to the impact of the confirmed plan has an impact on when the stay comes to an end.  As already mention the stay came into effect with the filing of the bankruptcy petition.  In order to get around the prohibition of BC 362(a)(8), the Tax Court is looking to see if the stay has lifted to allow the case to move forward.  BC 362(c) provides the rules regarding the lifting of the stay and states that the stay is lifted at the earliest of the closing of the bankruptcy case, the dismissal of the bankruptcy case or the granting or denial of a discharge to the debtor. 

With the change to the effect of confirmation in an individual case, the plan confirmation does not impact discharge.  The confirmation of a plan does not close or dismiss the bankruptcy case.  So, nothing had happened in the Cochran’s bankruptcy case to trigger a lifting of the stay and BC 362(a)(8) sits there stopping the Tax Court case from moving forward even though at this point the Tax Court case will have no adverse impact on the bankruptcy.  The decision while technically correct does not serve any real purpose.

Instead of fighting about this with the Tax Court, it should be fairly easy in these type situations to convince the bankruptcy court to enter a specific order lifting the stay to allow the Tax Court case to move forward.  That’s the workaround.

Congress might consider putting more effort into drafting BC 362(a)(8) to define the situations in which the stay applies to the Tax Court in a way that has it apply only when it would be meaningful to do so.  I suspect, aside from the fact there is a relatively easy work around in most cases to this problem, Congress simply feels it has more important things to do.