Objecting to Chapter 11 Plan/Objecting to Judge’s Questions

Quintela Group, LLC v. United States, No. 4:20-cv-03499 (S.D. Tex. 2021) provides insight both into the objection by the IRS to confirmation of a plan of reorganization and the objection by IRS counsel, presumably an assistant U.S. Attorney, to questions posed during the confirmation hearing.  Both objections provide the opportunity for discussion.  We have not previously discussed the situation in which the IRS objects to the confirmation of a chapter 11 plan.

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The district court describes Quintela as a small human resources consulting company.  It provides tests and testing software to guide human resources decisions.  The court states that, though small and in existence only since 2009, it has an impressive client list including several major universities and about 10 Fortune 500 companies.  That does seem impressive but despite landing some big clients, Quintela also landed in chapter 11 due to the accumulation of too much debt, including fairly significant tax debt.

Quintela had about $250K in federal tax liens filed against it in addition to other outstanding debts between $1 and $10 million.  The court says it proposed to pay its priority creditors in full over 5 years.  While the court makes this sound like a major accomplishment, basically putting this language in the plan fulfilled a requirement that would have led to an easily sustainable IRS objection had the debtor not said this.  Since the debtor’s plan met the statutory requirement for repayment in its description of what it promised to do, the IRS objection had to come from the more difficult position of arguing that the debtor could not actually do what it promised to do in the plan.

The IRS argument requires the court to determine the plan’s feasibility.  The debtor put on a witness to explain why the court should believe that it would make the payments it promised to make.  The IRS did not put on a witness but instead relied upon punching holes in the claims made by debtor’s witness.

I will pause here to note that this is very similar to what the IRS does in Tax Court cases – at least the relatively small dollar cases in which I am involved.  My former colleague in the Portland District Counsel Office and former director of the Lewis & Clark low income tax clinic, Jan Pierce, called this the raised eyebrow defense. In many small cases, it’s not cost effective or even feasible for the IRS to find a witness to actually contradict the testimony of the taxpayer.  So, the raised eyebrow defense has its place; however, if you want to attack financial projections it also has its severe limitations which the IRS faced in the Quintela case.

The bankruptcy court generally wants to confirm the plan.  If the plan works, creditors will generally get more money than they would in a liquidation.  If the plan doesn’t work, most creditors are not much worse off than they could have been if the court had denied confirmation.  So, the deck is a bit stacked against any creditor in this situation.  When you add to that natural stacking of the deck the fact that the IRS only used the raised eyebrow defense, stopping confirmation would have been difficult.

So, the bankruptcy court confirmed the plan, the IRS objected to that confirmation, and the district court essentially said the bankruptcy court had enough information to make its decision.  It declined to reverse confirmation, saying:

Having reviewed the record and the bankruptcy court’s thorough explanation of its reasoning, the Court concludes that the bankruptcy court’s finding was not clearly erroneous.

The record shows that Quintela Group sells products for which there is an appreciable demand. Quintela testified at the confirmation hearing that his company had brought in a significant amount of revenue and amassed an impressive clientele during its 11 years in business without conducting any sort of marketing or sales campaign. (Dkt. 8 at pp. 246–47). According to Quintela, Quintela Group counted 10 Fortune 500 companies among its clients, and it averaged between $1 million and $2 million in annual revenue for at least three of the years between 2015 and 2020. (Dkt. 8 at pp. 173, 228, 242–43). In its least successful year, 2020, Quintela Group was still on track to gross $700,000. (Dkt. 8 at p. 242). Quintela further testified that the COVID pandemic’s effect on Quintela Group’s business was starting to abate and that “the projects [Quintela Group] had in the pipeline [before the pandemic were] coming back[.]” (Dkt. 8 at p. 236). Quintela added that 2020 was “pretty unique,” and he projected that his company would “be back to probably at 1.2 million” in annual gross revenue in 2021. (Dkt. 8 at p. 243).

Since the record indicates that a market exists for Quintela Group’s products, the bankruptcy judge, in announcing his findings, focused on additional measures proposed by Quintela Group that would enable the company to tap into that market, promote its products more effectively, and ensure high net profits. The bankruptcy judge specifically mentioned the company’s more “focused marketing plan[,]” which included a contract with SHRM, the largest trade group in the human-resources industry, that would enable Quintela Group to offer its services on SHRM’s website for the first time. (Dkt. 8 at p. 284). The bankruptcy judge noted that the additional measures proposed by Quintela Group would not require substantial capital expenditures and that “management and current employees w[ould] continue to work for” Quintela Group. (Dkt. 8 at p. 284). The bankruptcy judge also discussed Quintela Group’s improved internal policies. Quintela testified that Quintela Group had improved its internal financial controls and accounti ng methods by working with a certified public accountant; the bankruptcy judge highlighted and credited that testimony. (Dkt. 8 at pp. 241, 283 –84).

The bankruptcy court did not clearly err in finding that Quintela Group’s proposed reorganization plan was feasible….

Pretty standard stuff for a review of a factual determination where the court was relying on a clearly erroneous standard.  The appeal of a bankruptcy decision to the district court does not involve the Appellate Section of the Department of Justice and the process of appeal review described in posts here and here concerning the room of lies.  I will be shocked if this case goes to the 5th Circuit.  I will not be shocked if debtor’s plan fails but, if it does, that does not necessarily mean the judge’s crystal ball is broken.

The IRS occasionally appeals plan confirmation but almost always it does so based on a legal failure of the plan and rarely, as here, based on an argument regarding a factual determination.

In addition to the somewhat unusual appeal of the fact-based decision where the IRS argued no contradicting evidence, the government attorney objected to questions asked by the bankruptcy judge.  This deserves quick mention.  Relatively rare circumstances exist where an attorney appropriately objects to a judge’s questions.  This does not seem to fit into those rare circumstances:

The mention of revenue projections during Quintela’s testimony led to an exchange in which the IRS objected to a line of questioning initiated by the bankruptcy judge. At the beginning of the confirmation hearing, the IRS objected to the admission of Quintela Group’s exhibits, including a set of written revenue projections, on the basis that Quintela Group had provided its exhibits to the IRS the day before the hearing instead of two days before the hearing. (Dkt. 8 at pp. 221–22).2 The basis for the IRS’s objection — untimely disclosure — seems a bit questionable as to Quintela Group’s written financial projections, considering that the IRS itself had extensively analyzed those same projections in a filing of its own two weeks before the hearing. (Dkt. 8 at pp. 55 –63). See Southern District of Texas bankruptcy case number 20-32577 at docket entries 53 and 61. In any event, the bankruptcy judge sustained the IRS’s objection but explained that he would give Quintela Group “an opportunity to prove [its exhibits] up.” (Dkt. 8 at pp. 221–22). When the bankruptcy judge later asked Quintela some general questions about there liability of Quintela Group’s revenue projections, the IRS objected to the bankruptcy judge’s line of questioning on the basis that it “[a]ssume[d] facts not in evidence” because “[t]he numbers in the projections [we]re not in evidence[.]” (Dkt. 8 at 241–42). The bankruptcy judge overruled the objection:

I’m overruling. I’m asking where the numbers came from. What facts did he have? What facts can be in evidence? Just asking where they came from. He can answer that.

I would be curious to learn from readers those circumstances in which they benefited from objecting to a question asked from the bench.  You know the court will overrule the objection.  The only hope is using the questions as a basis for appeal.  That did not work here.

District Court Reverses Outlying Bankruptcy Court Decision Regarding Discharge of Taxes Following SFR Assessment

The case of IRS, et al v. Starling, No. 7:20-cv-07478 (S.D.N.Y. 2021) reverses the bankruptcy case discussed here.  The bankruptcy court followed the authority created in the 8th Circuit almost two decades ago.  The 8th Circuit’s position is distinctly in the minority regarding how to treat a taxpayer who fails to timely file a return prior to the time the IRS makes a substitute for return assessment (SFR).  By adopting the 8th Circuit’s position regarding late filed returns, the bankruptcy court found that Mr. Starling discharged his taxes and that the IRS violated the discharge injunction by pursuing collection against him after the granting of the discharge.  The decision of the district court realigns the outcome with the majority of courts that have looked at the issue.  A significant split of authority continues to exist crying out for a legislative or judicial resolution.

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Mr. Starling didn’t file his 2002 return.  The IRS followed the substitute for return procedures including a preliminary letter and a notice of deficiency.  He did nothing in response to these letters allowing the IRS to assess the taxes it determined due through the substitute for return procedures.  After the assessment, Mr. Starling submitted a return prepared by him which reflected the same amount of tax as the IRS assessed based on the notice of deficiency.  This fact made his case almost identical to the facts in the Hindenlang case that started this issue almost a quarter century ago. 

Waiting until after the IRS has gone through the notice of deficiency procedure and made the assessment based on a defaulted notice has caused every taxpayer except Mr. Colsen in the 8th Circuit to lose the discharge argument for one reason or another.  The bankruptcy court’s decision surprised me.  The government appealed as I predicted in the prior post.  The outcome here does not surprise me.  Perhaps Mr. Starling will appeal to the 2nd Circuit which does not have circuit decisional law on this issue.  If he does appeal, I expect that he will lose but whether he loses or wins he will create a conflict with one circuit or another.  Perhaps this could be that case that after a quarter of century resolves the issue of when it becomes too late to file a return and still reap the benefit of a discharge.

The district court decision highlights the continued uncertainty which puts the IRS and state taxing authorities in a tough spot.  They must create protocols for discharging taxes.  The IRS has created a protocol that it will not discharge a tax if the taxpayer files the return after the IRS has assessed the liability using the substitute for return procedures (except it cannot safely use that protocol in the 8th Circuit.)  When the bankruptcy court disagreed with the majority of cases reviewing this issue, it then found that the IRS had violated the discharge injunction and imposed sanctions.  The IRS does not want to get sanctioned and it does not want a discharge standard that has too many variables and unknowns.  I am sure it will continue to appeal any adverse decisions similar to Starling.  Its failure to take the Colsen case to the Supreme Court many years ago has proved to have been a mistake.  The IRS believed it could fix the problem created by Colsen with legislation; however, the legislation passed in 2005 has just made the situation more complicated as discussed in the many prior blog posts on this issue.

The additional party in the Starling case was the private debt collection company used by the IRS.  That company essentially violated the discharge injunction as an agent of the IRS.  With the decision that bankruptcy did not discharge this debt, the private debt collection company gets off the hook the same as the IRS.

The district court does a nice job of consolidating the cases decided on this issue and describing the failed legislative fix.  It notes that the bankruptcy court’s decision in Starling goes even further than the 8th Circuit did in Colsen:

But even the Eighth Circuit is unlikely to have regarded Debtor here as having made an honest and reasonable effort. First, there is serious doubt that Colsen‘s reasoning survives the addition of BAPCPA’s hanging paragraph, and at least one bankruptcy court within the Eighth Circuit has instead adopted the one-day-late test. See Kline v. Internal Revenue Serv. (In re Kline), 581 B.R. 597, 604 (Bankr. W.D. Ark. 2018). Second, while Colsen held that “the honesty and genuineness of the filer’s attempt to satisfy the tax laws should be determined from the face of the form itself, not from the filer’s delinquency or the reasons for it,” Colsen, 446 F.3d at 840, the court also noted that the late-filed form in that instance provided the IRS with new information that assisted the agency in determining the taxpayer’s ultimate tax liability, id. at 841. The Eighth Circuit distinguished the facts before it from those in Hindenlang, “where the taxpayer’s forms contained essentially the same information as the substitute forms that the IRS prepared and the calculation of tax did not change substantially.” Id. (citing Hindenlang, 164 F.3d at 1031.) Unlike in Colsen, Starling’s late-filed Form 1040 appears to have simply reiterated the tax assessment the IRS had already performed, and although this effort may have been an “honest” attempt to satisfy his obligations under the tax law, it was hardly “reasonable” to ignore multiple notices and only file years late with the same number the IRS had already come up with on its own. While I do not believe that the Colsen test is the appropriate one to apply here, especially in the wake of BAPCPA, Debtor fails to meet even that most lenient standard for avoiding § 523(a)’s discharge exception.

The statute of limitations on collection has apparently run on Mr. Starling’s debt.  So, the discharge aspect of this case no longer matters to him.  I don’t know if the contempt fees would sufficiently fuel an effort to go to the 2nd Circuit but maybe someone wants another circuit court decision on this issue and another shot at the Supreme Court.  This case breaks no new ground, and puts Colsen back in the 8th Circuit only.  The IRS continues to argue that any document filed after the assessment is automatically not a return.  To date, the IRS has not gotten one court to buy this argument.   In Briggs v. United States (In re Briggs), No. 15-2427-MHC at p.8 (N.D. Ga., June 7, 2017) (government admitted at oral argument that no court of appeals had adopted the per se argument).  The IRS has won every case but one when it argues that the document filed after the SFR assessment was not a return.  So, it has a de facto, if not a de jure, rule.

The facts in Briggs offer a good argument for the non per se rule but the IRS will continue to push for a per se rule because that’s what it needs in order to comfortably administer a provision, the discharge rule, that has significant adverse consequences when the creditor gets it wrong.  Because of their desire for a clear rule, taxing authorities would benefit from a visit to the Supreme Court in order to seek an administrable rule they can follow without fear even if the rule is not as favorable to them as the current situation.  Debtors might prefer the current state of affairs unless they live in the 1st, 5th or 10th Circuits where the current rules create a crushing situation for them.  We’ll see if Starling is the case that brings the issue to a head.

BC 507(a)(8)(C) Priority Prevents Discharge under BC 523(a)(1)(A)

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.

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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.

Splitting the Refund When One Spouse Files Bankruptcy

Three individuals who have all provided guest blogs for PT have co-authored a new ABA Tax Section Publication that could be important for those interested in tax controversy work:  Litigating a Case in Tax Court by Sean Murphy Akins, Kandyce Lyndsey Korotky, and David M. Sams.  Designed to cover every aspect of a United States Tax Court case from start to finish, Litigating a Case in Tax Court provides detailed guidance and tips on the Tax Court process in an easy-to-read and easy-to-use paper format with an online portal for accessing many sample documents that practitioners can use.  If you are interested in the book, you can find information about ordering it here.  This is one of several books published by the ABA Tax Section on a tax procedure topic.

The case of In re Culp, No. 20-52558 (Bankr. E.D. Mich. 2021) resolves a fight between the debtor and the trustee of his chapter 7 case over who receives his 2018 refund.  The court decides that the trustee will get to keep the entire refund, applying one of the four tests that bankruptcy courts have developed for this situation.  The result follows the majority rule and follows the result that would attach outside bankruptcy in an injured spouse situation if one spouse had debts subject to offset.  I agree with the outcome but the various possibilities depending on where a bankruptcy petition is filed suggest that the issue should be resolved to reach a uniform application of the law.

I have written about bankruptcy and refunds previously here and here.  We have recently had articles about bankruptcy and offset, here and here.  In this case, the Culps were apparently up to date on the tax liabilities and offset did not become an issue.

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Mr. Culp filed bankruptcy but his wife did not.  Although they did not file a joint bankruptcy petition, an election similar to filing a joint return, they did elect to file a joint 2018 return.  The 2018 return requested a refund of $13,825 which had not been paid as of the date of the filing of Mr. Culp’s bankruptcy petition on December 23, 2020.  The court does not explain why a 2018 refund was still unpaid so long after the due date.  It does say that the IRS paid $590.00 of interest on the refund, indicating that the return was probably filed on time, and something held it up in processing.  The delay in processing the return, whatever the reason, works to the Culps’ distinct disadvantage here.

When the IRS did issue the refund check on April 15, 2021, it knew of the bankruptcy case and sent the check to the trustee who, I am sure, gratefully received it since now the trustee had an asset case and was assured of getting more money out of this case than the ordinary no asset chapter 7 case.  The trustee moved to include the entire refund check as property of the bankruptcy estate.  Mr. Culp opposed the motion, arguing that the check should be split 50-50 between him and his wife with whom he filed the joint return.

In 2018, Mr. Culp worked and earned all the income reported on the return.  He had also paid all of the withholding generating the refund.

The court notes that bankruptcy courts have split four ways in their treatment of refunds issued in situations in which only one spouse has filed a bankruptcy petition.  It cites to the case of In re McInerney, 609 B.R. 497, 503 (Bankr. N.D. Ill. 2019) as describing and discussing in detail all the approaches that bankruptcy courts have taken on this issue.  The four approaches are:

  1. The 50/50 Rule: to allocate a joint tax refund equally between the spouses, regardless of tax withheld, income produced, or credits applied. A presumption of equal contribution and thus equal ownership is applied to find that a joint tax refund, as marital property, should be equitably distributed. This follows from the imposition of joint liability for any tax deficiency resulting from the filing of a joint tax return. This approach represents the minority approach in U.S. courts.
  2. The Income Rule: to divide joint tax refunds proportionally according to the income generated by each spouse. This rule is based on the principle that income tax liability arises from the receipt of income but has little support because income does not directly correlate to amounts withheld. This rule has thus been effectively superseded by the Withholding Rule, below.
  3. The Withholding Rule: to allocate the refund between spouses in proportion to their respective tax withholdings during the relevant tax year. This rule is based on the premise that the filing of a joint tax return does not alter the property rights of the spouses, and that each spouse has a separate legal interest in any overpayment of tax made by them on their own respective income. This is the majority rule in U.S. courts.
  4. The Separate Filings Rule: to apportion the refund based on a determination of what each spouse’s contributions and tax liabilities would have been if the spouses had filed separately, and to apply that proportion to the joint tax refund resulting from filing a joint return. This method is based on Revenue Ruling 74-611, in which the IRS ruled that when a joint return is filed, each spouse has a separate interest both in the reported income and in any overpayment. This approach considers each spouse’s withholdings, estimated tax payments, income, and contributions as a whole.

As mentioned above, the debtor argued for the 50/50 split since that would preserve the largest refund from the trustee’s clutches.  The trustee chose the withholding approach since that would bring the largest amount into the estate.

Interestingly, the bankruptcy judge deciding this case had split on the issue himself in prior opinions.  He had an opinion from 2008 using the 50/50 approach and one from 2013 using the withholding approach.  He benefited from the nice discussion in McInerney.  He decides here that the withholding approach, which has become the majority approach among bankruptcy judges, applies.

Because the treatment in the withholding approach tracks tax law principles, it makes the most sense to me.  Here, it works to debtor’s disadvantage, but it could work to the debtor’s advantage or be relatively neutral in another case.  Having the bankruptcy outcome parallel the tax outcome seems the most appropriate, even though the combination of this approach and the IRS’s delayed issuance of the refund hurts the Culps here.

Because the refund was sizable, it makes you wonder if earlier receipt of the refund might have staved off the bankruptcy filing.  It’s also impossible, at least without digging into the bankruptcy case, to know which creditors are the winners and losers as a result of the late refund – assuming that the Culps would have used the refund to pay creditors.  The clear winner here is the trustee who will get to take a fee out of the refund.

Tolling the Statute of Limitations by Filing Bankruptcy

The case of Lufkin v. Commissioner, T.C. Memo 2021-71, puts the Tax Court in a position to rule on the impact of filing bankruptcy on the statute of limitations.  The taxpayers raise arguments not only regarding the collection statute of limitations but also the validity of the underlying assessment, which gives me the opportunity to discuss the impact of bankruptcy on the collection statute, which is significant, and on assessment, which after 1994 is rather small.  Bryan Camp wrote about the case as part of his Lessons from the Tax Court series which alerted me to the decision.  He provides some general background on bankruptcy which may also be helpful.

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The important IRC sections when working out these statute of limitations issues are (1) §6501(a) which provides the general three year time period for assessment after the return filing date; (2) §6502(a) which provides the general rule that the IRS has 10 years to collect after assessment: and (3) §6503(h) which “suspend[s] [the period of limitations] for the period during which the Secretary is prohibited by reason of such case [a bankruptcy case and the automatic stay] from making the assessment or from collecting and—(1) for assessment, 60 days thereafter, and (2) for collection, 6 months thereafter.” 

Assessment

Before 1994, the tolling in 6503(h) created a significant issue.  BC 362(a)(6) prohibits assessment during the period that the automatic stay is in effect.  A literal reading of this provision prohibits the IRS from assessing a self-reported tax on a return which would also prohibit the IRS from issuing refunds to debtors in bankruptcy while the automatic stay remained in effect.  This could prevent a debtor in a chapter 13 case from receiving a refund for five years absent a court order lifting the stay.  The language of BC 362(a)(6) provides an example of legislation that fails to consider the functional role of assessment.

For the 16 years from the passage of the Bankruptcy Code in 1978 until the change to 362(b) in 1994, the IRS arguably violated the automatic stay millions of times because it decided that Congress could not have intended to keep it from assessing returns where an overpayment existed.  So, it made the assessment of tax shown on the return and refunded to the taxpayer the overpayment resulting from the excess credits.  After almost two decades, the IRS, with significant assistance from the Tax Division of the Department of Justice, which had contacts in the Judiciary Committee, persuaded Congress to allow it to assess.  Congress did not, however, remove the restriction on assessment from 362(a)(6).  It still exists.  Instead, it neutered it by expanding the exception to the stay in 362(b)(9).

There exists one remaining area in which bankruptcy can suspend the statute of limitations on assessment.  It results from BC 362(a)(8), which prohibits taxpayers from commencing or continuing a Tax Court proceeding while the stay is in effect.  This provision can suspend the statute of limitations on assessment if the taxpayer has received a notice of deficiency and files a bankruptcy petition prior to the 90th day and prior to filing a Tax Court petition.  In this situation, the combination of the prohibition on filing the Tax Court petition, which suspends the 90-day period for timely filing a Tax Court petition, and the suspension of the statute of limitations on assessment caused by the notice of deficiency suspends the statute of limitations on assessment.  The suspension could be lengthy.  This suspension can also easily cause confusion since it operates through the intermediary of the notice of deficiency suspension.

For bankruptcy petitions filed after October 20, 1994, when the amendments to the bankruptcy statute occurred, the only way the automatic stay suspends the statute of limitations on assessment is through this two-step procedure triggered by the notice of deficiency.

Collection

The suspension of the statute of limitations on collection operates in a much more straightforward manner.  BC 362(a)(6) stays collection of pre-petition liabilities as well as assessment.  This prohibition on collection triggers the suspension of the statute of limitations on collection and lasts for the period during which the automatic stay exists plus, pursuant to IRC 6503(h), an additional six months.  To calculate the impact of the stay on collection, you must know when the stay begins and when it ends.  The beginning part is easy.  The stay begins the moment the debtor files the bankruptcy petition.  The ending of the stay creates more challenges.  It depends on the type of bankruptcy.  Generally, the stay will come to an end when the debtor receives a discharge or when the bankruptcy case comes to an end.  This could be several years in a chapter 13 case with a five-year plan.  Some debtors, like the Lufkins, file multiple bankruptcy cases, which can make the calculation trickier.

Before getting to the facts of the case, note that the docket here was interesting and different from the typical pro se case.  This was Mr. Lufkin’s second Tax Court CDP case.  He filed one in 2013 which he settled on a basis not available to see on the electronic Tax Court docket sheet.  He filed the current case in 2017.  In both cases, he took the offensive, filing his own motions for summary judgment and for other reasons.  Unlike his first case, which resulted in a settlement of some type, in this case, he went to trial.  The trial occurred before Judge Ruwe in June of 2019; however, Judge Ruwe retired in November 2020 before rendering an opinion.  So, the case was reassigned to Judge Greaves.

The taxes at issue in this case were employment taxes filed on Form 941.  Mr. Lufkin is a lawyer and the taxes arose from his law practice for the third and fourth quarters of 1998.  With taxes that old, which were assessed in 1998 and 1999, it’s easy to understand why Mr. Lufkin would argue that the statute of limitations had expired.  He also argued that he was not liable for these taxes.

Applying the assessment and collection statute suspensions to the Lufkin’s facts, Judge Greaves found that because Mr. Lufkin filed multiple bankruptcy petitions between 2000 and 2011, the statute of limitations on collection was suspended for a sufficiently long period to allow it to remain open when the IRS issued the notice of intent to levy.  Since Mr. Lufkin responded to that notice by requesting a Collection Due Process (CDP) hearing, he further suspended the statute of limitations on collection.

Mr. Lufkin made two arguments in the CDP hearing.  First, he argued that he was not liable for the taxes because another entity had assumed the debt.  The court does not spend much time with this argument and it shouldn’t.  Even if another entity assumed the debt, it would not relieve Mr. Lufkin of his liability for the debt.  Since he offered no evidence on this issue, the decision was easy.  It’s worth noting that the court did allow him to raise the merits of his employment tax liability since it would have been assessed without the issuance of a notice of deficiency.  The court did not perform any analysis regarding his ability to raise the merits.  So, I assume that the IRS did not object to the procedural issue of his raising this debt.

With respect to the statute of limitations argument, the court notes that its precedent regarding review of this type of challenge is ambiguous.  This might be considered a merits challenge in which the court would review the evidence de novo or it might be considered something the court reviews on an abuse of discretion standard.  Because the court finds it does not matter here which standard applies, it does not stop to sort out the correct answer.

The court does not perform an analysis of the impact of each of Mr. Lufkin’s bankruptcy petitions during the 11-year period between the assessment and the notice of intent to levy but states “even under a conservative calculation, more than 10 years had not elapsed” on the statute.  Probably, the IRS brief performed the analysis based on each bankruptcy petition.  It’s easy to believe that the court was correct if there were multiple petitions and this is one downside of going into bankruptcy repeatedly, since each filing triggers, at a minimum, a six-month extension of the statute of limitations on collection, even if the stay in bankruptcy is quite short.

In addition to challenging the statute of limitations, Mr. Lufkin challenged the verification by Appeals.  He argued that they had destroyed records regarding the assessment and this “amounted to a violation of procedural due process under the Thirteenth Amendment to the Constitution.”  For those of you who specialize in tax and not constitutional law, the Thirteenth Amendment abolished slavery and involuntary servitude.  It will not surprise you to learn that this argument failed with the court, which stated that Mr. Lufkin had failed to establish a nexus between the Thirteenth Amendment and his tax case.

As Bryan mentions in his post, the primary lesson here regards the impact of filing bankruptcy petitions on the statute of limitations.  Several actions can suspend the statute of limitations on collection.  I wrote recently that the IRS is having trouble correctly calculating the statute of limitations on collection primarily related to installment agreements.  Here, the IRS has plenty of cushion and easily turns back an argument based on the limitations period.

Jurisdiction of Bankruptcy Courts to Hear Innocent Spouse Cases

The case of In re Bowman, No. 20-11512 (E.D. La. 2021) denies debtor’s motion for summary judgement that Ms. Bowman deserves innocent spouse relief.  On its own, the court reviews the issue of its jurisdiction to hear an innocent spouse issue as part of her chapter 13 bankruptcy case and decides that it has jurisdiction to make such a decision.  The parties did not raise the jurisdiction issue, which is not surprising from the perspective of the plaintiff but may signal a shift in the government’s position since it had previously opposed the jurisdiction of courts, other than the Tax Court, to hear innocent spouse cases.

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The court addresses the issue of its jurisdiction at the outset of the opinion.  It first cites 28 U.S.C. § 1334 and the Order of Reference from the district court before stating that this is a core proceeding.  This part of the opinion addresses the basic issue of bankruptcy courts’ jurisdiction in all issues, stemming from the litigation in the Marathon Oil case from 40 years ago (challenging the basic authority of bankruptcy courts under the then-newly-created bankruptcy code).

Moving past the bankruptcy court’s basic basis for jurisdiction, the court hones in on its ability to hear an innocent spouse case.  It first states:

Although it is true that “Section 6015(f) does not allow a bankruptcy court to exercise initial subject matter jurisdiction over an innocent spouse defense because only the Secretary [of the IRS] receives the equitable power to grant innocent spouse relief under that Section,” here, it is undisputed that the Debtor sought such relief from the Secretary in July 2019 and the Secretary denied the request.  

This aspect of jurisdiction would apply to any court hearing an innocent spouse case.  In essence, the statute requires a taxpayer claiming this relief to exhaust their administrative remedies before seeking to have a court determine relief.

Next, the court turns to its specific ability to hear an innocent spouse case and cites heavily from an earlier case from Texas:

Section 6015(e)(1) states that, in a case where an individual requests equitable relief under Section 6015(f), “[i]n addition to any other remedy by law, the individual may petition the Tax Court to determine the appropriate relief available to the individual under this section . . . .” 26 U.S.C. § 6015(e)(1)(A). It is unambiguous that a Tax Court—and not just the Secretary—may grant relief to an individual. Moreover, the remedy available in the Tax Court is “[i]n addition to any other remedy provided by law.” 26 U.S.C. § 6015(e)(1)(A).

11 U.S.C. § 505 is another “remedy provided by law.” Section 505(a)(1) specifically provides bankruptcy courts with remedial power over tax liabilities and penalties . . . . This statutory language provides a bankruptcy court with the power to determine the legality of taxes and tax penalties.

Pendergraft v. United States Dep’t of the Treasury IRS (In re Pendergraft), 119 A.F.T.R.2d (RIA) 2017-1229 (Bankr. S.D. Tex. Mar. 22, 2017)

Because it determines that the tax liability directly impacts the administration of the bankruptcy case and because the IRS has filed a proof of claim seeking to have Ms. Bowman pay the liability for which she seeks relief, the court finds that it has jurisdiction while also noting that the IRS has not objected to its jurisdiction.

The opinion is important for being only the second court to deal with the issue of whether a bankruptcy court has jurisdiction to decide § 6015 relief.  The court says that it does have such jurisdiction because 6015(e)(1)(A) (giving the Tax Court jurisdiction) is only “in addition to any other remedy provided by law” and that the bankruptcy court is another such remedy.  The court cites the Pendergraft case, which is the only other opinion from a bankruptcy court on this matter.  The court conveniently doesn’t mention all the district court opinions holding that 6015 relief jurisdiction does not exist in collection suits or (in one opinion) in refund suits, but resides only in the Tax Court.

The last district court case to render an opinion on this issue was Hockin v. United States, 400 F. Supp. 3d 1085 (D. Or. 2019).  We blogged on the Hockin case here.  In Hockin, the district court rejected earlier district court opinions and found it had jurisdiction to hear an innocent spouse case.  The case never went to trial because the parties settled.  The issue highlighted differences in the Tax Division of the Department of Justice where the trial sections argued that the district courts lacked jurisdiction while the appellate section simultaneously argued that they had jurisdiction and used that argument as a basis for dismissing innocent spouse cases filed late in the Tax Court as having missed a jurisdictional deadline.  The Tax Clinic at Harvard filed an amicus brief in Hockin pointing out the dissonance in the positions taken within DOJ, and the court noted the conflicting positions.

Perhaps the failure to raise jurisdiction as an issue in Bowman means that DOJ has abandoned the issue that only the Tax Court has jurisdiction to hear innocent spouse cases, or perhaps a split now exists within the trial sections at DOJ.  Another possibility is that DOJ distinguishes between district court and bankruptcy court cases raising this issue.  In its motion to dismiss in the Hockin case, DOJ stated:

The language of Section 6015(e)(3) explicitly strips the Tax Court of jurisdiction once a refund suit is filed in district court, which avoids parallel proceedings. But another court explicitly rejected Boynton. In re Pendergraft, 16-33506, 2017 WL 1091935, at *3 (S.D. Tex. B.R. Mar. 22, 2017). That court held that it could consider an innocent spouse defense as part of a bankruptcy court’s powers to determine the amount or legality of a tax under 11 U.S.C. § 505. The court was unconcerned with the possibility of inconsistent judgments, finding that jurisdiction cannot be “based on a hypothetical possibility that concurrent proceedings could produce inconsistent results. That issue, if it ever exists, should be left to Congress.” Id.

Pendergraft is an outlier decision, and it ignores Boynton’s most convincing point: if Congress intended to provide two equally accessible lanes for a taxpayer to seek review of an innocent spouse determination, why does Section 6015(e)(3) treat the process as a one-way street? The Tax Court is clearly divested of jurisdiction when a refund suit is filed in district court, yet the statute is silent on the reverse scenario. Section 6015 sets out a clear, detailed process for funneling review of innocent spouse determinations to the Tax Court. That statute provides no such scheme for the district courts.

DOJ did not try to distinguish Pendergraft because bankruptcy is different.  In Pendergraft, the DOJ argued that the availability of a Tax Court 6015 action precluded 6015 relief under BC 505. The Pendergraft opinion provides a lengthy response disagreeing with the DOJ and its citations — but one that does, in part, rely on the purpose of BC 505.  Section 505 grants jurisdiction to bankruptcy courts to resolve tax merits issues.  The Pendergraft court says that BC 505 is a remedy encompassed by the “in addition to any other remedy provided by law” clause in 6015(e)(1)(A).

Going past the jurisdictional issue, the court in Bowman declined petitioner’s invitation to grant her relief based on summary judgment.  Here is her motion and here is the DOJ response.  She sought relief under 6015(f) but did not submit an affidavit or much other information related to the factors that the IRS has established as required for relief in Rev. Proc. 2013-34.  The court found that insufficient evidence was presented to allow it to grant relief at this stage.  Of course, she can still succeed if she puts on adequate evidence at trial.  At least, based on the court’s finding of jurisdiction, she will have that opportunity.

Offsetting Stimulus Payments Due to a Taxpayer in Bankruptcy

The case of Lockhart v. CSEA, et al, No. 1:20-ap-00038 shows another facet of the offsetting of last year’s stimulus payments.  In this case the taxpayer owed past due child support, which was the one type of debt to which the stimulus payments could be offset; however, he argues that the offset in his situation violated the automatic stay of his bankruptcy case as well as the terms of the confirmed chapter 13 plan.  Though the court tosses certain claims, it leaves open the possibility that the offset of the refund violates the terms of the plan of reorganization.

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Before looking at the issues the court addressed regarding the offset, a couple issues deserve mention.  First, the offset took both the refund of Mr. Lockhart and his current spouse and applied it to his past due child support.  This issue was discussed in several posts last year collected here.  The court simply sends her to file an injured spouse form.  I am a little surprised the IRS did not just fix the problem without the need for that form.

Second, the IRS should not be a party to this case.  It gave Mr. Lockhart what he requested – the stimulus payment.  The IRS did not refuse to give him the payment or make the offset.  The offset occurred at the Bureau of Fiscal Services.  It seems to me that would be the appropriate focus of any wrong activity at the federal level and not the IRS.  Maybe it doesn’t really matter, but by focusing on the IRS, Mr. Lockhart, and perhaps the court, focus on the wrong point in time.  This is a common mistake for taxpayers subject to offset.  They often see the IRS as the source of their problem, but when the offset goes to an agency outside of the IRS, the offset occurs once the funds have been approved by the IRS.

The first issue the bankruptcy court addresses is sovereign immunity.  Both the IRS and the state agency assert sovereign immunity in seeking dismissal of the action.  I was surprised by the IRS arguments regarding sovereign immunity as described by the bankruptcy court.  The court found that B.C. 106 waived sovereign immunity in matters of this type.  That decision seems consistent to me with the determinations regarding sovereign immunity that have developed over the last quarter century since the bankruptcy code was amended; however, I have not looked at the brief filed by the IRS and perhaps there is a nuance I am missing.  The court essentially lumped the state and federal sovereign claims together and found a waiver as to both.  The fact that sovereign immunity was waived does not win the case for the debtor, but it does allow the case to move forward.

The debtor seeks to hold the parties in contempt for taking the stimulus payment and applying it to the past due child support because he confirmed a plan that provided he would pay out the almost $20,000 of past due child support during the life of the plan. The state child support agency countered that it was not bound by the confirmation order, an argument I assume is grounded in the failure to include it as a named creditor, and that the stimulus payment was not property of the estate, an argument that would be grounded in the language of the chapter 13 plan itself. A common provision of chapter 13 plans revests all property in the debtor upon confirmation in return for the promise to pay.

The court refuses to hold anyone in contempt, stating that more facts are needed, especially since neither the IRS nor the state agency were served with the bankruptcy petition.  It also makes an interesting note that the debtor does not appear to be performing under the plan.  If the debtor is not actually making their plan payments which will resolve the child support issue or if the debtor is running up additional child support obligations post-petition, that could put the offset in a different light.

With respect to the automatic stay, the state child support agency asserted a defense based on one of the exceptions to the automatic stay, B.C. 362(b)(2)(F).  The automatic stay creates a stay of eight actions specified in B.C. 362(a), one of which is collection by a creditor of a pre-petition debt and another of which is offset.  In a chapter 13 case, the automatic stay lasts from the moment of filing the petition until the end of the case, which could be five years later.  The bankruptcy code, however, in B.C. 362(b) contains a list of 29 exceptions to the automatic stay. 

If a creditor fits under one of the 29 exceptions, it can take the collection action even though such action is barred by the provisions of B.C. 362(a).  I am most familiar with the exceptions that apply to taxes, most of which are found in B.C. 362(b)(9), and I was not familiar with B.C. 362(b)(2)(F).  It excepts “the interception of a tax refund, as specified in sections 464 and 466(a)(3) of the Social Security Act or under an analogous State law.”  Here, the debtor argued that the stimulus payment was not a tax refund but rather a credit.  The bankruptcy court sided with the government arguments that the stimulus payment is a tax refund.  This decision could have implications beyond bankruptcy cases but given the language of the application exception to the automatic stay provides sufficient cover for the action from the perspective of fending off a stay violation argument.

This case provides no remarkable revelations but does examine the taking of the stimulus payment under the only offset provision available.  If the debtor is not keeping current on his chapter 13 plan, he may face a difficult task in getting the return of the stimulus payment or a contempt charge against the state agency.  If the federal government did not know of the bankruptcy, it’s hard to fault it for making an offset where the state left a marker on the Treasury Offset Program database.  Removing the marker upon the filing of bankruptcy should fall on the state agency that knew of the bankruptcy, and not the TOP program.

The Fourth Circuit and the Primacy of Refund Offsets in Bankruptcy

We welcome guest blogger Michelle Drumbl. Professor Drumbl runs the tax clinic at Washington & Lee Law School and teaches tax there as well. She started as a clinician at almost the same time I did, and it has been a pleasure to work with her over the years. Starting later this summer she will take on the role of acting dean at the law school which is quite a testament to her abilities. She is also the author of a relatively recently published book, Tax Credits for the Working Poor – A Call for Reform, quite a timely book given the recent boost in refundable tax credits authorized by Congress. She is also the co-author of the Examinations chapter of the 8th Edition of Effectively Representing Your Client Before the IRS. Today she writes on a recent 4th Circuit decision at the intersection of tax and bankruptcy and brings to our attention a forthcoming article she has written on the same intersection triggered by another 4th Circuit decision that came out last year. If you want a more in depth discussion of offset you can look at the article written by Michael Waalkes and me which will be published later this year in the Florida Tax Review. Keith

Income tax refund offsets have been a hot topic on Procedurally Taxing, especially of late. While there has been interest in offset bypass refunds and injured spouse relief since long before the pandemic, the CARES Act added some new wrinkles. As has been well documented on this blog, Economic Impact Payments generally were not subject to offset, with some limited exceptions such as past due child support. Offset questions came up again in the context of the Recovery Rebate Credit.

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As we followed the legislative and administrative changes and implementation, it sparked conversations about how and when the IRS should exercise its discretionary refund offset authority under section 6402. Nina Olson revitalized a proposal that she had made prior to the pandemic, urging the IRS to be more proactive in granting offset relief in cases of economic hardship. Along similar lines, the ABA Section of Taxation recommended that the IRS implement systemic offset bypass relief for three categories of taxpayers during the pandemic.

Meanwhile, the Fourth Circuit has also had occasion to think about section 6402 in the last year, not in the context of COVID or offset bypass refunds, but in the context of bankruptcy. Two recent decisions from the circuit underscore how powerful a collection tool section 6402 remains for the IRS, leaving no ambiguity as to where the circuit stands on a question that has divided lower courts.

Keith blogged about the first decision, Copley v. United States, 959 F.3d 118 (4th Cir. 2020). Anticipating an income tax refund for tax year 2013, the Copleys listed the refund as a homestead exemption on their bankruptcy schedule prior to filing their income tax return. The Copleys had outstanding federal income tax liabilities for tax years 2008, 2009, and 2010; the tax debt for 2008 and 2009 was dischargeable in bankruptcy, while the debt for 2010 was nondischargeable. Despite the Copleys’ exemption claim, the IRS used its discretionary authority under IRC 6402(a) to offset the refund, applying it to tax years 2008 and 2009. Of course, applying it to the dischargeable tax debt was in the best interest of the IRS while also the worst possible economic outcome for the Copleys: if the homestead exemption did not entitle them to keep the refund for their fresh start, presumably they would prefer that it be applied to reduce the nondischargeable tax debt.

The Copleys brought an adversary proceeding in bankruptcy court seeking turnover of their tax refund, asserting that they had properly claimed it as exempt under Virginia’s homestead exemption provision as allowed by BC 522. Ultimately the matter was decided by the Fourth Circuit, which held that the refund became part of the Copleys’ bankruptcy estate, but that BC 553(a) preserves the IRS’s right of offset notwithstanding the Copleys’ exemption rights under BC 522(c). I wrote a forthcoming article about Copley in which I traced the case law split on this issue and discussed the significance of the Fourth Circuit’s holding.

The lower court case law is mixed and at times confusing, in part because it includes cases in which the IRS offset tax refunds to tax debt and also cases in which the Treasury made TOP offsets to nontax debt. The Bankruptcy Code’s automatic stay rule generally prohibits offset against prepetition debts; however, in 2005, Congress enacted BC 362(b)(26),  an exception that allows the IRS to offset a prepetition income tax refund against a prepetition income tax liability. As Keith has discussed, this exception does not extend to TOP offsets – the automatic stay limits the government’s right to offset a tax refund against a nontax debt.

Copley is the first circuit court opinion to resolve the tension between BC 522 and 553 while also finding the tax refund was part of the bankruptcy estate. In the conclusion of my article, I queried whether courts might limit the Copley holding to offsets of tax refunds against tax debts, as distinguished from offsets of tax refunds against nontax debts. Last month, while the article was still in the editing stages with the South Carolina Law Review, the Fourth Circuit provided an answer.

In Wood v. U.S. Department of Housing &  Urban Development, 993 F. 3d 245 (4th Cir. 2021), the Fourth Circuit followed Copley, holding that the government’s right under IRC 6402 to offset a tax refund against a preexisting nontax debt prevails over the debtors’ right under BC 522(c) to claim an exemption in their tax refund.

The Woods defaulted on a HUD-backed loan, which was subject to the Treasury Offset Program. The Woods filed bankruptcy in March 2018 and a week later filed their 2017 income tax return. Pursuant to IRC 6402(d), the government offset the federal income tax refund against the outstanding debt to HUD. The Woods brought an adversary proceeding in bankruptcy court, asserting that the tax refund was part of their bankruptcy estate, was protected by the automatic stay, and was protected by exemption under BC 522. The government argued that the tax overpayment was not considered a tax refund under IRC 6402, was thus not part of the bankruptcy estate, and therefore was not subject to exemption and not protected by the automatic stay. At the time of the adversary proceeding, the Fourth Circuit had not decided Copley.

Keith blogged about Wood last year when the district court affirmed the bankruptcy court’s  finding that the exemption provision of BC 522 disallowed a setoff under BC 553. While acknowledging a split on the issue, the district court found that the tax refund was part of the bankruptcy estate; it then followed other bankruptcy courts within the Fourth Circuit in finding that “a properly-claimed exemption trumps a creditor’s right to offset mutual prepetition debts and liabilities.” However, as Judge Wilkinson noted in Wood, “those courts lacked the guidance of [the Fourth Circuit’s decision in] Copley.” Judge Wilkinson’s Wood decision refers to IRC 6402(a) (offset against tax debts) and 6402(d) (offset against TOP debts) as “sister provision[s].” Importantly, the Wood decision notes that an offset under section 6402(a)  is discretionary while an offset under 6402(d) is mandatory, with the result that “the case for a statutory setoff right is even stronger [in Wood] for § 6402(d) than it was in Copley for § 6402(a).”

But as the opinion notes, that “is not the end of the matter” because unlike in Copley, the Wood court still had to had to address the applicability of the automatic stay. The district court in Wood noted that BC 362(b)(26)’s automatic stay exception does not apply to a TOP offset, with the result that the Woods’ tax refund was protected by the automatic stay. The district court rejected the government’s argument for retroactive annulment of the stay. In his blog post, Keith expressed surprise that the DOJ lawyer representing HUD would argue that the United States had the right to seek a retroactive annulment of the automatic stay to allow the offset. Keith noted that other federal agencies would need to go to Congress and have 362(b)(26) expanded if they wanted to use TOP while an individual was in bankruptcy.

The Fourth Circuit in Wood did not find this problematic, however. While acknowledging that 362(b)(26) does not apply to an offset against a HUD liability, and that the government’s actions violated the automatic stay, the court also noted that the government can seek relief from the stay and that “barring exceptional circumstances, the government’s motion for relief from the automatic stay in cases of this kind should ordinarily be granted” (citing Cumberland Glass Mfg. Co. v. De Witt on this point).  In remanding Wood to the lower court to consider that question, the Fourth Circuit emphasized the Copley precedent and its finding that “the government’s statutory setoff rights under § 6402 trump the Woods’ right to exempt their overpayment.”

It remains to be seen whether other circuits will follow the Fourth Circuit’s holdings in Copley and Wood as to the primacy of IRC 6402. In the meantime, debtors and bankruptcy attorneys should take note. In my article I outline a few takeaways, each of which highlight the need for careful planning when a bankruptcy debtor has outstanding tax debt. While Keith and Nancy Ryan come to my mind as notable exceptions, it is my observation that tax lawyers are not typically also bankruptcy experts and bankruptcy lawyers are not typically also tax experts. These two Fourth Circuit cases, however, are a reminder that both types of lawyers must be cognizant of the ways in which the statutory worlds of bankruptcy and tax collide.