The Surprise Bill – Interest Due after Bankruptcy

The case of In re Widick, No. 10-40187 (Bankr. D. Neb 2019) provides a reminder that bankruptcy does not discharge all debts even when the debtor pays all of the tax for the year through the bankruptcy plan.  Mr. and Mrs. Widick completed a chapter 13 plan.  To obtain the plan and to complete the plan, they paid all of the income taxes for two years and all of the trust fund recovery penalties for two quarters.  I suspect that their bankruptcy attorney did not mention to them that paying all of the taxes does not keep the IRS from coming back after the bankruptcy case to collect the interest.  They brought this action to hold the IRS in contempt for violating the discharge injunction due to its efforts to collect from them after the bankruptcy court granted the discharge in this case.  With relative ease, the bankruptcy court delivered to them the sad news that the IRS could continue to collect from them after the discharge and the authority for the IRS actions went back for three decades in the controlling circuit case of Hanna v. United States (In re Hanna), 872 F.3d 829 (8th Cir. 1989).

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In bankruptcy creditors cannot generally collect post-petition interest from a debtor.  An exception to this rule exists if the creditor has a secured claim with enough equity to pay the interest or if the debtor is in chapter 11 where the creditor can receive interest after the plan confirmation (but not for the period from the petition to confirmation.)

Although bankruptcy generally serves as an interest free zone, interest still runs.  The difficult concept for debtors with tax debt comes where the IRS starts pursuing them after discharge to collect interest on a debt that they believe they have satisfied.  Whether the IRS can come after this debt post-discharge depends on whether the debt itself qualified as non-dischargeable debt.  In the case of the Widicks, it did.  Because the debt satisfied the exception to discharge in 523, the IRS could pursue collection of the interest after the granting of the discharge.

The Widicks owed income taxes that were recently incurred.  These income taxes received priority status under B.C. 507(a)(8)(A).  The unpaid TFRP liabilities also attained priority status under B.C. 507(a)(8)(C) and due to their nature have priority status no matter how old they were.  Because the income taxes and TFRP taxes had priority status, the debtors had to provide for payment in full of these taxes and all pre-petition interest in order to obtain confirmation of their plan.  The chapter 13 plan did not require, and could not require, the Widicks to pay the interest that ran on these taxes over the 5 year life of the plan.  Debtors might think that because the plan did not require payment of post-petition interest, they got a pass on this interest.  Because debtors might easily reach this conclusion, their lawyer must carefully advise them of the interest rules with respect to taxes.  Otherwise, they will become quite upset when the IRS offsets post-discharge refunds and takes other collection action.

A similar situation occurs in offers in compromise.  The standard language of the offer in compromise developed by the IRS requires that the debtor forego any refund for the year in which the IRS accepts the offer (and any pre-offer years.)  As with bankruptcy, the taxpayer’s representative must carefully explain to the individual obtaining the offer the consequence of this provision.  The taking of the refund might occur 12 months or more after the offer acceptance.  At that point the taxpayer can easily have forgotten the promise to forego the refund.  For this reason, putting a discussion of the refund taking in the letter closing out the offer provides a good way for the representative to prepare the taxpayer for the future and protect themselves from criticism and anger that occurs when the IRS takes the refund.

Here, the debtors’ chapter 13 attorney did not prepare his clients for the consequence of the post-discharge interest liability.  In its relatively short opinion the court points out that although the Hanna case cited above involved a chapter 7 debtor, case law existed with respect to chapter 11 and 13 cases in their district.  The law here is well settled even if it is surprising.  Clients may not like this aspect of the law, but if they know it’s coming, then they understand it’s part of the bargain of the discharge — just as the taking of the post-offer acceptance refund is part of the bargain of the offer in compromise.

Timely Filing Issues in Bankruptcy Court

Dixon v. IRS, No. 2:18-cv-00274 (N.D. Ind. July 24, 2019) presents the issue of whether filing a bankruptcy petition extends the time within which a taxpayer can file a claim for refund.  In re Long, No. 19-20186 (Bankr. E.D. Wis. July 29, 2019) raises the issue of whether a debtor in a bankruptcy case must accelerate the time for filing their income tax return because of filing bankruptcy.  The answer to both questions is no.  Details and explanation below.

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Charles Dixon filed a chapter 13 bankruptcy petition on September 2, 2010.  As with most chapter 13 cases, it took time before his bankruptcy case came to an end on July 22, 2016.  While his bankruptcy cases was pending Mr. Dixon filed an amended return for tax year 2012 on April 13, 2015.  The IRS notified him by Letter 105C, a statutory notice of claim disallowance, on January 21, 2016, that it would not allow his claim.  For some reason he filed another amended return for 2012 in June of 2016 and the IRS sent him a statutory notice of claim disallowance with respect to that claim on August 3, 2016. 

On July 26, 2018, Dixon filed a complaint alleging that the IRS improperly denied his first claim.  The IRS filed a motion to dismiss because of the filing of the complaint more than two years after the notice of claim disallowance.  Though the court couches the dismissal discussion in jurisdictional terms, readers of this blog know that the timing of filing of the complaint vis a vis the sending of the claim disallowance issue may not present a jurisdictional issue though the time frame for filing provided in IRC 6532(a)(1) does represent an important time frame that a taxpayer must meet or show reasons for the failure to meet the time frame.

The statute requires that the taxpayer file the refund suit within two years of the sending of the statutory notice of claim disallowance.  Here, Mr. Dixon filed suit more than two years after the notice.  To overcome this timing problem, Mr. Dixon argues that his bankruptcy case tolled the time for filing the refund suit.  In support of this argument he cites to IRC 6503(h).  This section provides a tolling of “the period of time in which the United States can collect a tax against a taxpayer/debtor.” But it does not mention tolling the time within which to bring a refund suit.  The bankruptcy court declined to extend the tolling provision to the refund situation.  Doing so would have created a shocking result.  The tolling statute that he cited in support of the timeliness of his claim seeks to give the IRS more time to collect a liability in situations in which the automatic stay of bankruptcy prevents it from collecting.  The statute has nothing to do with extending the time for a taxpayer to file bankruptcy.

Next he argued essentially that his second refund claim gave him more time; however, the second claim mirrored the first claim.  It did not raise new grounds for recovery.  The court found that a second claim could only extend the time within which to bring suit if the second claim raised new legal arguments.  Since it did not, the filing of the second claim here had no meaning.  (The IRS pointed out that even if the second claim had contained a second ground for recovery it would have done no good here because Mr. Dixon filed it after the statute of limitations for filing a refund claim.)  Although Mr. Dixon did not argue that the statute of limitations for filing his refund claim did not create a jurisdictional bar to filing a claim after that date, he presented no evidence that appeared in the opinion which would have allowed him to miss the due date.

As a result of making arguments on which he achieved little traction, the court grants the motion to dismiss filed by the IRS with relatively little discussion.  He does not appear to have made the argument that the time frame for filing a refund suit is not a jurisdictional time frame.  The facts available in the published opinion do not suggest that he would succeed in an equitable tolling argument.

The second case pits the taxpayer/debtor against the chapter 13 trustee rather than the IRS.  Here, the trustee argues that the taxpayer should have filed his return prior to the first meeting of creditors in his chapter 13 bankruptcy case.  The opinion parses the interpretation of a statute designed to require taxpayers to file their tax returns in order to obtain chapter 13 relief. 

Before the passage of the relevant statute in 2005, at almost every chapter 13 confirmation hearing day across the country, the IRS routinely sent attorneys who objected to the confirmation of a debtor’s plan because the debtor had unfiled returns which prevented the IRS from knowing whether, and how much, to claim against the estate.  Bankruptcy judges got tired of postponing hearings so that delinquent debtors could file these returns.  I made the objections in the 1980s and 1990s in the bankruptcy court in Richmond.  When we first started making them, the bankruptcy judge would give a stern lecture to the debtor about their criminal behavior in not filing returns.  It didn’t take too long before the judge realized that far more people failed to file their returns than he thought possible.  So, he stopped making the lectures but he still denied confirmation.  Stopping confirmation wastes the time of the court which must reschedule the hearing, prevents creditors from getting paid, costs the debtor’s attorney money to fix the plan and reappear and costs the trustee time and effort.  In 1994 when Congress appointed a bankruptcy commission to assist it in revising the bankruptcy laws to fix problems stemming from the Bankruptcy Code’s passage in 1978, the commissioners quickly identified this as a problem that needed to be fixed.  It took about eight years after the commission presented its findings before Congress got around to passing the correctively legislation but now anyone going into bankruptcy must be up to date on their return filing (the same basic rule that applies to anyone seeking an installment agreement or offer in compromise from the IRS). 

The Long case looks at the meaning of the statute requiring chapter 13 debtors to be current in their tax filing.  The bankruptcy case here was filed on January 8, 2019, during the filing season.  Usually the first meeting of creditors is scheduled within 20 to 40 days of the bankruptcy petition.  So, the debtor had more time to file their return according to the Internal Revenue Code than the date scheduled for the first meeting of creditors.  The issue before the court was whether the bankruptcy code accelerates the return filing date in this situation.  Here’s how the bankruptcy court framed the question at the outset of its opinion:

“Shortly after a debtor commences such a case, the United States trustee (or a designee) must “convene and preside at a meeting of creditors.” Id. §341(a); Fed. R. Bankr. P. 2003(a). By no later than “the day before the date on which the meeting of the creditors is first scheduled to be held”, the debtor must file with appropriate tax authorities the prepetition tax returns specified in 11 U.S.C. §1308(a), unless the chapter 13 trustee gives the debtor more time, see §1308(b). If the debtor does not file “all applicable Federal, State, and local tax returns as required by section 1308”, the court cannot confirm the debtor’s plan. Id.§1325(a)(9). The issue presented here is whether the prepetition tax returns specified in §1308(a) include returns that are not due to be filed with the appropriate tax authority before the date on which the meeting of creditors is first scheduled to be held.”

The bankruptcy court in Wisconsin was not working with a clean slate.  This issue, at least in that jurisdiction had been bubbling for quite a long time.  The court described the situation:

“This provision [Section 1308] may simply require the debtor to file, before the date on which the meeting of creditors is first scheduled to be held, all tax returns for the specified prepetition taxable periods that the debtor was otherwise required to file — i.e., that were due to be filed — before that date. But In re French, 354 B.R. 258 (Bankr. E.D. Wis. 2006), offers a competing construction: that §1308(a) requires “debtors who file for Chapter 13 protection . . . to have their return for the prior year filed by the date first scheduled for the meeting of creditors, even if the return is not yet delinquent under [applicable nonbankruptcy law].” Id. at 263.”

The opinion is lengthy and goes into some depth in seeking to find the meaning of Section 1308 and how it interacts with other provisions of the bankruptcy and tax codes.  The court expresses concern that following French really puts debtors filing early in the calendar year into a near impossible bind and allows the trustee to stop their bankruptcy cases by the simple act of refusing to extend the time of the first meeting of creditors.  After balancing the competing provisions, the court decides that the French case reaches the wrong conclusion and allows the debtor here to confirm a plan without filing the return not yet due under the tax code. 

I agree with this result as a logical reading of the code and the intent of the statute.  The statute seeks to require debtors to file past due returns.  The IRS or the debtor have a mechanism to add the debt for the 2018 year into the plan if they choose to do so.  Adding in the debt for the prepetition year after plan confirmation is a bit messy and expensive but denying confirmation to someone for not filing a return by the end of January also presents problems.  On balance the court reaches the logical result, but debtors who know they will owe taxes for the immediately past year do themselves no favors by failing to address the year in their plan.  Perhaps chapter 13 debtors should consider, as one of the factors in deciding the timing of filing a bankruptcy petition, postponing if possible to avoid filing at the very beginning of a calendar year.  If they can wait a few weeks or months before filing, they can avoid this problem.  Such a delay, however, is not always possible and taxes should not drive this timing.

Count Days BEFORE Filing for Bankruptcy

The case of Anthony Hugger v. Lawrence J. Warfield et al.; No. AZ-18-1003 (April 5, 2019) shows the danger of not carefully counting days before filing for bankruptcy if you seek to discharge taxes. Mr. Hugger filed a chapter 7 bankruptcy case and received his discharge in May of 2017 before coming to the realization that he had filed too early to obtain a discharge of his tax debts. After the epiphany in September of 2017, he requested that the bankruptcy court vacate his discharge and dismiss the chapter 7 case. Essentially, he requested a do over because it was understood that if the court granted his request he would file another chapter 7 case, but this one after the time passed to allow the tax debts to age into discharge status. The decision linked above is the 9th Circuit Bankruptcy Appellate Panel (BAP) affirming the decision of the bankruptcy court denying the request for vacature and dismissal.

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The bankruptcy court denied Mr. Hugger’s request because:

(1) Debtor lacked standing under § 727(d) and (e) to revoke his discharge, and the bankruptcy court could not use its § 105 equitable powers to circumvent the Bankruptcy Code (citing Law v. Siegel, 571 U.S. 415 (2014)); (2) Debtor had not established any grounds for relief under Civil Rule 60 because all of the relevant information was known before the bankruptcy case was filed, and Debtor had proffered no excuse why his or his counsel’s error had not been addressed earlier; (3) the cases cited to the court were distinguishable; and (4) the tax creditors would be harmed if the court were to grant the requested relief.

After the denial, he filed a request for a new trial and alleged that extraordinary circumstances existed. Specifically, he argued that:

(1) Debtor’s counsel had given him inaccurate or incomplete advice regarding the deadlines for filing; (2) no creditors had participated in the case before the motion to vacate discharge was filed; and (3) there would be no prejudice to creditors because the IRS and ADOR could continue to collect, while Debtor would be prejudiced by having to wait to file a new bankruptcy case.

It’s easy to believe that Mr. Hugger’s bankruptcy attorney may have failed to appreciate the need to count and therefore failed to alert him to the bad timing of the filing of the petition. It’s also possible that other issues caused him to file bankruptcy and that taxes did not drive the filing of his petition. The fact that no creditors participated probably results from the fact that he filed a no asset chapter 7 and creditors would have received notice not to bother filing a claim. Just because the creditors did not file a claim does not mean that the bankruptcy did not have an impact on their actions.

The BAP determined that it should review some of the bankruptcy court’s actions for abuse of discretion and other aspects of the case it would review de novo. With respect to abuse of discretion, the BAP determined that the decision of the bankruptcy court properly found that all of the facts were known by the debtor and his attorney at the time of the filing of the bankruptcy petition. This was not a case of fraud on the debtor or later discovered facts. The facts were there. Just because debtor and his attorney did not appreciate the importance of the facts does not form a basis for equitable relief.

The debtor argued that granting his request would not harm the creditors of the estate but the court did not agree:

… a chapter 7 debtor seeking to dismiss his case has the burden to show that doing so would not result in “legal prejudice” to creditors. Hickman v. Hana (In re Hickman), 384 B.R. 832, 841 (9th Cir. BAP 2008); Leach v. United States (In re Leach), 130 B.R. 855, 857 (9th Cir. BAP 1991) (citing Schroeder v. Int’l Airport Inn P’ship (In re Int’l Airport Inn P’ship), 517 F.2d 510, 512 (9th Cir. 1975)). Debtor contends that there would be no prejudice to the taxing authorities in permitting the relief requested because those creditors would be able to collect until such time as Debtor files a new chapter 7 case after enough time has elapsed for him to discharge the older taxes.5 Debtor’s argument ignores the fact that, as things stand, the taxing authorities would have much more time to collect than they would have had the bankruptcy court granted the requested relief. Debtor has not shown that the bankruptcy court abused its discretion in denying the motion.

The BAP found that the debtor had no arguments that established the bankruptcy court abused its discretion in denying him the relief he requested. He offered no good equitable reasons for revoking the discharge and dismissing the original case. Although the court did not fashion its discussion in this manner, the situation in this case reminds me of certain tax cases in which the debtors seek relief from penalties. If the court grants the relief, it essentially lets the attorney off the hook for malpractice. The same circumstances appear present here. If the court allowed Mr. Hugger a do-over, and if his attorney did drop the ball on noticing the dates the taxes would become dischargeable, the bankruptcy court would essentially be allowing Mr. Hugger’s attorney to avoid the malpractice claim that otherwise seems almost certain to follow from these facts. The fact that granting the relief would relieve the bankruptcy attorney from liability is not a reason to deny Mr. Hugger relief but neither is the bad advice a reason to grant the relief under these circumstances.

The case points to the critical importance of understanding tax transcripts and properly counting days in order to maximize the benefits of a bankruptcy filing. Since Mr. Hugger must now wait for years before he can file another chapter 7, the missed date means that it’s open season for the IRS and the state and local taxing authorities on his income and assets. Nothing prevents him from making an offer in compromise or otherwise trying to deal with his liability and the ability of the IRS to collect from him does not mean that it will succeed. Still, he lost the chance to rid himself of the tax liability and the loss has significance.

IRS Can File a Proof of Claim in Bankruptcy Court for the Full Amount of Tax Liability Even After an Accepted Offer in Compromise

Guest blogger Ted Afield today discusses the intersection of offers in compromise with bankruptcy. Professor Afield (with co-author Nancy Ryan) will be creating a chapter on Offers in Compromise for the next edition of Effectively Representing Your Client Before the IRS. Christine

In our clinic at GSU, we do a lot of collections work and routinely submit offers in compromise, which the IRS often accepts, on behalf of our clients. While our hope is always that the accepted offer will be a critical step that allows the taxpayer to get back in compliance with his or her tax obligations and get out from under the weight of a detrimental financial liability, unfortunately the accepted offer is sometimes not enough to prevent a taxpayer from continuing to be overwhelmed by other financial obligations. In situations like these, the taxpayer may in fact file bankruptcy during the 5-year compliance window for the offer in compromise. If this happens, the IRS potentially has a claim in the bankruptcy proceeding because the offer in compromise may have already been defaulted or may be defaulted in the future if the taxpayer fails to file tax returns and timely pay taxes. Accordingly, the IRS will file a proof of claim in the bankruptcy proceeding, which raises the question of should this proof of claim be for the full amount of the tax liability or for the compromised amount of the tax liability.

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This was the question recently taken up in a memorandum opinion by the Bankruptcy Court for the Southern District of Texas, Houston Division, in In Re: Curtis Cole, No: 18-35182 (May 29, 2019). In this case, Mr. Cole and the IRS had entered into a compromise of tax liabilities for 2003-2014 totaling over $100,000 for the much more manageable sum of $1,000. During the five-year monitoring period, Mr. Cole started off well and timely filed and paid his 2016 income tax. For 2017, however, Mr. Cole recognized that he would not be able to timely file a return, and he accordingly requested and was granted an extension. Mr. Cole did then file his 2017 return and pay his 2017 tax bill on October 15, 2018.

PT readers who do a lot of OIC work will immediately recognize the potential problem that Mr. Cole created for his offer because an extension of time to file is not an extension of the time to pay taxes, raising the possibility that the IRS would default Mr. Cole’s offer for failing to pay his 2017 taxes in a timely manner. Compounding the problem was that Mr. Cole had filed for Chapter 13 bankruptcy one month earlier, on September 15, 2018. As a result, the IRS filed a proof of claim in the bankruptcy proceeding for the full amount of the original tax liability that was compromised under exactly that theory (i.e., that Mr. Cole’s late payment of 2017 taxes caused his offer to default and thus caused the amount of the IRS’s claim to be the full amount of the tax liability).

Mr. Cole was not happy with this development and attempted to raise a couple of equitable arguments that did not have much of a leg to stand on. Mr. Cole’s first hope was that he would be simply forgiven his confusion over whether a filing extension also constituted a payment extension. This did not have much resonance in light of the fact that it is well established that filing extensions are not in fact payment extensions. Mr. Cole also attempted to argue that he effectively had rights under the Internal Revenue Manual by asserting that the IRS violated its own procedures when it did not offer him any opportunity to cure his late payment before declaring the offer to be in default. See I.R.M. 5.19.7.2.20, which states that in the event of a breach of the offer’s terms, the IRS should send the taxpayer a notice letter and provide an opportunity to cure before defaulting the offer. Again, this argument could not carry much weight in light of the well-established principle that the IRM does not give taxpayers any rights, and thus the IRS was not obligated to provide an opportunity to cure the default. Ghandour v. United States, 37 Fed. Cl. 121, 126 n.14 (1997).

Mr. Cole’s strongest argument was based on his reliance on a bankruptcy court opinion from the Eastern District of North Carolina that had ruled on a similar issue and had concluded that the proof of claim should be for the compromised amount rather than the full amount of the tax liability. In re Mead, No. 12-01222-8-JRL, 2013 WL 64758 (Bankr. E.D.N.C. Jan. 4, 2013). The Mead court found that the contractual language in Form 656 stating that the IRS may file a “tax claim” for the full amount of the tax liability if a taxpayer files for bankruptcy before the offer’s terms expire is ambiguous in regards to whether the “tax claim” refers to the full liability or the compromise amount. Accordingly, the Mead court held that the IRS violated the nondiscrimination rule of 11 U.S.C. § 525(a), on the grounds that it appeared that the IRS was trying to collect the full amount of the tax liability, rather than the compromised amount, solely because the taxpayer was in bankruptcy.

The Cole court, however, was not persuaded by its sister court in North Carolina and held that Mead was both distinguishable and simply incorrect.  Mead was distinguishable because, unlike in Cole, there was not an issue of whether the offer had been defaulted. However, even without that distinguishing characteristic, the Cole court noted that the outcome would be the same. In other words, regardless of whether the offer was in default, if the terms of the offer had not yet expired, the IRS would still need to file a proof of claim for the full amount of the tax liability in order to preserve its rights in case the taxpayer did subsequently default the offer. This is why the terms of the offer explicitly state in Section 7: “If I file for bankruptcy before the terms and conditions of the offer are met, I agree that the IRS may file a claim for the full amount of the tax liability, accrued penalties and interest, and that any claim the IRS files in the bankruptcy proceeding will be a tax claim.” I do not agree with the Mead court’s assertion that this language is ambiguous.

It’s not that the issue of whether the offer has been defaulted is irrelevant. Rather, that issue is simply premature at the moment when the IRS files its proof of claim. Even if the offer has unequivocally not yet been defaulted, the IRS must file a proof of claim for the full amount of the liability to protect its right to recover the full amount, should a default occur. So when can Mr. Cole attempt to make his likely to be very uphill arguments that he has not defaulted the offer? As the court notes, he does this when he submits his Chapter 13 plan, in which he will propose how to treat the IRS’s claim. If he believes he has not defaulted his offer, he can propose that the IRS only receive what it is owed if the offer is still in force. The IRS can then object if it believes that the offer is in default, and the issue can then be decided.

In comparing Cole and Mead, I think the Cole court likely has the better argument. The contractual language in Form 656 pretty unambiguously gives the IRS the right to file a claim for the full amount of the tax liability in a bankruptcy proceeding during the five-year monitoring period. That does not mean that the IRS will recover the full amount if the offer is not in default, but taxpayers should certainly expect such a claim to be filed and that they will have to litigate whether the offer is defaulted when they propose their bankruptcy plan.

Breland, Jr. v. Commissioner: Another Bankruptcy-Tax Trap for the Unwary Practitioner

Today we welcome first-time guest blogger Brad D. Jones. With editorial assistance from returning guest Ken Weil, in this post Brad evaluates the implications for bankruptcy debtors and practitioners of the Tax Court’s recent Breland decision. For a bankruptcy primer written for tax practitioners, see the bankruptcy chapter of Effectively Representing Your Client Before the IRS. Ken and Brad will be updating this chapter for the 8th edition of the book, expected to be published in December 2020. Several of Keith’s past PT posts also address the intersection of tax procedure and bankruptcy. Christine

If a tax is non-dischargeable, an understated IRS claim for that tax can have a devastating impact on an individual debtor’s financial well-being post-bankruptcy. This is because 11 U.S.C. § 523(a)(1)(A) of the Bankruptcy Code provides that non-dischargeable IRS claims can be collected by the IRS post-petition “whether or not a claim for such tax was filed or allowed.” If the IRS’s claim is understated, a person’s unpaid tax liabilities will generally be collectible by the IRS even if all of the individual’s available assets were used in the bankruptcy to pay other, lower-priority debts. As a result, an unfiled or undervalued IRS claim can lead the IRS to continue to pursue an individual for unpaid tax debt post-bankruptcy, even if the IRS did not pursue its claims in the bankruptcy case or allowed funds that should have gone to its claims to be paid to other creditors. The issue of how to fix a debtor’s tax liability and what needs to occur in the bankruptcy court to do so was at issue in Breland, Jr. v. Commissioner, 152 T.C. No. 9 (2019).

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Bankruptcy debtors generally have two main avenues to fix the amount of their tax liability for a given year: (1) file a motion for the bankruptcy court to determine the amount of their tax debt pursuant to 11 U.S.C. § 505; or (2) object to the IRS’s proof of claim. See Internal Revenue Service v. Taylor, (In re Taylor), 132 F.3d 256, 262 (5th Cir. 1998). In Breland,the Tax Court considered the effect of a resolved proof-of-claim objection on the ability of the IRS to pursue post-petition claims “regardless of whether a claim for the tax was filed or allowed,” as contemplated in § 523(a)(1)(A).

Breland involved a commercial-real-estate investor who allegedly owed a substantial sum to the IRS post-bankruptcy. The issue was whether the IRS could agree in the bankruptcy to a consent order setting the amount of its priority claim, allowing the debtor to pay a substantial sum to creditors subordinate to the IRS, and then later issue a notice of deficiency seeking up to $45 million more for the same tax years that it had compromised. The Tax Court held that it could, narrowly interpreting the bankruptcy court’s order as not addressing the total amount of the debtor’s federal tax liability. The Tax Court reached that result even though its interpretation conflicted with the interpretation of the bankruptcy court that entered the order. The Tax Court’s holding is surprising given that proof of claim objections are generally res judicata on the IRS and final orders resolving contested matters in bankruptcy are typically given broad preclusive effect. The Breland ruling forces bankruptcy practitioners to be particularly vigilant in addressing tax issues in the bankruptcy context.

Breland undercuts the ability of individual debtors to rely on proof of claim objections to fix the amount of their tax liabilities. In Breland, the debtor filed a Chapter 11 bankruptcy case and the IRS filed a proof of claim stating it was owed over $2 million in income tax for the years 2004 to 2008. The debtor filed an objection, stating in its entirety, that the “Debtor objects to the penalties assessed against him on the grounds that the Debtor had reasonable cause for not paying the taxes on time.” The parties entered into a consent order in which the IRS agreed to settle the debtor’s objection by agreeing to specific amounts for its priority tax debts with both sides agreeing that the disputed penalty portion was a general unsecured claim to be resolved after bankruptcy plan confirmation. After conducting discovery related to the disputed penalty portion, the IRS filed an amended proof of claim and asserted additional tax was due. The debtor objected on the grounds that the consent order fixed the debtor’s tax obligation. The bankruptcy court granted the objection and the IRS appealed. The district court remanded to the bankruptcy court for clarification as to the preclusive effect of the consent order. In response to the remand from the district court, the bankruptcy court ruled:

[T]he Court finds that the Consent Order . . . is the controlling document as to the extent of the Debtor’s tax obligation to the IRS. The Consent Order contains a clear statement of the total IRS claim amount and divides that amount into priority and general unsecured values. . . Moreover, by its terms, the Consent Order appears binding and complete. No specific limitation on the Consent Order’s effect is indicated in its terms. The IRS did not reserve the right to assert additional claims. Indeed, the Consent Order did not reserve any rights to the IRS, only to the Debtor. The purpose of the Consent Order is unclear if it was not meant to bind the IRS to its terms.

The IRS appealed, losing in the district court and stipulating to dismissal of its appeal to the 11th Circuit. In the midst of the proceedings in the bankruptcy and district courts, the IRS issued its notice of deficiency, triggering the filing of the debtor’s petition before the Tax Court.

Outside of bankruptcy, a consent order would normally be res judicata on the IRS’s attempt to collect additional amounts for the tax years set forth in the consent order. See United States v. Int’l Bldg. Co., 345 U.S. 502, 506 (1953) (consent order not binding on the United States for tax years subsequent to those years covered in the consent order). The consent order would also be binding if the tax in question were dischargeable. And Breland agreed that the consent order would be res judicata on the IRS if the “order had fixed petitioner’s total Federal tax liability for the subject tax years.”

Even though on remand the bankruptcy court had directly addressed the issue before the Tax Court and found its own order to be “the controlling document as to the extent of the Debtor’s tax obligation to the IRS,” the Tax Court interpreted the consent order narrowly. In the Tax Court’s view, the bankruptcy court’s order did not control for two reasons: First, the Tax Court believed res judicata did not apply because it believed that the consent order establishing the amount of the IRS’s claim and resolving an objection to plan confirmation is an inherently different proceeding than a proceeding to determine whether a particular liability is owed. The Tax Court noted that debtor’s proof of claim objection only challenged the penalties assessed, which the Court found undercut his argument that the consent order determined the total pre-petition tax liability. Second, in the Tax Court’s view, reading the consent order as a final determination of the debtor’s tax liabilities would have the effect of discharging otherwise non-dischargeable debts and contradict § 523(a)(1)(A). The Tax Court did not think res judicata applied because in its view the consent order was not “a final judgment on the merits of [the debtor’s] entire Federal tax debt for any given year.”

The Tax Court’s statement that a determination of an individual’s tax debt in bankruptcy is not the same cause of action as determining the tax debt generally is puzzling. The Court did not cite to any cases in its res judicata analysis that arose in the context of a settled or litigated proof of claim objection. The Tax Court’s view that the consent order was a different cause of action than a determination of tax liability is a more restrictive interpretation than is typically applied in a res judicata analysis. Generally, causes of action are the same for res judicata purposes if they arise “out of the same nucleus of operative fact.” In re Piper Aircraft Corp., 244 F.3d 1289 (11th Cir. 2001). In the context of a contested proof of claim, it is difficult to see how a dispute over the amount of the same tax, for the same years, and involving the same individual, can possibly not arise out of a common factual nucleus, which is precisely the reason that proof of claim objections generally are res judicata. See Hambrick v. Commissioner, 118 T.C. 348, 353 (2002) (recognizing that unlike proof of claim objections or a tax liability determination by the bankruptcy court, the mere confirmation of a Chapter 11 plan generally does not require a determination of the amount of a debtor’s non-dischargeable tax liability).

Similarly, the Tax Court’s consideration of the non-dischargeable nature of the debt also does not make much sense in the context of interpreting the scope of the bankruptcy court’s order regarding a proof of claim settlement. While unpaid non-dischargeable debts will generally survive whether the plan is confirmed or not, the purpose of a proof of claim objection is different. A claim objection is generally filed to determine the total amount owed, which does not turn on dischargeability (though a claim objection often establishes the facts from which dischargeability can easily be determined). In this case, the debtor conceded the non-dischargeability of the tax at issue. So in compromising the amount of the priority claim under the consent order, the IRS knew it was establishing the amount of the non-dischargeable portion of its claim. The bankruptcy court clearly understood this difference, which is why it interpreted its order as controlling for the amount of tax at issue.

Moreover, the Tax Court did not give any consideration to the way proofs of claims fit within the bankruptcy scheme as a whole. A basic underpinning of bankruptcy law is the absolute priority rule: the concept that higher priority claims (such as priority tax claims) must be paid in full before estate assets are used to pay lower priority claims. See Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973, 983 (2017) (recognizing that the “priority system has long been considered fundamental to the Bankruptcy Code’s operation”). Establishing the amount of priority tax claims and paying those claims before funds are lost paying lower priority debts is central to both the bankruptcy priority scheme and claims filing process – so much so that the Bankruptcy Code permits debtors to file a proof of claim on behalf of the IRS when doing so is necessary to determine the amount of the tax debt. 11 U.S.C. § 501(c); Taylor, 132 F.2d at 262 (suggesting the option of filing a claim for the IRS to fix the amount of the tax debt). The Tax Court’s decision to apply a restrictive reading of the consent order, at odds with the bankruptcy court’s own interpretation, frustrates these objectives of the Bankruptcy Code. It is also incompatible with the deference courts typically exercise in favor of orders entered by another court. See Colonial Auto Center v. Tomlin (In re Tomlin), 105 F.3d 933, 941 (4th Cir. 1997) (recognizing that the bankruptcy court is in the best position to interpret its own order and its interpretation warrants customary deference).

On May 7, 2019, the debtor filed a Motion to certify the Tax Court’s order to permit an immediate appeal and the Tax Court issued an order requiring the IRS to respond by June 10, 2019. Regardless of the outcome of any appeal, Breland is instructive for practitioners with bankruptcy clients facing tax debts. The Tax Court made much of the fact that neither the plan nor the consent order referenced the bankruptcy court’s authority under 11 U.S.C. § 505 to determine the amount of a debtor’s tax liability. It would be advisable for practitioners to seek to include language either in the Chapter 11, 12, or 13 plan or in orders resolving the IRS claims that specifically reference Bankruptcy Code § 505 and state that the plan or the order constitutes a determination of the amount of the total tax due for the years at issue. Similarly, the Tax Court in Breland also appeared troubled that the debtor’s proof of claim objection only stated that the objection was to the amount of the penalties. If a debtor is going to file an objection to the IRS’s proof of claim anyway, it may be helpful to include an objection to any amounts in excess of those asserted in the IRS proof of claim with a reference to 11 U.S.C. § 505.

Update: coincidentally, on the date this post was published the Tax Court issued a memorandum opinion holding that the Brelands had overstated their long-term capital loss by nearly a million dollars. Christine

Seeking Attorney’s Fees for Violation of Automatic Stay

What does a court do when the statute requires exhaustion of administrative remedies before a grant of attorney’s fees and the administrative agency (here the IRS) guides people to perform an impossible act in order to seek to exhaust administrative remedies?  That was the issue facing the bankruptcy court in Langston v. Internal Revenue Service, Case No. 17-10236-B-13 (Bankr. E.D. Cal. 2019).  In the end, the court denied the request for attorney’s fees because of precedent in the 9th Circuit but the courts are split on the issue and the IRS is about a decade behind in updating its guidance to the public on how to make an administrative request to fix a problem it creates by violating the automatic stay. Outdated language referencing the non-existent “Chief, Local Insolvency Unit” role remains in the current version of the CFR.

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Mr. Langston is a retired federal employee who also owed federal taxes.  I don’t think he is the only retired federal employee with this issue, but the government especially wants individuals to whom it is paying a pension to pay their taxes.  So, it has a program for taking from their pension payments to satisfy the outstanding tax debt.  The program is a perfectly legitimate method for the IRS to collect past due taxes except when used while the automatic stay comes into effect.  That’s what caused the problem here.

Mr. Langston and his wife filed a Chapter 13 bankruptcy case in January 2017.  The bankruptcy court notified the IRS within two weeks of the filing and the IRS filed a proof of claim one week thereafter.  So, it is indisputable that the IRS knew about the automatic stay.  Normal procedures would have had it input a code into its computer system almost immediately after learning of the case.  Here, it is not the IRS specifically that took the action violating the stay.  The agency taking from his pension and sending the money to the IRS was the Office of Personnel Management (OPM).  It could well be that the debt offset indicator arrived at the OPM before the bankruptcy case and there was a delay in that office in taking action.  It is also possible that there was a delay at the IRS getting information about the stay to OPM or a delay at OPM in putting the stay into its system.  The bankruptcy court does not go into the details of how the problem occurred and it really does not matter in the resolution of the case, but it should matter to the IRS and OPM so that a system exists to immediately notify OPM of the stay and for OPM to immediately put the stay into its system. 

For undescribed reasons, OPM sent to Mr. Langston a letter he received in early April saying that it would withhold a part of his pension to satisfy the outstanding federal tax debt. OPM withheld almost $400 a month for four months starting in April 2017.  The Langstons’ bankruptcy lawyer filed an adversary proceeding in May 2017 after informally trying to convince the IRS to stop taking the money.  Their representative did not seek to formally stop the taking of the pension funds prior to bringing the suit.  The IRS eventually gave back all of the money taken by OPM.  In responding to the complaint which undoubtedly included a request for monetary damages, the IRS would have pointed out that the Langstons did not first try to resolve the problem administratively.  Apparently, in doing so the IRS informed the Langstons that they were supposed to send a request to the “Chief, Local Insolvency Unit” of their district.

A few reorganizations ago, there existed in every IRS district (also a thing of the past) an insolvency unit that handled bankruptcy cases and a few other related proceedings.  Most of the IRS bankruptcy function was centralized some time ago, and local offices no longer had someone with the title “Chief, Local Insolvency Unit.”  Of course, if you weren’t following the staffing flows of the IRS, you would have no easy way of knowing this and that was the problem the Langstons faced in trying to make their administrative request for relief.  Here’s what the court said about it:

Then, Langstons’ counsel tried without success to find the right “Chief, Local Insolvency Unit” to receive an administrative claim. Many web searches and even formal discovery was met with no identified “Chief, Local Insolvency Unit.” Exasperated, Langstons’ counsel sent the administrative claim addressed to “Chief, Local Insolvency Unit” to every IRS office located within this district. The IRS admitted in discovery that to their knowledge no employee retains the title of “Chief Local Insolvency Unit” after the IRS reorganized in 2010. The IRS instead referred debtors’ counsel to a listing of “Collection Advisory Groups.” The IRS did respond after receiving debtor’s administrative claim noting they were referring it to the “Local Insolvency Unit.” But the IRS did not name a “Chief” of that unit. And so, it goes.

The Langstons could not show they had actual damages from the taking of $400 of his pension for four months.  Of course, they did incur attorney’s fees as their attorney tried to get the IRS to stop taking their money.  So, they sought attorney’s fees even though they were not entitled to damages.  The IRS fought the payment of attorney’s fees stating:

… [the] court does not yet have subject matter jurisdiction to decide the attorney’s fees issue because the debtors filed this adversary proceeding before filing an administrative claim with the IRS. They reason that their waiver of sovereign immunity under § 106(a)(1) for attorney’s fees claims stemming from automatic stay violations is conditioned upon a debtor’s compliance with 26 U.S.C. §§ 7430 and 7433 and the applicable regulations before filing suit. Counsel for the United States noted in oral argument that the Plaintiffs have now complied with the exhaustion requirement because they filed the administrative claim, albeit at the wrong time and that more than six months have passed with no action by the IRS. 26 C.F.R 301-7433-2(d)(ii).

The debtors must have wondered, “Wait a minute, how could we file an administrative claim prior to filing suit when your instructions told us to file the claim with someone who does not exist?”  Seems like a reasonable question to ask.

The IRS responded with two arguments.  First, it argued

“all that is required to satisfy the plain language of the regulation is that a writing be sent to ‘Chief, Local Insolvency Unit’,” the actual existence of an individual with that title being immaterial for compliance. 

[Keep that in mind because this is not the only place where the title in the regulations or other IRS guidance does not match the actual lineup at the IRS. Of course, the IRS did not say where the taxpayers should mail this letter and that could become an issue in a future case.]

Second, the IRS argued that the debtors’ reliance on Hunsaker v. United States, 902 F.3d 963, 968 (9th Cir. 2018) was misplaced.  Les blogged the district court opinion in Hunsaker here and the bankruptcy court opinion here.  We did not blog the 9th Circuit’s opinion in Hunsaker, in which it reversed the district court and determined that the bankruptcy code did waive sovereign immunity to obtain damages for emotional distress.  The IRS argued that the Langstons’ reliance on the 9th Circuit opinion was misplaced because Hunsaker did not address the situation where the only issue involved attorney’s fees.  It determined that there was a waiver for emotional damages, but here that issue does not exist.

The bankruptcy court looked at the litigation on this issue around the country and found that courts are split over the sovereign immunity argument.  Focusing on 9th Circuit jurisprudence, it found a 1992 opinion, Conforte v. United States, 979 F.2d 1375, 1377 (9th Cir. 1992) (almost all cases involving Conforte are worth reading if you enjoy cases with lurid details) holding that debtors must exhaust administrative remedies in order to receive attorney’s fees.  So, on the legal aspect of the IRS argument, the court finds that the IRS is correct in the precedent controlling it.

Then the court addressed the factual issue of whether the debtors did try to exhaust administrative remedies despite the barriers imposed by the IRS.  It stated:

In none of the cases previously discussed have the courts examined this issue raised by Plaintiffs — that complying with the statute is impossible. The courts either found that the taxpayer made no attempt (see Swensen v. United States (In re Swensen), 438 B.R. 195, 198 (Bankr. N.D. Iowa 2010); In re Rae v. United States, 436 B.R. 266, 275 (Bankr. D. Conn. 2010); Kight v. Dep’t of Treasury/IRS (In re Kight), 460 B.R. 555, 566 (Bankr. M.D. Fla. 2011)), or found that the taxpayer’s attempt was deficient for a number of reasons (see Klauer v. United States (In re Klauer), 23 Fla. L. Weekly Fed. D 153, at *11-14 (M.D. Fla. 2007); Don Johnson Motors, Inc. v. United States, 532 F. Supp. 2d 844, 883 (S.D. Tex. 2007); McIver v. United States, 650 F. Supp. 2d 587, 593 (N.D. Tex. 2009); Barcelos v. United States (In re Barcelos), 576 B.R. 854, 857-58 (Bankr. E.D. Cal. 2017); Galvez v. IRS, 448 F. App’x 880, 886 (11th Cir. 2011); Kuhl v. United States, 467 F.3d 145, 148 (2d Cir. 2006); In re Lowthorp, 332 B.R. 656, 659-61 (Bankr. M.D. Fla. 2005)), but no court addressed whether compliance was possible because the tax-payer was required to send the documents to a person that did not exist, nor was that argument ever raised.

Because the debtors’ original and amended complaint did not allege that they exhausted their administrative remedies, the court ultimately concludes that it cannot award attorney’s fees.  But it does not stop there.  Before dismissing the case without prejudice, it finds that

Plaintiff actually did send such a notice but after the lawsuit was filed. The IRS now admits Plaintiffs have complied and could proceed with another action for attorney’s fees.

I do not know if that means we should stay tuned for the second suit for attorney’s fees or that the Langstons can get fees if the IRS does not adequately resolve the matter.  In any event, it’s clear that the law here is not clear.  It’s also clear that the IRS paints itself into a corner when it asks people to do the impossible. 

Bankruptcy Decisions Impacting Taxes in 2018

We provided a year in review look at the Collection Due Process cases decided in 2018 on which we wrote. Here is a similar year in review for bankruptcy cases involving tax issues. We wrote 18 posts on bankruptcy issues involving a wide range of issues. For the most part 2018 was not a year of groundbreaking jurisprudence in the intersection of bankruptcy and taxes but cases continue to clarify certain areas not previously addressed or to supplement prior decisional law. Because it is possible to litigate the merits of a tax liability in bankruptcy as well as to eliminate the liability completely under the right circumstances, it is not possible to fully discuss tax procedure without examining the law and the case in the bankruptcy area.

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  • What is the effect of BC 523(a)(7) on the fraud penalty and how does bankruptcy impact the statute of limitations on collection?

In the case of United States v. Joel No. 3:13-cv-01102 (W.D. Ky. Oct. 18, 2018) the taxpayer committed fraud on the bankruptcy court. His bankruptcy case was reopened once the fraud was uncovered. At issue in this case is the impact of his bankruptcy case on the statute of limitations for collection.

https://procedurallytaxing.com/effect-of-a-revoked-discharge-on-the-suspension-of-the-collection-statute-of-limitations/

  • Interplay between the Federal Tax Lien and the Homestead exemption.

The bankruptcy trustee tries to use the federal tax lien to his advantage to bring property into the estate. The bankruptcy court holds that the trustee cannot step into the shoes of the IRS for the purpose of reaching property that he could not otherwise reach.

https://procedurallytaxing.com/the-federal-tax-lien-and-the-homestead-exemption/

  • Excluding pension plan from property of the estate.

Even though the Supreme Court ruled a couple of decades ago that pension plans are not included in property of the estate under BC 541, the issue of what is a pension plan remains and was addressed in this case. Here, the court holds that the taxpayers retirement plan did not qualify under ERISA and therefore the assets in the retirement account came into the bankruptcy estate for the creditors to use to satisfy their claims.

https://procedurallytaxing.com/bankruptcy-court-declines-to-exclude-retirement-plan-from-estate/

  • Tolling the Period for the IRS to obtain priority status for its claim

If the taxpayer files a prior bankruptcy case or submits an offer in compromise, the act can extend the period in which the IRS can file its claim as a priority claim. A pair of cases discuss how actions taken prior to bankruptcy can extend the statute. In the Clothier case the Assistant United States Attorney arguing the case initially, failed to fully apprise the bankruptcy court of the scope of the statute extension available which caused a motion for reconsideration and a revised opinion from the court once it understood the reach of the statute.

https://procedurallytaxing.com/suspending-the-priority-claim-period-and-an-update-on-clothier-v-irs/

https://procedurallytaxing.com/bankruptcy-court-limits-prior-supreme-court-decision-on-equitable-tolling/

  • Proper treatment of the EITC as source of funds for trustee vs taxpayer

Bankruptcy trustees regularly seek a chapter 13 debtors tax refund during the time the case is pending. The Seventh Circuit holds that the trustee does not have a right to a refund caused by the EITC if the taxpayer can show that the amount received by the taxpayer is needed for necessary expenses. Here there was evidence that the money the debtor received through the EITC tax refund allowed her to pay necessary expenses. Under these circumstances, the court did not order the debtor to pay over to the trustee the amount of the refund related to the EITC.

https://procedurallytaxing.com/proper-treatment-of-earned-income-tax-credit-in-calculating-disposable-income/

  • Who owns the refund in consolidated return cases

When some but not all members of a consolidated group go into bankruptcy the issue arises of who is entitled to refunds of the consolidated group and whether the refunds become property of the estate.

https://procedurallytaxing.com/who-owns-a-refund-consolidated-returns-and-bankruptcy-add-wrinkles-to-refund-dispute/

  • When can the bankruptcy court clawback money paid to the IRS by a fraudster

Cases regularly arise in which a party perpetrating a fraud pays taxes on the money gained by the fraud with the money fraudulent acquired. A circuit split exists on whether the bankruptcy court can clawback the money paid for the taxes in order to use it to repay the parties who lost it due to the fraudulent scheme.

https://procedurallytaxing.com/another-clawback-of-money-paid-to-the-irs/

  • The application of the voluntary payment rule in bankruptcy cases

The IRS allows taxpayers to designate the liability to which their payment will be posted if they make a voluntary payment. If the IRS levies to obtain money or otherwise obtains it involuntarily, it does not allow the taxpayer to designate how the payment will be applied. How does a bankruptcy payment fit into this scheme?

https://procedurallytaxing.com/bankruptcy-and-the-voluntary-payment-rule/

  • What happens when the IRS wrongly tells the taxpayer a debt was discharged by a bankruptcy case

Following bankruptcy many taxpayers have not spoken to their bankruptcy lawyer in a long time and rely upon the IRS determination regarding discharge. Sometimes the IRS person to whom they speak may give them wrong advice. What then?

https://procedurallytaxing.com/detrimental-reliance-on-the-irs/

  • Filing the notice of federal tax lien during the automatic stay

The stay prohibits collection action including filing the NFTL. In this case the IRS asked the bankruptcy court to lift the stay to allow it to file the NFTL and the bankruptcy court agreed to do so.

https://procedurallytaxing.com/filing-the-notice-of-federal-tax-lien-during-the-automatic-stay/

  • Must the IRS affirmatively obtain permission of the bankruptcy court before pursing post discharge collection from a taxpayer.

The IRS makes a discharge determination in each bankruptcy case in which it is listed as a creditor. When it makes the decision that a debt is excepted from discharge, it sends the case back into the collection stream. It does not seek a ruling from the bankruptcy court before doing so. One bankruptcy court challenged this practice. If the IRS must seek a ruling from the bankruptcy court in every case in which it makes a discharge determination and determines that the bankruptcy case did not discharge the taxes, the bankruptcy courts will see a definite rise in the cases on their dockets since it is common for some taxes to pass through bankruptcy without being discharged.

https://procedurallytaxing.com/does-irs-bear-the-responsibility-to-affirmatively-obtain-a-ruling-from-the-bankruptcy-court-before-pursuing-collection-after-discharge/

  • Can a taxpayer obtain a discharge on a late filed tax return

There is a serious circuit split on the meaning on the language at the end of BC 523(a) regarding late filed tax returns. These cases continue to bubble up although the pace has slowed and the tide has turned against the per se one day late rule adopted by three circuits. 2018 did not produce any groundbreaking decisional law in this area but an opinion from the 9th Circuit continued to provide a basis for court opinions on the subject of late returns.

https://procedurallytaxing.com/mr-smith-continues-to-suffer-from-his-failure-to-file-and-other-updates-on-late-filed-returns/

  • Validity of IRS claims in bankruptcy

A pair of cases examines how and when to attack IRS claims in bankruptcy. One deals with who is authorized to file the claim while the other deals with the amount of the claim.

https://procedurallytaxing.com/irs-claims-in-bankruptcy/

  • Priority claim status of unpaid individual mandate tax (penalty)

Several liabilities imposed by the IRC carry the label tax but walk like a penalty and talk like a penalty. Bankruptcy courts have determined that several such liabilities cannot result in priority status claims. It recently applied the same logic to the liability imposed by the individual mandate of the ACA.

https://procedurallytaxing.com/priority-status-of-individual-mandate-tax-obligation/

  • Dischargeability of the first time homebuyer credit

In an issue similar to the priority provision for the individual mandate, a bankruptcy court addresses the dischargeability of the credit. The similarity between to two situations is the need for the bankruptcy court to examine what type of debt is really present and whether the debt created when someone does not fulfill their obligation under the homebuyer credit provisions is tax debt or some other type of debt.

https://procedurallytaxing.com/dischargeability-of-the-first-time-homebuyer-recapture-liability/

  • Cases raising the issue of excepting a liability from discharge due to the fraud exception

Taxpayers who fraudulently evade their liability cannot obtain a discharge. A pair of cases are discussed.

https://procedurallytaxing.com/bankruptcy-cases-involving-evasion-of-payment-and-classification-of-the-failure-to-file-penalty/

  • Who can avoid the federal tax lien in a bankruptcy case

A debtor tries to avoid the federal tax lien and fails in a situation in which the trustee would have succeeded.

https://procedurallytaxing.com/avoiding-the-federal-tax-lien-securing-penalties-in-a-bankruptcy-case/

 

Ninth Circuit Affirms Earlier Decisions Denying Debtor Right to Alter IRS Lien after Bankruptcy

On November 7, 2017, I posted on the case of In re Nomillini in which the debtor sought to limit the secured claim of the IRS based on the confirmation of his chapter 13 plan. The Ninth Circuit, in an unpublished opinion dated December 18, 2018, denied the debtor’s motion to cut off the rights of the IRS lien in debtor’s property. Here, the debtor’s plan did not seek to limit the rights of the IRS as a secured creditor. The court relied on the normal rule that a lien against a debtor passes through the bankruptcy unaltered absent a specific attack on the lien as a part of the bankruptcy proceeding.

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The Ninth Circuit stated the general rule as follows:

For a debtor to avoid a creditor’s lien or otherwise modify the creditor’s in rem rights, the debtor’s confirmed plan must do so explicitly and provide the creditor with adequate notice that its interests may be impacted. Id. at 873. Any ambiguity in the plan will be interpreted against the debtor. Id. at 867.

Mr. Nomillini did not mention the IRS lien in his chapter 13 plan. He gave no notice to the IRS during his bankruptcy proceeding that he sought to reduce or eliminate its lien on his property. He sold his home. He entered into an agreement with the IRS that its lien would attach to the proceeds. The sale of the home brought a greater price than anticipated by the IRS when it filed its original lien. Based on the sale price, the IRS amended its claim to increase the amount of its lien claim to match the proceeds. Mr. Nomillini sought to limit the IRS lien claim to the amount of the original claim. He then brought an action seeking to avoid the IRS lien to the extent that it exceeded the original claim. The lower courts dismissed the case and the 9th Circuit affirmed.

Lien claims not only pass through bankruptcy unimpacted (absent a specific challenge) but the amount of a lien claim can change during or after a bankruptcy as the value of the property increases or decreases. When the IRS filed its original claim in this case, it had to value its lien claim and claim any portion not covered by equity in Mr. Nomillini’s property as an unsecured claim. Here, the value of the secured property turned out to be low either because the IRS made a wrong determination at the outset or because the property continued to increase in value. In either event the debtor does not receive a windfall because of the low value in the initial claim.

Once the property was sold, the value of the property was set and the IRS amended its claim up to the amount of the sales proceeds. The Ninth Circuit joins the lower courts in determining that the IRS has the right to do this. Had the property sold for less than the amount of the lien claim that the IRS made, the value of the lien claim would have decreased rather than increased. For this reason creditors often seek to protect themselves from a downward movement of value in secured property by seeking adequate protection. The IRS does not do this often because of the time involved to seek adequate protection and, in cases in which its lien is secured by real property, because of the difficulty in proving that the property will decrease in value.

The case resolves the issue in a manner consistent with existing law. The lesson here is that the value of a lien claim is not fixed at the time of filing bankruptcy.