Karrie L. Bercik, JD, LLM

New Cases of Interest

I. Discharge Cases

A. Priority Taxes

1. The Three-Year Period under §507(a)(8)(A)(i)

Benny Allen Daniel v. United States (In re Daniel) 81 AFTR2d Par. 98-578 (N.D. Ind 1998).

The court, granting the IRS summary judgment, held that the three-year "look-back" period of §507(a)(8)(A)(i) is suspended six months by §6503 for each of a debtor's prior bankruptcy petitions. The IRS contended that, as provided by §6503, §507(a)(8)(A)(i)'s three-year look-back period was extended six months for each of the debtor's three prior chapter 13 cases. The debtor argued that §6503 extends for six months the look-back period only once for all his bankruptcy cases. The IRS moved for summary judgment.

The judge, citing In re Montoya, 965 F.2d 554 (7th Cir. 1992), and In re Dodson, 191 B.R. 869 (Bankr. D. Or. 1996), held that the IRS is entitled to a six-month credit for each bankruptcy petition, provided that the time between a case's dismissal and a subsequent petition exceeds six months. The court in In re Dodson emphasized that the purpose of §6503 is to give the IRS ample time to "'restart and refocus its collection efforts once able to do so.'" The IRS contended in the debtor's case that it was entitled to the full six-month credit for each bankruptcy petition regardless of the time between dismissal and re-filing, but the judge said this method of counting would allow the government to "double count the days remaining on the [six-month] period until it expires during the pending bankruptcy case."

2. Offers in Compromise under §507(a)(8)(A)(ii)

Nancy P. Genung 81 AFTR2d Par. 98-593 (N.D. NY 1998).

The court held that, for purposes of priority status under 11 U.S.C. § 507(a)(8)(A)(ii), the assessment period is tolled during the pendency of an offer in compromise until the offer is rejected on appeal. The offer contained language that stated that the offer was pending until any appeal was resolved.

Michael Emerson, et ux. v. United States (In re Emerson) 80 AFTR2d Par. 97-5338 (W.D. LA 1997).

The court, entering summary judgment against the IRS, held that a debtor's tax liabilities were discharged in a prior chapter 7 case because the taxes were assessed outside the time period specified in §507(a)(8)(A)(ii), which pertains to the pendency of an offer in compromise. The debtors filed an offer in compromise that was rejected by the IRS. They appealed the decision. The court held that the offer was outstanding until rejected by the IRS. The offer was not outstanding during the pendency of the appeal. Thus, the taxes were dischargeable.

Lawrence C. Chelena v. IRS (In re Chelena) 80 AFTR2d Par. 97-5509 (N.D. GA 1997).

The court ruled that a debtor's tax liabilities are not dischargeable, because the IRS assessed them within the time period specified under §507(a)(8)(A)(ii) with respect to the pendency of an offer in compromise. The court found that the IRS assessed debtor's 1989-92 taxes within that time period and that the debtor filed no objection to the government's motion for summary judgment on the issue.

In re: Hillmer J. Little II, et ux. 80 AFTR2d Par. 97-5644 (E.D. N.C. 1997).

The court, disagreeing with four courts of appeal, held that the 240-day priority period of §507(a)(8)(A)(ii) is not tolled during the pendency of a bankruptcy proceeding.

3. Assessable But Not Assessed under §507(a)(8)(A)(iii).

In re Smargon, 212 B.R. 1001 (BK M.D. FLA 1997)

The court held that a tax was priority under §507(a)(8)(A)(iii) where the debtor mailed a letter to the IRS stating he would seek a redetermination of his tax assessment. The court found that the letter was a petition for redetermination that tolled the statute of limitations for assessment. Thus, the tax was still assessable on the date of filing the bankruptcy petition.

B. What constitutes a Return for purposes of §523(a)(1)(B)?

John C. Pierchoski v. IRS (In re Pierchoski) 81 AFTR2d Par. 98-641 (W.D. PA 1998).

The court held that a debtor's 1983-89 tax liabilities were not excepted from discharge even though he didn't file his returns until after the IRS made assessments, rejecting the IRS's contention that the debtor's post-assessment filings could not be considered "returns" under 11 U.S.C. §523(a)(1)(B).

The judge found nothing in §523(a)(1)(B) to support the IRS's position that a Form 1040 must be submitted before assessment in order to qualify as a "return." The court refused to follow the several cases on which the IRS relied, following the minority position of In re Hindenlang, 205 B.R. 874 (Bankr. S.D. Ohio 1997), aff'd, 214 B.R. 976 (S.D. Ohio 1997) instead.

The only provision in §523(a)(1)(B) regarding the timing of a return, the judge explained, is in §523(a)(1)(B)(ii), which provides that a discharge is denied if the taxpayer files a return after the due date and within the two years preceding the debtor's bankruptcy filing. There is nothing regarding "the temporal relationship between the filing of a 'return' and the assessment of tax liability by the IRS," the court stated. And because Congress referred to assessment in §507(a)(8), the court concluded that the absence of such a reference in §523(a)(1)(B) was intentional and significant.

Jerry R. Savage v. IRS (In re Savage) 81 AFTR2d Par. 98-434 (BAP 10th Cir 1998).

The Tenth Circuit Bankruptcy Appellate Panel held that Forms 1040 filed with the wrong IRS service center were not properly "filed," but that returns filed with the correct center were "returns" even though assessments had already been made. The Service insisted that the forms were amended returns that are not "returns" for dischargeability purposes, citing Arenson v. United States, 145 B.R. 310 (D. Neb. 1992). The court rejected the IRS's statutory interpretation and pointed to other courts that have taken contrary positions, such as in Hindenlang v. United States (In re Hindenlang), 205 B.R. 874 (Bankr. S.D. Ohio), aff'd, 214 B.R. 847 (S.D. Ohio 1997). Judge Cornish also noted that §523(a)(1)(B)(i) does not refer to assessment and, thus, should not be read to preclude a finding that a debtor has filed a "return" even if an assessment has already been made.

United States v. William C. Hindenlang (In re Hindenlang) 80 AFTR2d Par. 97-5407 (DC OH 1997)

A U.S. district court, affirming a summary judgment granted to a debtor on the dischargeability of taxes, held that the debtor's returns, which were based on IRS substitute returns, were proper even though the debtor filed the returns after the IRS assessed the taxes. The taxes were discharged.

Alan Wayne Gentry v. United States 81 AFTR2d Par. 98-491 (DC Tenn 1998)

A U.S. district court has affirmed a bankruptcy court's summary judgment against an uncooperative debtor seeking to discharge tax liabilities, holding that his Forms 870 and 4089 were not constructive returns. The court found that the debtor's prior refusal to cooperate with the Service's collection efforts doomed his contention that filing the forms was intended to act as a return for assessment and collection purposes. The taxes were not discharged.

Robert McGrath v. United States (In re McGrath) 80 AFTR2d Par. 97-5678 (BK N.D. N. Y. 1997).

The court held that a debtor filed "returns" when he filed Forms 1040 after the IRS made assessments, and thus his taxes were dischargeable under §523(a)(1)(B). However, the court ruled that the taxes were nondischargeable under §523(a)(1)(C) because the debtor had attempted to evade the taxes.

In re Hatton, 216 B.R. 278 (9th Cir BAP 1997).

An SFR followed by a signed voluntary payment agreement and Form 433-D constitutes a "return" for purposes of §523(a)(1)(B).

In re Mickens, 215 B.R. 693 (BK N.D. Ohio 1997).

Tax return filed by Chapter 7 debtor more than seven years after IRS made assessment was not a return for purposes of §523(a)(1)(B).

In re LaRue, 215 B.R. 766 (BK D. AZ. 1997).

Debtor did not file return when he filed a tax return with no information except zero on line for tax owed. A frivolous return is not a return.

C. Chapter 13

Marshal J. Dixon, et ux. v. IRS (In re Dixon) 81 AFTR2d Par. 98-482 (W.D. OK 1997).

The court held that a claim for income taxes that was entitled to priority in the debtors' chapter 13 proceeding was discharged without having been paid, because no claim was filed by or on behalf of the IRS.

The debtors filed their chapter 13 petition on April 9, 1993, listing a debt to the IRS for 1992 taxes. One week later the debtors filed their 1992 tax return without paying the balance due. The bankruptcy court confirmed the debtors' chapter 13 plan, which provided for full payment to the IRS. No claim, however, was filed on behalf of the IRS.

The debtors made all the payments required by the chapter 13 plan, but no payments were distributed to the IRS. The debtors received their discharge in March 1996. The IRS then began collection efforts with respect to the unpaid 1992 tax debt. The debtors commenced this adversary proceeding, seeking a determination that the 1992 tax debt was discharged. The court concluded that the liability was discharged under 11 U.S.C. § 1328(a) because the debt was provided for by the confirmed chapter 13 plan; the IRS did not receive payment because no proof of claim was filed.

United States v. Larry Price (In re Price) 81 AFTR2d Par. 98-744 (M.D. PA 1998)

The court has denied the Service's motion to vacate an order granting the chapter 13 debtor a discharge without payment of the Service's claim, reasoning that the IRS failed to timely object to the debtor's plan.

The IRS filed a proof of claim in debtor's chapter 13 case; the secured tax claim was nearly $161,000. The debtor's plan didn't provide for full payment of the tax claim, but the plan was confirmed in January 1992. Two weeks later the debtor filed an objection to the Service's claim; the IRS filed an answer, but the court held no hearing on the debtor's objection.

The court rejected the Service's contentions that (1) the discharge order was entered by mistake and should be revoked or (2) the chapter 13 plan was invalid because it failed to provide for a priority tax claim. Regarding the validity of the chapter 13 plan, the court held that under 11 U.S.C. § 1322(a)(2), the IRS had agreed to less than full payment of its priority claim by failing to object to the plan. The court also relied on In re Szostek, 886 F.2d 1405 (3d Cir. 1989).

II. Section 505(b)

In re: Paul W. Goodrich 81 AFTR2d Par. 98-600 (Mass 1998)

The court held that the IRS's issuance of an 11 U.S.C. § 505(b) letter does not release a bankruptcy estate from liability for post petition tax penalties and interest. In Paul Goodrich's chapter 7 case, the trustee filed post petition tax returns for the estate, paid the tax liability due in full. and requested a determination, under section 505(b), of the bankruptcy estate's unpaid tax liability. The IRS responded by letter that it accepted the returns as filed; nevertheless, because the returns were filed late, the IRS filed an administrative claim for $84,000 in unpaid penalties and interest.

The trustee filed a proposed distribution of assets, allowing 50 percent of the IRS's claim as a non administrative claim and disallowing the remaining 50 percent. The IRS objected to the distribution on the basis that its entire claim was administrative in nature and, thus, was entitled to payment along with other administrative claims.

The trustee argued that the estate was discharged of liability because the IRS issued a section 505(b) letter. The IRS responded that the discharge under that section applies only to the trustee, the debtor, and the debtor's successor, not to the estate. The IRS relied on Kellogg v. United States (In re West Texas Marketing Corp.), 54 F.3d 1194 (5th Cir. 1995) , while the trustee relied on In re Flaherty, 169 B.R. 267 (Bankr. D.N.H. 1994).

The court, finding merit to both positions, concluded first that the legislative history shed no light on the issue. The court then noted that section 505(b) addresses a specific problem and is not one of those bankruptcy sections that is related to others that must be consulted to interpret section 505(b). Thus, "In the absence of useful legislative history, and absent a conflict with any other section of the [Bankruptcy] Code," the judge resorted to the plain language of section 505(b), which does not extend to an estate and concluded that the IRS's entire claim was entitled to first priority status as an administrative claim.

III. Setoff of Refunds against Pre-petition Taxes

Maurice Len Alexander v. IRS (In re Alexander) 81 AFTR2d Par. 98-634 (W.D. KY 1998).

A U.S. bankruptcy court has held that the IRS may not offset a tax refund against the debtor's exempt property, reasoning that the creditor's right of setoff in 11 U.S.C. § 553 is superseded by the debtor's right to exempt assets under 11 U.S.C. § 522.

The court noted that § 553(a) preserves the IRS's right of setoff granted under § 6402 of the IRC if the debts are mutual and both parties' obligations arose prepetition. Those conditions were satisfied in this case. The court distinguished this case, however, by pointing out that the IRS had set off the refund against property that the debtor had claimed as exempt under state law, which is protected by §522(c). Because none of the exceptions under § 522(c) applied, the court concluded that the debtor's refund could not be used to satisfy his pre-petition tax debt. The court found some cases supporting the Service's offset against exempt property, but found that the majority of courts have concluded that property exempted under § 522 is not subject to offset. Deciding to follow that majority rule, the judge said that § 553 "does not supersede [section] 522. Rather, [section] 522 must be given priority." Any other conclusion, the court stated, would render § 522(c) meaningless.

In re Kirkpatrick, 214 B.R. 314 (BK, S.D. Ohio 1997).

The court held that the IRS was not entitled to relief from stay in a Chapter 13 case to set off refund owed to the debtor against the debtor's prepetition tax liability.

IV. Property of the Estate

A. Earned Income Credits

Several cases have discussed whether the earned income credit is property of the estate. They come to different conclusions.

Robert L. Baer, et al. v. Jan Becky Montgomery, et al. (In re Montgomery) 81 AFTR2d Par. 98-636 (BAP 10th Cir 1998).

The Tenth Circuit Bankruptcy Appellate Panel held that chapter 7 trustees are entitled to recover earned income credits the debtors claimed as refunds for the year during which they filed for bankruptcy, rejecting the lower court's decision that the EICs didn't accrue until the end of the tax year, which was post petition. The EIC was property of the estate.

In re: Jeff George, et ux. 81 AFTR2d Par. 98-681(N.D. OK 1998)

The court has that a couple's earned income credit was property of their bankruptcy estate under §541(a)(1), but that the credit was exempt property under Oklahoma law. Citing In re Davis, 136 B.R. 203 (Bankr. S.D. Iowa 1991) the court concluded that debtors have a clear interest in the credit under §32 and that §541(a)(1)'s definition of "property of the estate" is very broad. However, the court held that the EIC is exempt under Oklahoma law as "support" within the meaning of the phrase "alimony, support, separate maintenance or child support payments. The court reasoned thatch state statute "does not limit the exemption to payments arising from a divorce decree."

In re: Juanita Fraire, et al. 81 AFTR2d Par. 98-680 (DC KAN 1997).

A U.S. district court, affirming the bankruptcy court, has held that earned income credits are property of the bankruptcy estate under §541 and are not exempt under state (Kan.) law as "support" of the debtor within the meaning of §522(d)(10)(D).

V. COD Income

A. Insolvency Exception

Dudley B. Merkel, et ux. et al. v. Commissioner 109 T.C. No. 22 (1997)

The Tax Court held that two couples are not entitled to exclude discharge-of-indebtedness (COD) income under §108(d)(3)'s insolvency provision, rejecting their contention that the husbands' liabilities under corporate guarantees and on a corporate state tax assessment rendered the couples insolvent. The court stated that the payment obligation must be 'more probable than not' to constitute a liability under the insolvency provision.

B. Basis

Mel T. Nelson v. Commissioner 110 T.C. No. 12 (1998).

The Tax Court, in a reviewed decision, has held that cancellation-of-indebtedness (COD) income realized but not recognized by an insolvent S corporation is not passed through to the shareholder and, thus, does not increase the shareholder's basis in his stock.

TAM 9739002 (May 19, 1997).

The Service has ruled in technical advice that a partner may increase the basis in his partnership interest by his share of the partnership's income from the discharge of indebtedness that is excluded from the partner's income under the insolvency exclusion.

Questions, comments or suggestions? kbercik@taxcounsellor.com

Last updated June 24, 1998

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