From: David Moore
Subject: Bankruptcy Tax Bulletin--October 3, 2001


The Bankruptcy Tax Bulletin
October 3, 2001

Dear Subscribers,

This week's bulletin features the Supreme Court's decision to grant certiorari in a First Circuit case holding that the three-year lookback provision for tax claims was automatically tolled during the pendency of the debtors' prior bankruptcy case.

Also included are a bankruptcy court decision that an individual's prepetition overpayment of taxes wasn't part of the bankruptcy estate; a bankruptcy court decision that IRS tax liens attached to a couple's equitable interest in property even though they didn't acquire record ownership of the property until after their bankruptcy petition was filed and the tax debt was discharged; and a district court decision that an estate's executor had a fiduciary duty to the government for purposes of 11 U.S.C. section 523(a)(4).

Please send any comments or suggestions to bankruptcy.group@tax.org.

David Moore, moderator

1. Supreme Court to Consider Tolling Issue in Successive Bankruptcy Cases

The Supreme Court has granted certiorari in a First Circuit case holding that the three-year lookback provision for tax claims was automatically tolled during the pendency of the debtors' prior bankruptcy case.

Cornelius and Suzanne Young filed their 1992 federal income tax return on October 15, 1993. Their return showed taxes due, but no payment accompanied the return. Instead, the Youngs made modest payments to the IRS for a number of months, and then, on May 1, 1996, filed for Chapter 13 bankruptcy.

The IRS filed a proof of claim for the unpaid 1992 taxes, but the Youngs moved to dismiss their Chapter 13 petition on October 23, 1996. The bankruptcy court did so on March 13, 1997, which would normally terminate the automatic stay. However, one day before the Chapter 13 proceeding was closed, the Youngs filed a new "no asset" bankruptcy petition under Chapter 7. This in turn continued the automatic stay. On June 17, 1997, the Youngs received a discharge in the Chapter 7 proceeding, generally discharging their debts "[e]xcept as provided in [11 U.S.C.] section 523."

After the discharge the IRS sought the unpaid balance for the Youngs' 1992 taxes, and the Youngs then asked the bankruptcy court to rule that their remaining 1992 tax liability had been discharged. The IRS countered that sections 523(a)(1)(A) and 507(a)(8)(A)(i) preclude the discharge of any claims for taxes for which the return was due three years or less before the petition was filed. The Youngs' 1992 return was due on October 15, 1993; more than three years before their Chapter 7 petition was filed on March 12, 1997. But the IRS argued that in calculating the three-year period under section 507, the court should exclude the period during which the Chapter 13 automatic stay had prevented the IRS from collecting the Youngs' tax debt. If this is done, the elapsed delay is well under three years.

Following the majority view, the bankruptcy court agreed with the IRS that the three-year lookback period in section 507 should be tolled during the period of the prior automatic stay. The district court affirmed, saying that the better reasoned decisions supported this result.

The First Circuit affirmed the judgment of the district court. The court noted that virtually all of the circuit cases dealing with successive bankruptcy petitions and the three-year lookback provision have held that some judge-made tolling adjustment is required for section 507(a)(8)(A)(i). According to the court, the most common rule, adopted by five circuits, is that the lookback period is automatically tolled during a prior bankruptcy. Three other circuits, the court said, have held that the lookback period is not automatically tolled by a prior bankruptcy proceeding, but that equitable considerations may permit tolling on a case-by-case basis.

The First Circuit elected to follow the majority view in favor of automatic tolling. The court explained its decision as follows: "In some cases, the equities alone might justify tolling, but the automatic tolling rule rests on a broader basis: it preserves for the government the benefit of the 1966 compromise by giving it the full three years to assess and collect taxes. The taxpayer is faced with 'old' tax claims only if he or she has chosen to make back-to-back bankruptcy filings. And, as a final, although less important benefit, automatic tolling is infinitely easier and more predictable to administer." (For a summary of the First Circuit's opinion, see Tax Notes, Dec. 11, 2000, p. 1408; for the full text, see Doc 2000-31181 (11 original pages) or 2000 TNT 235-10.)

The Supreme Court on September 25 granted certiorari in Cornelius P. Young, et ux. v. United States, S. Ct. Dkt. No. 00-1567.

2. Prepetition Overpayment Not Part of Bankruptcy Estate

A bankruptcy court has held that an individual's prepetition overpayment of taxes wasn't the bankruptcy estate's property, which precluded the estate's trustee from obtaining the refund.

Helen Metcalf overpaid her 1999 income taxes and elected to have the overpayment applied to her estimated liability for the next year. Metcalf filed a Chapter 7 petition. Harvey Morton, the estate's trustee, filed an amended return, seeking to rescind the election and receive the 1999 refund on the estate's behalf. Both the trustee and the government moved for summary judgment. The IRS argued that because Metcalf elected before filing her bankruptcy petition to have the overpayment applied to the next year's liability, that election was irrevocable and, thus, the refund wasn't the estate's property because Metcalf no longer had any interest in it. The trustee countered that the refund was the estate's property and that the IRS was required under 11 U.S.C. section 524(a) to deliver the property to him.

U.S. Bankruptcy Judge Robert L. Jones (Northern District of Texas, Abilene Division) granted summary judgment to the government, holding that once an overpayment is properly transferred to the IRS prepetition, it can't become property of the estate and isn't recoverable under 11 U.S.C. section 542. The court noted that such an overpayment is essentially an advance payment on the subsequent year's tax bill and can't be subject to turnover.

3. Tax Liens Attached to Couple's Equitable Interest in Property

A bankruptcy court has held that IRS tax liens attached to a couple's equitable interest in property even though their personal tax liability was discharged and they didn't acquire record ownership of the property until after they filed their bankruptcy petition.

Thomas and Barbara Ready and David and Joy Lively entered into a written agreement in 1984 to convey their respective residences to each other by warranty deed. The agreement provided that the warranty deeds would be held in escrow until the properties were refinanced. The Readys lived in the Livelys' former residence on Laurel Lane for 16 years and paid all of the expenses associated with the home. The deed to the home was not recorded, however, due to the Ready's inability to obtain refinancing.

The IRS determined that the Readys owed income taxes for 1990 and 1991 and filed tax liens against the Laurel Lane property. The Readys filed a Chapter 7 bankruptcy petition and received a discharge in August 1999. The bankruptcy court determined that the Readys' income tax liabilities were dischargeable, but the tax liens remained in effect as to any property or rights to property belonging to them as of the filing of their bankruptcy petition.

The Livelys signed a quitclaim deed transferring the Laurel Lane property to the Readys in December 1999. The Readys then filed a motion in the bankruptcy court seeking sanctions against the IRS for willfully violating the permanent injunction stemming from their discharge by not releasing the tax liens on the Laurel Lane property. The IRS argued that it was entitled to enforce the tax liens because the Readys had acquired a right or interest in the property prior to the filing of their Chapter 7 petition.

U.S. Bankruptcy Judge Paul M. Glenn (Middle District of Florida, Tampa Division) held that the IRS was entitled to enforce its tax liens on the Laurel Lane property. The court concluded that the Readys held a beneficial or equitable interest in the Laurel Lane property at the time they filed their bankruptcy petition, and that the tax liens attached to the equitable interest even though the Readys' personal liability for the underlying tax has been discharged, and even though they did not acquire record ownership of the property until after the bankruptcy case was filed. Because the IRS was entitled to enforce its tax liens, the court determined that the IRS had not violated the permanent injunction and denied the Readys' request for sanctions.

For the full text of the bankruptcy court's opinion in In re Thomas G. Ready, et ux., 88 AFTR2d Par. 2001-5332 (Sep. 7, 2001), see Doc 2001-24573 (11 original pages) or 2001 TNT 186-12.

4. Executor Has Duty to Pay Estate Taxes; Dischargeability Issue Can Proceed

A district court has held that because an estate's executor had a fiduciary duty to the government to pay estate taxes, the IRS could proceed with its objection to the dischargeability of the executor's personal tax debt in bankruptcy court.

Daniel Tomlin Jr. was the coexecutor of his father's estate. The IRS alleged that the estate taxes remained unpaid because of Tomlin's acts as executor. The IRS sought to obtain a judgment against Tomlin for breach of his fiduciary duties. Tomlin filed a Chapter 7 bankruptcy petition seeking to discharge his indebtedness to the IRS. The government objected to any discharge, arguing that Tomlin's indebtedness was excepted from discharge under 11 U.S.C. section 523(a)(4) because his acts amount to "fraud or defalcation while acting in a fiduciary capacity." Tomlin moved to dismiss the government's complaint, arguing that, as a matter of law, he did not owe a fiduciary duty to the IRS to pay the federal estate taxes.

The bankruptcy court denied Tomlin's motion to dismiss, holding that, under Texas law, an estate executor occupies a position of trust to all parties who have an interest in the estate, especially to creditors when the estate is insolvent, and that the executor's duty to creditors extends to the United States. (For a summary of the bankruptcy court's opinion, see Tax Notes, Dec. 25, 2000, p. 1730; for the full text, see Doc 2000-33558 (4 original pages) or 2000 TNT 244-1.) The bankruptcy court granted Tomlin leave to bring an interlocutory appeal from the order denying his motion to dismiss.

U.S. District Judge Sidney A. Fitzwater (Northern District of Texas, Dallas Division) affirmed the bankruptcy court's decision, holding that Texas common law creates the trust-type obligation that section 523(a)(4) requires. The court found that because an independent executor was charged with the duty of paying claims against the estate, Tomlin, as executor, had a fiduciary duty to pay the estate taxes to the IRS. Thus, the district court concluded that the bankruptcy court correctly denied Tomlin's motion to dismiss the government's complaint objecting to discharge, and remanded the case to the bankruptcy court for further proceedings.

For the full text of the district court's opinion in United States v. Daniel O. Tomlin Jr., 88 AFTR2d Par. 2001-5334 (Sep. 6, 2001), see Doc 2001-24575 (8 original pages) or 2001 TNT 186-13.

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