Taxes and BAPCPA Not Such a Bad Effort

Taxes and BAPCPA Not Such a Bad Effort

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The hallmark of a good legislative fix is not that the decisions come out right, it's that it makes the decisions go away altogether. An obvious example is the change made in 1994 to the deadline in §546(a) for filing avoidance actions. Prior to that change, decisions about those deadlines had generated a veritable cottage industry of conflicting decisions and analyses of the numerous factual variations. No less than eight appeals courts (the 2nd, 3rd, 4th, 6th, 7th, 8th, 9th and 10th) had weighed in, with no discernible consensus on the correct answer (and many had issued multiple decisions on different fact patterns). In addition, there were hundreds of lower-court opinions (as of Jan. 1, 1995, there had been 310 opinions discussing §546(a), with others still issuing thereafter in cases that had been filed before the new law took effect.)

After the new language was enacted, cases under this section dropped to almost none. There have been a few decisions with respect to whether the selection of an interim trustee met the deadline, but the section was actually well enough written that the few decisions that did issue generally all came out the same way. See, e.g., In re Allied Digital Technologies Corp., 341 B.R. 171 (D. Del. 2006). In short, the best reward a good legislative drafter can hope for is a resounding silence in the courts. 1

Interestingly, for better or for worse, the drafters of the means test in the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) may have achieved that goal, at least with respect to the initial goal of using the test to determine which cases should be diverted to chapter 13 and which could remain in chapter 7. Of course, the secondary use of the means test in chapter 13 for above-median income debtors has, on the other hand, spawned a multitude of cases. The problem is engendered in large part because of the disconnect between its use in chapter 7 as a quick-and-dirty screening tool, and the attempt to use it in chapter 13 to fine-tune the actual payments to be made. The possibly correct, but logically absurd, position espoused in In re Farrar-Johnson, ___ B.R. ___, 2006 WL 2662709 (Bankr. N.D. Ill. 2006), that debtors should be able to deduct the entire $1,233 housing allowance even though they received free housing from the military, is perhaps the most obvious example of the problems arising from the use of the means test in this regard. Graded on the "silence" standard, the drafters of the means test failed miserably, not with regard to the need for a uniform means test, but because of their refusal to allow the political process of getting the bill passed to be impinged upon by the more or less constructive criticism that it received from all sides about the details of what it was doing.

In any event, under this standard (otherwise known as the "first, do no harm" standard), the new tax provisions in the Code appear, on the other hand, to have largely been successful. The taxing authorities that participated on the task force before the National Bankruptcy Review Commission and made suggestions to the legislative drafters on BAPCPA and its predecessors did not seek major substantive changes to existing Code provisions. Instead, in most cases, they sought merely to codify and clarify favorable decisions from the Supreme Court and the lower courts as well as to write into law sensible practices used in many, but by no means all, courts.

One such codification was made to §507(a)(8) by including tolling language that expanded upon the decision in Young v. U.S., 535 U.S. 43 (2002). In that case, the Supreme Court had sided with taxing authorities who had argued that a prior bankruptcy should toll the time periods for priority status and dischargeability of taxes. The new provision not only provides for tolling for time spend in prior bankruptcies but also for other delays, such as while the parties are pursuing offers in compromise. It also adds an extra 90 days after the end of the bankruptcy or other tolling event to account for the time needed to bring a mothballed case back to life after attention has been diverted from it. To date, the only decision reported under this section appears to be In re McDaniel, ___ B.R.___, 2006 WL 2413684 (Bankr. M.D. Fla. 2006), where the court allowed a debtor to dismiss her case after her counsel failed to account for these tolling periods in deciding when to have her file her petition. The court concluded that where the tolling provisions would still leave the United States with at least two more years to pursue the debt after the case was dismissed, the debtor should not lose any chance of eventually obtaining a fresh start. Apparently, other debtors' counsel have been able to count better.

Other sections that have also occasioned little or no litigation are the provisions that create an automatic exception for the setoff of pre-petition tax debts and refunds from the automatic stay (§362(b)(26)),2 and those that require that plans provide for the payment of taxes in equal installments over not more than five years from confirmation, with interest as determined under nonbankruptcy law (§§1128(a)(9)(C) and 511, respectively). The only published case addressing §511 is In re Davis, ___ B.R. ___, 2006 WL 2594865 (Bankr. N.D. Tex. 2006), which held that even private parties could invoke the provision where they had participated in a tax sale and acquired the right to collect on a tax claim. Clearly, the idea was to prevent parties from using bankruptcy as a way to write themselves a low-cost loan for their taxes, particularly since taxes are the "lifeblood" of government, Raleigh v. Illinois Dept. of Revenue, 530 U.S. 15, 21 (2000). Moreover, since the Code deprives governmental tax creditors of the right to vote on a plan so long as the debtor complies with the minimum provisions for plan confirmation, it makes sense for those tax claims to not be artificially discounted below what would be owed outside of bankruptcy. The decision to grant the same status to private creditors is less clear, but perhaps explainable as a way to ensure that the government will receive the highest return from its tax sales and will collect as much as possible of the revenues to which it is entitled.

Although some had suggested the interest provisions could be too difficult to meet, it would appear that the lack of attacks thereon by parties seeking confirmation would indicate that it had been possible for debtors to confirm plans with these provisions. Alternatively, of course, it may be that debtors are simply ignoring the provisions in their plan and gambling that neither the court nor the taxing authorities will catch the error and demand correction. Or finally, it may simply mean that most chapter 11 cases in which this provision will be relevant that have been filed since the effective date of BAPCPA have yet to come to confirmation. Only time and close vigilance by taxing authorities will tell which is the answer and ensure that this provision is complied with.

The automatic stay exception for setoff of taxes tracks what many courts already did officially or unofficially. It was generally agreed that because the earlier a setoff could be affected, the sooner the debtor would stop accruing interest and penalties on any unpaid tax debts, allowing such to take place automatically would be beneficial to the debtor in most cases. Cf. In re Rivera, 345 B.R. 229 (Bankr. E.D. Cal. 2005). Moreover, since the courts generally agree that they cannot impose their own "equitable" limitations on the right to setoff allowed by §553,3 there would be few if any occasions where the setoff would not be allowed if requested. Thus, making the setoff automatic unless the exceptions set forth in the section apply serves all parties because it avoids making them spend the time and effort to litigate the issue or bring the motion to lift the stay. Perhaps because the benefits are so obvious, there appear to have been no decisions on this topic as yet.

The one provision that does appear to have engendered significant litigation thus far is the requirement that the debtor must provide various tax returns to the trustee and creditors. Section 521(e)(2)(A) requires that the debtor provide "not later than seven days before the date first set for the meeting of creditors" a copy of the federal income tax return "for the most recent year ending immediately before the case and for which a federal income tax return was filed." Section 521(f) requires the debtor to file with the court, upon request, a copy of each income tax return for post-petition years, and any returns required under applicable law for any tax year ending during the three-year period prior to the filing of the case that had not been filed at that time but that were subsequently filed. That provision, in turn, is tied in chapter 13 to new requirements (in §§1307(e), 1308(a) and 1328(a)(9)) to file all required tax returns for periods ending during the four-year period prior to the petition date) in order to remain in chapter 13 and confirm a plan.4 Interestingly, there appears to be no similar provision in chapter 11, which may be due to the focus of much of BAPCPA solely on individual chapter 7 and 13 debtors (to the exclusion of dealing with chapter 12 at all in most places)!

There are a number of interesting issues that have arisen in this regard. First, and apparently easiest for the courts, is the question of whether the "beyond the debtor's control" language protects debtors whose attorneys have failed them. The courts have, to date, all agreed that the debtor should not be liable either for the attorney's failure to appreciate the new duties under BAPCPA or his negligence in timely forwarding documents received from the debtor to the court. See In re Moser, 347 B.R. 471, 472 (Bankr. W.D.N.Y. 2006) (attorney admitted he had returns more than a week in advance of the §341 meeting and simply failed to forward them); In re Duffus, 339 B.R. 746, 748 (Bankr. D. Ore. 2006) (same); In re Grasso, 341 B.R. 821, 823-25 (Bankr. D. N.H. 2006) (experienced bankruptcy counsel hadn't realized that there was a new deadline; client provided returns immediately upon request made three days before §341 meeting and trustee agreed he was not prejudiced); In re Merrill, 340 B.R. 671 (Bankr. D. N.H. 2006) (returns provided to attorney more than seven days in advance of §341 meeting, but not forwarded).

The next issue that the courts have addressed (generally in dicta since they already decided that the failure to provide the information could be excused) is whether the trustee retains discretion in deciding whether or not to seek to dismiss the case. Both Duffus and Grasso concluded that the trustee did have such discretion, despite the apparently mandatory dismissal language in the statute. They concluded that the language applied to the court, but did not require the trustee to bring the matter to the court's attention. (And with the trustee practicing benign neglect, the court presumably would not generally have reason to know the information had not been timely furnished). Both cases relied on cases discussing the trustee's discretion to bring suit, although those cases generally dealt with avoidance actions that had no similar mandatory language involved. Both cases also compared the language in §521(f) to language in §521(i)(1), which they held really required automatic dismissal of a case for the debtor's failure to provide other forms of information.5

On the other hand, In re Norton, 347 B.R. 291, 302 (Bankr. E.D. Tenn. 2006), concluded that the trustee had no authority to waive the debtor's failure to timely provide his income tax return. It is probably no coincidence that the ruling occurred in a case where the debtor could not blame his failure on counsel and had, apparently, not provided the return even by several weeks after the §341 meeting. That court looked at the requirement that debtors "shall" provide their returns and that the court "shall" dismiss the case, unless there is a bona fide excuse and concluded that those provisions gave the trustee no authority to seek an extension for the debtor to comply. Section 521(e)(2)(B), the court noted, only provided for the debtor to seek to avoid dismissal and there was no role for the trustee to play. Whether this case will push the consensus in the opposite direction remains to be seen, but, in light of many courts' reluctance to dismiss cases even where "automatic dismissal" is provided for, it is quite possible that this provision will turn out to have more discretion than Congress might have imagined.

The next issue is one that hopefully will be resolved by assuming, even if the language used was ambiguous, that Congress should be presumed to be seeking to accomplish reasonable goals. That issue deals with which pre-petition return needs to be provided. Section 521(e)(2)(A) requires the debtor to provide the return "required under applicable law" for the "most recent tax year ending immediately before the commencement of the case and for which a federal income tax return was filed." Two cases have dealt with the issue. The first, Merrill, decides one aspect very sensibly. In that case, the debtor filed in January 2006 and the §341 meeting was held on Feb. 16. As of that date, the most recent tax year prior to the meeting was 2005, but the debtor was not required to, and had filed the return by that date, since it was not due until April 15. The court concluded that, during the period from January-April 15 (or presumably later if the debtor obtained an extension), the logical reading of the section was that the required return was the one for 2004 (i.e., the most immediate year before the bankruptcy for which the debtor had both been required to file, and had filed, a return). There is no problem with that reading since §521(f)(2) requires the debtor, upon request, to file any returns that had not been filed at the commencement of the case but were later filed (i.e., by April 15), for any tax year ending within the three years prior to the filing, which would thereby cover the 2005 tax year.

The other case, In re Ring, 341 B.R. 387 (Bankr. D. Me. 2006), raised, but found it unnecessary to decide, the more difficult issue. In that case, two sets of debtors sought a ruling that they had satisfied their obligations even though they had not provided any pre-petition tax returns. In both cases, their sole income had been from Social Security payments (for 10 and 20 years, respectively) at levels below that which would have required they file a return. In both cases, they had requested their last prior return (from many years earlier) from the IRS, but it had not been able to provide one. The court first held that, in view of the IRS' inability to supply the returns, the failure to comply was for reasons "beyond the debtor's control." It then noted that, because it had excused the debtors' failure, it did not need to decide whether the statute required returns to be filed for those earlier years. The court also noted that it did not think declaratory rulings were necessary in the future because, under the Duffus analysis, the trustee was free not to bring an action in such circumstances and it was unlikely that creditors would do so.

The court clearly thought that the logical reading of the requirement (and one that tied into the §1308 requirement) was that only the return for the year most recently before the filing must be furnished and then, only if the return was actually required (and filed). It noted that Collier had supported that narrow reading. (Collier on Bankruptcy ¶521.20). On the other hand, it noted that the legislative history had referred to requiring a tax return "for the latest taxable period ending prior to the filing of the bankruptcy case for which a tax return was filed...." H.R. Rep. No. 109-31, pt. I, at 78 (2005), reprinted in 2005 U.S.C.C.A.N. 88 (emphasis added). It is far from clear, though, how much one can draw from the difference between the use of "last" in the statute and "latest" in the legislative history—especially since that language could have been used to address the issue in Merrill: that one must provide the return for the "latest" year for which a return had been filed (i.e., for the 2004 year and not the 2005 year, in cases filed during the beginning of a calendar year).

In any event, this appears to be an area where the statute is, at best, ambiguous, and there is no need to read it in a deliberately illogical fashion. Certainly, when read in context with the remainder of the debtor's obligations in §§521(f), 1307, 1308 and 1328, it would make no sense to suggest that Congress in §521(e)(2)(A) requires that debtors provide a decades-old return merely because that was the last one they filed. Rather, it makes sense to read the provision as requiring, prior to the §341 meeting, that the debtor automatically provide the return for the most recent year if a return was required for that year because that return would always be useful to the trustee and creditors. Section 521(f) allows the trustee and creditors to request copies of returns for the three years prior to the bankruptcy if they had not previously been filed and were filed after the case began. Section 1308 requires debtors to automatically provide returns for the four years prior to the bankruptcy, but again only if they were required to be filed. While that provision clearly only requires returns to be furnished for that time period if they were required, the introduction to §521(e)(2)(A)(I), while slightly less clear, still refers to returns "required under applicable nonbankruptcy law."

In context, and reading the provisions together, it is surely an allowable reading to require only recent returns be submitted and then only if they were actually required to be filed. The courts need not strain to find a reading that produces absurd results when a reasonable reading is plausible. And as someone who has tried to draft legislative language and thought the result was clear—but found out that others thought my efforts were clear as mud—I would urge some sympathy for the drafters. There are always pressures to try to write succinctly, and it is not always easy to do so and still cover all of the possible issues that may arise. If there are better suggestions, Congress will perhaps now be ready to hear them when it finally gets around to its long-promised "technical corrections bill." In the meantime, the tax provisions may not be perfectly drafted, but they seem to be meeting the "silence test" In any event, compared to much of the rest of the language in BAPCPA, the tax provisions aren't that bad—which is praise enough for them!

 

Footnotes

1 This silence is to be distinguished from the silence with which the legislature assertedly greets decisions by the court with which it agrees. See Van Dorpel v. Haven-Busch Co., 350 Mich. 135, 146 (1957) (in overruling prior view of workers' compensation law, court rejected view that legislative silence is always meaningful, noting that "one pictures the legislators of our various states periodically clamoring and elbowing each other in their zeal to get at the pearls of wisdom embalmed in the latest decisions and advance sheets of their respective supreme courts—and thenceforth indicating their unbounded approval by a vast and permanent silence").

2 One interesting case treating this issue in passing is In re Shultz, 347 B.R. 115 (6th Cir. BAP 2006). In that case, under pre-BAPCPA law, the bankruptcy court had refused to lift the stay to allow the IRS to set off a refund that would be received post-petition (for pre-petition income) against a pre-petition tax debt—but did not order the IRS to turn the refund over to the debtor. The BAP upheld the decision, holding that §362(b)(26) was irrelevant, in that the ability of the IRS to hold the refund in an administrative freeze, apparently for the entire term of the plan, meant that it was adequately protected and did not need to have the stay lifted. That holding is intriguing in that a number of courts have assumed that the Supreme Court's decision in Citizens Bank of Maryland v. Strumpf, 516 U.S. 16 (1995), allowing such a freeze, only holds good for a limited period of time during which the creditor must move to lift the stay. This case appears to assume that the freeze can (and should) continue indefinitely.

3 See, e.g., U.S. v. Maxwell, 157 F.3d 1099, 1103 (7th Cir. 1998).

4 The difference in time period between the three years in §521 and the four years in §1308 appears to be a consequence of the jockeying over how many years should be required. The taxing authorities had sought six years in §1308, as had been recommended by the National Bankruptcy Review Commission (rec. 4.2.22, p. 961 (Oct. 20, 1997)). H.R. 3150, introduced by Rep. George Gekas (R-Pa.) and others in early 1998, did have the requested six years in §1308, but only three years in §521 (compare §§407 and 517 of H.R. 3150, as introduced). By the time the bill came out of conference committee in the fall of 1998, there was a three-year period in both places (see §§603 and 816 of the reported bill). In the next Congress, the taxing authorities continued to press for six years, but S. 625, as initially filed in 1999 only had three years in §1308. Amendment S. 2758 was submitted on Nov. 5, 1999, by Sens. Roth and Moynihan to increase the period to six years, but when Sen. Hatch actually proposed the amendment for inclusion in the bill on Nov. 9, 1999, the time had been dropped to four years. The amendment was passed by voice vote and remained unchanged until the bill's final passage in April 2005, thus leaving this dichotomy.

5 Interestingly, though, many courts considering the language in §521(i) have concluded that it too does not require the trustee to act. See, e.g., In re Jackson, 348 B.R. 487, 497-99 (Bankr. S.D. Iowa 2006) (court noted that "while it may be difficult to grasp a concept that something called an 'automatic dismissal' is not really automatic," that was the correct reading of §521(i), and the party must still initiate a request for dismissal for it to occur).

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Friday, December 1, 2006