Jonathan B. Fuller
St. John's University School of Law
American Bankruptcy Institute Law Review Staff
In In re Peete, the Bankruptcy Court for the Eastern District of Wisconsin (the “Bankruptcy Court”) held that “special charges” purported to be property taxes were “penalties” rather than “taxes;”[1] and thus, said charges were not entitled to priority status under section 507(a)(8) of title 11 (the “Bankruptcy Code”).[2] On July 7, 2021, a creditor, the City of Milwaukee (“the City”), amended a proof of claim asserting that John Peete, its debtor, owed $46,754.99 of delinquent real estate taxes.[3] Acknowledging that $20,000 of the debt was secured by the debtor’s real estate,[4] the City “contend[ed] that the remaining $26,574.99 [was] entitled to priority status under 11 U.S.C. § 507(a)(8)(B).”[5] Peete objected to the City’s amended claim, alleging that the charges at issue were “not property taxes and should be treated like other general unsecured claims.”[6] Peete amended his plan accordingly.[7] The City then objected to Peete’s amended plan alleging it would not compensate the City in full.[8] In support, the City submitted affidavits from two employees.[9]
Ultimately, the Bankruptcy Court found that the City’s demonstration and evidence supporting its amended claim “failed to explain the nature or purpose” of the charges.[10] According to the Bankruptcy Court, it was “not apparent” whether the charges were assessed to collect funds (indicating a tax) or to compensate for service (indicating a penalty).[11] Consequently, on June 30, 2022, the Bankruptcy Court sustained Peete’s objection to the City’s amended proof of claim.[12] Of the $26,754.99 sought as a priority claim, all but $957.56—tax principal and prepetition interest—was denied priority status.[13]
First, regarding the burden of proof, the Bankruptcy Court determined that “the party seeking to establish a priority claim bears the burden of proving that the claim is entitled to priority treatment.”[14] Since the City sought priority status, it bore the burden of proving the special charges fell within Bankruptcy Code § 507(a)(8) and failed to satisfy that burden.[15]
Second, with regard to the purpose and nature of the charges, the Bankruptcy Court found that, because the Bankruptcy Code defines neither “tax” nor “property tax,” courts must “conduct a ‘functional examination’ of whether any particular charge should be considered a property tax"[16] and that such a “determination is a federal question.”[17]Then, in its functional analysis, a court “must determine whether the charges generate revenue for general public purposes, or for the regulation and benefit of the parties upon whom the fees are imposed.”[18]
The facts in In re Peete presented two types of special charges: (1) “MWW charges” (for municipal services, storm water, water, and sewer); and (2) “DNS charges” (for health abatement and building reinspection).[19] The former were held not to be taxes because the City failed to produce evidence to satisfy its burden of proof.[20] The latter were held not to be taxes—and instead to be a penalty—because the chargers were “meant to discourage unwanted conduct” and “defray the City’s costs in providing services to specific property owners.”[21] Finally, with regard to the interest and penalties, the court held that “[t]he City [] offered no viable argument that any of the penalty charges [were] entitled to priority”[22] but that “[t]he portion of the prepetition interest attributable to the principal tax” was a tax and accordingly subject to priority status under 11 U.S.C. § 507(a)(8).[23]
The Bankruptcy Court concluded that the tax principal and prepetition interest portion of the City’s claim was entitled to priority status under Bankruptcy Code § 507(a)(8)(B) but that “[t]he remainder of the unsecured portion of the City’s claim [is] a general unsecured claim” not entitled to priority status.[24] Because the City failed to meet its burden of proof regarding all charges except the tax principal and prepetition interest, those remaining charges were deemed penalties as opposed to taxes and, thus, not entitled to priority under Bankruptcy Code § 507(a)(8).[25] The Bankruptcy Court emphasized that the City’s “failure to provide the necessary evidence requires the Court to find . . . in favor of Mr. Peete.”[26]
Based on the Bankruptcy Court’s analysis and holding in In re Peete: (1) MWW charges may be deemed penalties or taxes depending on the facts of the case;[27] (2) DNS charges are likely penalties rather than taxes;[28] (3) penalties—less those which fall under Bankruptcy § 507(a)(8)(G)[29]—are likely penalties rather than taxes;[30] and (4) prepetition “interest charges, to the extent they are attributable to the [] tax principal,” are likely taxes and, accordingly, entitled to priority status.[31]
[1] See In re Peete, 642 B.R. 299, 310–312 (Bankr. E.D. Wis. 2022).
[2] Id.
[3] Id. at 301.
[4] Id.
[5] Id. (“11. U.S.C. § 507(a)(8)(B) . . . ‘allow[s] unsecured claims of governmental units, only to the extent that such claims are for . . . a property tax incurred before the commencement of the case and last payable without penalty after one year before the date of the filing of the petition.”).
[6] Id. at 300.
[7] See id. at 300.
[8] Id.
[9] See id. at 301 (“The City submitted affidavits from two employees . . . to clarify the further breakdown of the special charges.”).
[10] Id. at 302.
[11] Id. (“[I]t is not apparent from the record whether any delinquent charges included on Mr. Peete’s 202 tax bill were assessed to collect funds to pay for a public benefit, [sic] or were imposed to compensate the City for services provided to Mr. Peete specifically (in other words, to raise revenue used for the benefit of the individual owner of the property upon which the charges were assessed).”).
[12] Id. at 312.
[13] Id.
[14] Id. at 309 (citing In re Alewelt, 520 B.R. 704, 708–10 (Bankr. C.D. Ill. 2014) (concluding that the creditor had the burden to prove by the preponderance of evidence that his claim was entitled to priority treatment) (citations omitted).
[15] Id.
[16] Id. at 305.
[17] Id. at 310.
[18] Id. at 311; see id. at 308 (“The determinative distinction, according to the debtor, is that the charges were not incurred to generate revenue, but to recover actual costs.”), 310 (“[T]he only material distinction [between taxes and fees] is between exactions designed to generate revenue—taxes, whatever the state calls them . . . —and exactions designed either to punish (fines, in a broad sense) rather than to generate revenue . . . .”).
[19] Id. at 311–12.
[20] See Id. at 311 (“While it is likely that some of the charges are to recover the costs of the City providing services to Peete (and based on a property owner’s water usage, rather than land ownership), it is just as likely that some of the charges are not. For example, as the district court observed in Oneida, charges imposed for storm water management are often found to be taxes rather than fees . . . . But without evidence to support such a finding, the Court cannot reach that conclusion.”).
[21] Id. (“These are not charges imposed on all property owners in a community, nor do they generate revenue to benefit the general public.”) (emphasis added). Further, “[b]ecause the City [] failed to prove that any of the special charges . . . are ‘property taxes,’ the Court need not reach the secondary question of whether any of the charges were last payable without penalty within a year prior to the petition date.” Id. at 312.
[22] Id.
[23] Id. (“In sum, the portion of the City’s claim entitled to priority status under 11 U.S.C. § 507(a)(8)(B) is $957.56 ($903.36 in tax principal and $54.20 in prepetition interest).”). And accordingly, “the remainder of the unsecured portion of the City’s claim will be treated as a general unsecured claim.” Id.
[24] Id.
[25] See id. at 311–12.
[26] Id. at 311.
[27] See id. at 311.
[28] See id. at 311–12.
[29] See id. at 309, 312.
[30] See id. at 312.
[31] Id.