Some of Debtors' Tax Penalties Are Dischargeable in Bankruptcy

The Court stayed this adversary proceeding, with the exception of the Cassidy issue raised by the Motion, by the Order Staying Proceedings entered on September 22, 2015 (Docket No. 27).

Courts review motions for judgment on the pleadings as follows:

While the parties have not presented matters outside the pleadings to the Court, which would trigger treatment of the Motion as a summary judgment motion pursuant to Fed. R. Civ. P. 12(d), made applicable to this adversary proceeding by Fed. R. Bankr. P. 7012(b), they have argued the substantive merits of the dischargeability of certain of the IRS claims, rather than the pleading sufficiency of the Amended Complaint to Determine Dischargeability of Debts filed by Debtors on June 24, 2015 (Docket No. 6) (the "Complaint"). The parties have asked the Court to rule upon such substance in the Motion, the Response and the Reply, contrary to the normal sufficiency standard of review for a Rule 12(c) motion. Indeed, the IRS asked the Court to enter a substantive ruling either way: "The [IRS] . . . moves for judgment on the pleadings, and this includes suggesting that, if the Court disagrees with certain of the [IRS'] legal arguments below, then judgment on the pleadings in favor of [Debtors] would be appropriate. . . . If this Court concludes that [accuracy penalties are dischargeable], it should enter judgment for [Debtors] on those items, without prejudice to the [IRS'] right to decide whether to appeal, as we have no further defense in respect thereto." (Motion, pp. 1-2.) Debtors did not argue against a ruling on the merits of the Cassidy issue in their Response.

Moreover, the scope of the relief sought by the Motion has been subsequently narrowed. Among other things, in its prayer for relief, the IRS requested a "judgment on the pleadings in favor of the [IRS] regarding the taxes and the 2011 penalty and, in respect to the 2009 and 2010 penalties, [the Court] should grant judgment on the pleadings to one side or the other, depending on its resolution of the meaning of § 523(a)(7)."¹ (Motion, p. 28.) The narrowing occurred by virtue of Debtors' concession, after the briefing on the Motion, that the taxes for the 2009, 2010 and 2011 tax years are nondischargeable and Debtors' agreement with the IRS as to the amounts of such taxes.² The concession and agreement were made in at least one pleading and one hearing substantively related to the tax issues but procedurally unrelated to the Motion.³

Therefore, the Court will rule dispositively on the merits of the Cassidy issue. Having reviewed the Motion, the Response, the Reply, the Complaint, the United States' Answer to Amended Complaint filed by the IRS on July 27, 2015 (Docket No. 14) (the "Answer") and the records in this adversary proceeding and the bankruptcy case relating to the tax issues, having heard the arguments and representations of counsel for Debtors and counsel for the IRS at various hearings and status conferences in this adversary proceeding and the bankruptcy case relating to the tax issues, and being otherwise duly advised, the Court hereby enters this order solely with respect to the Motion and the Cassidy issue.

However, the binding nature of the ruling in Cassidy I was "disclaimed" by the Seventh Circuit in Matter of Cassidy, 892 F.2d 637, 640 (7^th Cir. 1990) ("Cassidy II"). In Cassidy II, the court wrote:

After Cassidy II, other courts in this circuit have considered the interpretation of § 523(a)(7)(A) and (B) to be an "open issue," not controlled by Cassidy I, and have looked "to other jurisdictions for guidance". Roberts v. United States (In re Roberts), 129 B.R. 171, 172-73 (C.D. Ill. 1991) ("Illinois Roberts"). See also Torres v. Illinois Dep't of Revenue (In re Torres), 143 B.R. 183, 188-89 (Bankr. N.D. Ill. 1992); and Carlen v. Dep't of the Treasury Internal Revenue Serv. (In re Carlen), 1991 WL 424977 at *27 (Bankr. N.D. Ind. 1991).

The Court agrees -- it is bound by Cassidy II's determination that Cassidy I's "ruling" is dicta, and therefore Cassidy I has no preclusive impact. Accordingly, the Court will start its analysis with the plain language of § 523(a)(7)(A) and (B). In re Crane, 742 F.3d 702, 708 (7^th Cir. 2013) ("We begin with the language of the statute. When the language of the statute is plain, we enforce it according to its terms.").

Section 523 provides:

The IRS is right that § 523(a)(7)(B) could be applied to a free-standing penalty if a transaction or event that gave rise to the imposition of such a penalty occurred more than three years preceding the petition date, but the crux of the IRS' argument in favor of alternative (2) is that § 523(a)(7)(B) can be applied to only free-standing penalties. Fatal to that argument is the fact that the plain language of § 523(a)(7)(B) is not so limiting. Understanding that multiple types of penalties could fall under § 523(a)(7)(B) does not create ambiguity in the statute. Rather, it recognizes that Congress used broad language such that free-standing penalties and other types of penalties could be dischargeable pursuant to § 523(a)(7)(B).

Because the Court does not conclude that § 523(a)(7) is ambiguous, the Court will not resort to an analysis of the legislative history. The Court joins a number of other courts in relying on the "plain language" of § 523(a)(7)(A) and (B). See Roberts v. United States (In re Roberts), 906 F.2d 1440, 1445 (10^th Cir. 1990) ("[b]ecause the statutory language is clear and unambiguous and does not compel an irrational result, it is not necessary to refer to the legislative history to interpret its meaning"); Burns v. United States (In re Burns), 887 F.2d 1541, 1544 (11^th Cir. 1989) ("[w]e must therefore look to the language of section 523(a)(7) itself, and where, as here, that language is plain, we must enforce it according to its terms"); McKay v. United States, 957 F.2d 689, 694 (9^th Cir. 1992) ("[w]e, like other circuits which have carefully considered this issue, have adhered to the language of the statute"); Illinois Roberts, 129 B.R. at 172-73; and Torres, 143 B.R. at 188-89.

Based on the plain language, the Court joins the majority of courts who have determined that a tax penalty is dischargeable if the penalty is described by either § 523(a)(7)(A) or § 523(a)(7)(B).

Section 507(a)(8)(A)(i) gives priority status to allowed unsecured claims of governmental units for income taxes "for which a return, if required, is last due, including extensions, after three years before the date of the filing of the petition". As noted above, the 2011 penalties relate to a tax return that was filed within such three-year period. Therefore, they are nondischargeable pursuant to § 523(a)(7)(A).

The Court need not reach the underlying question of whether the 2009 and 2010 penalties relate to fraudulent returns because § 523(a)(7) is written in the disjunctive. If such penalties meet § 523(a)(7)(A) or (B), they are dischargeable. Therefore, even if it were determined that the returns were fraudulent such that the 2009 and 2010 penalties may be nondischargeable pursuant to § 523(a)(7)(A), they are nonetheless dischargeable under § 523(a)(7)(B) because they were imposed with respect to a transaction or event that occurred more than three years prior to the Petition Date. See Illinois Roberts, 129 B.R. at 173 ("where the requirements of § 523(a)(7)(B) are met, the tax penalty is dischargeable without regard to the provisions of § 523(a)(7)(A)"). Therefore, it is unnecessary to determine whether the 2009 and 2010 returns were fraudulent because the penalties are dischargeable pursuant to § 523(a)(7)(B).⁷

With respect to the 2011 penalties, the Court need not analyze whether the underlying return was fraudulent for the purpose of the § 523(a)(7)(A) analysis because the 2011 penalties relate to a tax of a kind specified in § 523(a)(1)(A). However, in determining what the amount of the 2011 penalty is that Debtors will owe going forward -- a fraud penalty amount or a negligence penalty amount, the nature of the underlying return will need to be determined.

Contemporaneously herewith, the Court will enter partial judgment in favor of Debtors with respect to the dischargeability of their 2009 and 2010 tax penalties, and partial judgment in favor of the IRS with respect to the nondischargeability of Debtors' 2011 tax penalties.

IT IS SO ORDERED.

² Based on Debtors' concession and agreement with regard to the amount and nondischargeability of the underlying taxes, the Court need not address the tolling arguments raised in the Motion, the Response and the Reply pursuant to § 507(a)(8).

³ In the Amended Objection to Proof of Claim filed by Debtors on August 23, 2015 (Bankruptcy Case Docket No. 135) with respect to the IRS' amended proof of claim no. 3, Debtors state: "1. Debtors will consent to the amounts listed for the 2009, 2010, and 2011 being non-dischargeable and priority to avoid having additional attorneys fees." Debtors' counsel confirmed that Debtors conceded to the nondischargeability of the 2009, 2010 and 2011 taxes during the August 27, 2015 hearing in this adversary proceeding on Petitioners' Motion to Stay Tax Court Proceedings, Have Defendant Stay Tax Court Proceedings or in the Alternative to Set a Hearing Prior to October 1, 2015 in Bankruptcy Court filed by Debtors on July 17, 2015 (Docket No. 12).

⁴ Contested between Debtors and the IRS is whether the penalties are fraud or negligence penalties. The Court notes, however, that the language of § 523(a)(7) is "tax penalty" with no distinction between fraud or negligence penalties.

⁵ This result has been acknowledged by the IRS. See Motion, p. 1 ("The only arguably discharged liabilities are the penalties for 2009 and 2010"), and United States' Memorandum in Support of Its Motion to Dismiss or in the Alternative -- Abstain filed on May 15, 2015 (Bankruptcy Case Docket No. 64-1), p. 6 ("the fraud penalties for returns filed prior to September 30, 2011, are discharged pursuant to § 523(a)(7) and this appears to mean that years 2009 and 2010 are discharged").

⁶ The parties have not argued that § 507(a)(3), and by reference § 502(f), are applicable to a ruling on the Motion.

⁷ There are other examples in the Bankruptcy Code of this type of disjunction. For example, even if a chapter 11 plan does not satisfy the confirmation requirements of § 1129(a)(8), the plan still could be confirmed if it meets the requirements of § 1129(b).