In Betancourt v. United States, the bankruptcy court for the Western District of Missouri addresses an issue of the character of a debt owed to the IRS as it determines the dischargeability of that debt.
The taxpayer seeks a determination that this type of debt gets discharged in bankruptcy because it does not fall within any of the enumerated exceptions to discharge that apply to taxes. The court finds for the taxpayer. Although the issue here is narrow and has scarcely be litigated, it points to the problem the IRS can have when a debt does not conform to norms for tax debt and the IRS seeks to prevent a discharge.
Ms. Betancourt purchased a home in Liberty, Missouri in 2008. She claimed the first-time homebuyer credit and received a $7,500 credit on her 2008 return. To obtain the credit, she needed to purchase a home for the “first time”, between April 9, 2008 and May 1, 2010. However, Congress was not just concerned with the initial purchase and added in the law a requirement for repayment of the credit over a 15-year period in certain circumstances. For those unfamiliar with this credit, some links to the IRS descriptions of the credit, here, here, here and here, may help in understanding the issue. Ms. Betancourt argues that the debt for repayment of the credit relates either to 2008 when she received the credit or 2010 when her repayment period began. Based on when she incurred the debt she argues that it is not entitled to priority status and neither is it excepted from discharge.
The IRS argues that the recapture obligation arises each year and that for the years starting with 2017, when she filed bankruptcy, the debt is a future debt contingent upon events that have not yet occurred and, therefore, it did not need to file a claim for this future debt and the future debt was not discharged by the bankruptcy case. It filed a claim for $39.00 as a priority amount because that was the amount of unpaid repayment due at the time of the filing of the bankruptcy petition. The IRS relied on the decision in In re Bryan, 2014 WL 789089 (Bankr. N.D. Cal. 2014), in which the court characterized the obligation to repay the new homebuyer’s credit as a non-dischargeable tax rather than a dischargeable general obligation. Bryan held that the obligation to repay was a tax obligation and that characterization triggers the application of the discharge provisions for taxes rather than for general claims.
At issue here is both the character of the debt as tax and the character of the debt as a fixed future obligation or an obligation so contingent as to fail to meet the broad definition of the word claim. Rather than viewing the repayment obligation as a tax obligation, the court in Betancourt views the transaction as a loan when viewing all of the parts of the transaction. If the credit and its repayment obligation has the character of a loan rather than a tax, then the bankruptcy outcome is completely different. The court cited an IRS Information Release, IR-2008-106, which states “the credit operates much like an interest free loan because it must be repaid over a 15 year period.” Form 5405 is subtitled “Repayment for the First Time Homebuyer Credit” and the instructions for the Form repeat the term “repayment.” There are other bankruptcy cases in which the courts have looked at the substance of the transaction in characterizing the nature of a liability in order to determine its status as a claim in the bankruptcy case. Two of the most famous examples of this are Sotelo v. United States, 436 U.S. 268 (1978), in which the Supreme Court characterized the trust fund recovery penalty of IRC 6672 as a tax rather than a penalty because it is a provision designed to allow the IRS to collect the underlying tax and not one imposing a penalty on the person assessed. In 1996, the Supreme Court in United States v. Reorganized CF&I Fabricators of Utah, Inc., 518 U.S. 213 (1996) determined that the excise tax imposed by IRC 4971 for late payment of funds into a pension plan was not a tax but rather was a penalty, calling into question the character, for purposes of filing a bankruptcy claim, of a whole host of excise taxes imposed for wrongful behavior or to discourage “sin,” such as the excise taxes on cigarettes and alcohol.
In addition to the tax versus loan issue, the court also raises the issue of what constitutes a debt. This is a much litigated issue in bankruptcy because it goes to the core of when a claim must be filed and when the discharge provisions come into play. The court cites to the precedent on this issue in support of its conclusion that the IRS possesses a right to payment which triggers an obligation to file a claim against the estate and not to rely on future repayment as a basis for arguing the debt is not a claim.
The court finds that the right to payment arose before the filing of the bankruptcy petition, which fits within the definition of claim in B.C. 101(5)(A). It determines that this prepetition debt is not a priority tax obligation but a non-tax one. Stripped of its tax veneer, the debt loses its exception to discharge and the court determines that the repayment obligation is dischargeable.
I do not know if the IRS will appeal this decision. The decision could impact a decent number of individuals who benefitted from the first time homebuyer credit and whose obligation to repay has not yet run. Any dischargeability determination like this has consequences for anyone who has gone through bankruptcy with this type of debt since they could still bring a discharge action even if the bankruptcy ended some time ago. If correct, the decision would mean that the IRS probably has a number of discharged debts on its books that it continues to attempt to collect in violation of the discharge injunction. The decision could also implicate other situations in which Congress chooses to use the tax code to front money to taxpayers as it did here in an attempt to spend our way out of the great recession. If Congress is concerned about the loss of priority status here, it may need to structure similar provisions differently in the future to make sure that they do not lose their character as tax debt and to make sure, if they want these types of debt to retain priority claim status throughout the repayment period, that the debt arises anew each year (or something to keep it new enough for priority status). The court seems clearly right on the issue of whether this debt meets the requirements of being a claim. The tax versus non-tax character of the debt is closer since the taxpayer is repaying a tax benefit, but I cannot say that the court was wrong on that aspect of its decision either.