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Effect of Bankruptcy Confirmation on Tax Liability

Posted on Nov. 11, 2021

In Wathen v. Commissioner, TC Memo 2021-100 the taxpayer argued that the confirmation of his chapter 13 plan precluded the IRS from subsequently pursuing a deficiency case for periods not included in the plan.  Petitioner represented himself in this case which brings its own limitations on the understanding of procedure.  This was his second Tax Court petition regarding these years.  The first was filed in 2015 while the automatic stay was in effect.  It was dismissed for lack of jurisdiction because of B.C. 362(a)(8).

In this second case, Mr. Wathen tried to move for summary judgment on the issue of res judicata, collateral estoppel and judicial estoppel regarding the effect of the bankruptcy case, but he did not file his summary judgment motion until trial, which violates T.C. Rule 121(a), requiring that motions for summary judgment be submitted at least 60 days before the calendar call on which the case is placed.  This rule, adopted by the court slightly over a decade ago, was necessitated by the onslaught of these motions submitted by the IRS at calendar call in CDP cases.  The denial of the motion did not mean that petitioner could not make these arguments but only that he must address them in his post-trial briefs, thus postponing the day on which he would learn the arguments would fail.

Although petitioner was pro se, he is a bankruptcy lawyer.  The underlying issues in the case concerned unreported receipts and unverified expenses.  I found this statement by the court regarding expenses to be surprising for a law firm:

Petitioner did not keep any records–such as records of travel expenses or
office expenses–of how much he spent on any given bankruptcy case as counsel for the debtor.

But this blog is not about recordkeeping so you can explore that aspect of the case separately.

In 2021 petitioner filed for chapter 13.  The IRS filed a proof of claim for 2010 and 2011 which it later amended in February of 2013, two days after petitioner filed his tax returns for those years.  In 2005, the changes to the bankruptcy code required debtors to get up to date on their tax filing.  Prior to 2005, it was common for the IRS to object to chapter 13 plans by the droves because of unfiled returns.  I imagine that Mr. Wathen filed his late returns for 2010 and 2011 under threat of dismissal from the trustee since BC 1308 requires the filing of back tax returns.

A lawyer with unfiled returns and few if any receipts does not make for a good beginning to a story of what will happen in Tax Court.  At this point in reading the opinion I developed a strong suspicion about the likely outcome.  When I looked at the docket, I noticed that Mr. Wathen requested an extension of time to file his opening brief three times, extending the period by approximately six months from the original due date.  I could not see his motions but only the court orders which grew increasingly impatient though still quite generous in allowing him the extra time.  I cannot say that multiple requests for this type of extension necessarily has an impact on the outcome, but I would not recommend it as a course of action.

The Tax Court says that he proposed a chapter 13 plan in June of 2014. This is almost two years after he filed his bankruptcy petition. A delay of that length in filing a chapter 13 plan is quite unusual. I would have expected a dismissal from bankruptcy before the passage of that much time. Nonetheless, the plan gets confirmed in August of 2014.

The order confirming the plan did not cite to BC 505(a), which is the section allowing a contest of taxes in bankruptcy cases. It did not state it was issued pursuant to the bankruptcy court’s authority to determine taxes. It also did not include any factual recitations about the taxes for any year.

He received a discharge in December 2017 close to the five-year window for chapter 13 cases. The discharge order, in what I imagine is boilerplate language, provided that some debts are not discharged and provided examples, including the exception to discharge provided in BC 523(a)(1)(B) for unfiled and late filed returns. The Tax Court notes that the bankruptcy discharge noted no waiver by the IRS with respect to taxes excepted from discharge.

While the bankruptcy case was pending, the IRS issued a notice of deficiency that forms the basis for this Tax Court case.  When a notice of deficiency is issued during a period when the automatic stay is in effect, BC 362(a)(8) prevents the filing of a Tax Court petition unless the bankruptcy court issues an order lifting the stay to allow the filing of the Tax Court petition.  This is the reason for the dismissal of his first Tax Court case as mentioned above.  The time for filing a Tax Court petition would have been suspended and the debtor given an additional 60 days to file.  The Tax Court filing in March of 2018 coincides with the timing of the discharge in the chapter 13 case which would have terminated the automatic stay.

This brings us back to the 2010 and 2011 years on the notice of deficiency.  The Tax Court first takes on the issue preclusion argument since, if successful, it would render the remainder of the case unnecessary.  The Tax Court looked to its relatively recent precedential opinion in Breland v. Commissioner, 152 T.C. 156 (2019) which we blogged here in a guest post by Brad Jones critical of the Breland decision.  (I posted on the case of Minor v. United States earlier this year where the res judicata impact of a stipulation barred the IRS from further collection.)

In Breland, the debtor and the IRS entered into a consent order resolving an objection to a chapter 11 plan. The IRS later issued a notice of deficiency for the same year involved in the consent order. The debtor argued res judicata but the Tax Court found that:

res judicata did not apply because the redetermination of a taxpayer’s total Federal tax liability for the years covered by a notice of deficiency and the resolution of the IRS’ objection in a bankruptcy plan confirmation proceeding were not the same cause of action. Id. at 161-162. Notably, the facts that gave rise to the deficiency proceeding were the taxpayer’s income, deductions, and credits, whereas those that gave rise to the consent order and plan confirmation were the viability of the proposed plan of reorganization and the disposition of the debtor’s assets.

The Tax Court also held in Breland that:

collateral estoppel did not apply because there was no indication that the taxpayer’s total Federal tax liability was ever actually litigated or even at issue before the bankruptcy court. Id. at 171, 172. Notably, the consent
order did not cite or otherwise mention the bankruptcy court’s authority to
determine taxes under 11 U.S.C. sec. 505(a)(1), nor did it include any factual recitations of the taxpayer’s income, deductions, and credits or otherwise state his total Federal tax liability for any year before the bankruptcy court.

The Tax Court finds Mr. Wathen’s case analogous to Breland on both issues. The plan confirmation proceeding did not raise petitioner’s tax items for the years at issue but focused on plan confirmation and disposition of assets. It pointed to the three indicia of an actual litigation of the tax liability in the bankruptcy proceeding: 1) reference to B.C. 505(a); 2) fact findings related to the tax items; and 3) waiver of rights by the IRS. These items did not exist in Breland and similarly did not exist in Mr. Wathen’s case.

The Tax Court then addressed the argument of judicial estoppel finding:

he does not identify how the IRS’ proof of claim in his chapter 13 bankruptcy is completely contradictory to its determination of deficiencies in
this case. He merely states that respondent would “gain the advantage of not being bound by its proofs of claim in bankruptcy.” But that is an outcome contemplated by the Bankruptcy Code, particularly when the taxpayer has failed to timely file certain returns, see 11 U.S.C. 523(a)(1)(B) (2018), and one petitioner was made aware of in the order discharging his debts.

After disposing of the arguments that the IRS could not proceed in the deficiency case, the Tax Court determines his liabilities including penalties for late filing.

The Breland and Minor cases signaled the difficulties that taxpayers have in bringing up actions in a bankruptcy case, other than a specific challenge to a tax liability under B.C. 505(a), to stop the IRS from asserting additional liability for periods not discharged.  Mr. Wathen’s case follows the earlier decisions.  Debtors who want to bind the IRS should consider bringing a 505(a) action in bankruptcy to obtain finality.

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