6321 Bankruptcy page2

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In re Floyd W. Beam, Elaine M. Beam, Debtors. Floyd W. Beam, Elaine M. Beam, Appellants v. Internal Revenue Service, Appellee

(CA-9), U.S. Court of Appeals, 9th Circuit, 98-35576, 10/15/99, 192 F3d 941, Affirming a District Court decision, 98-1 USTC ¶50,469

[Code Sec. 6301 ]

Liens and levies: Enforcement of lien: Bankruptcy: Levy, property subject to.--Payments made by married debtors into their unconfirmed bankruptcy plan were subject to an IRS levy since the funds were not specifically exempted from levy under Code Sec. 6334 . The provision of the Bankruptcy Code requiring the trustee to return the payments to the debtors did not take precedence over the provisions of the Internal Revenue Code authorizing the IRS, via its broad levy powers, to seize the encumbered funds by any means since it ultimately held superior rights of possession.

[Code Sec. 6331 ]

Liens and levies: Enforcement of lien: Bankruptcy: Notice of levy, sufficiency of: Authority of IRS agent.--The IRS properly served a notice of levy on a bankruptcy trustee since the trustee was in possession of the funds deposited in the bankruptcy plan. Furthermore, the IRS agent who served the notice of levy on the trustee did not act outside the scope of his authority since he had authority to levy under Code Sec. 6301

Floyd W. Beam, Elaine Marie Beam, pro per, Springfield , Oregon , for the appellants. Charles F. Marshall, Department of Justice, Washington , D.C. 20530 , for the appellee.

Before: ALDISERT, ^* KLEINFELD and FLETCHER, Circuit Judges. ^**

OPINION

ALDISERT, Circuit Judge:

Appellants Floyd W. Beam and Elaine M. Beam filed a petition for bankruptcy reorganization under Chapter 13 and deposited $24,000 towards a proposed plan with the trustee in bankruptcy. They subsequently filed a motion to withdraw their bankruptcy petition and demanded return of the money they had deposited into their unconfirmed Chapter 13 plan. Upon dismissal of their petition, the Internal Revenue Service served a notice of levy on the trustee in bankruptcy, directing him to distribute the deposited funds directly to the IRS in partial satisfaction of the Beams' federal tax liability. We are to decide whether a Chapter 13 trustee in bankruptcy is required to honor an IRS notice of levy under 26 U.S.C. §6331 on these funds, notwithstanding 11 U.S.C. §1326(a)(2), which instructs the trustee to return the debtor's payments where a debtor's plan is not confirmed. The district court concluded that the IRS's power to levy is not compromised by the bankruptcy distribution provision. We affirm the judgment of the district court.

The bankruptcy court had subject-matter jurisdiction under 11 U.S.C. §157. The district court had jurisdiction under 28 U.S.C. §158(a). We have jurisdiction under 28 U.S.C. §1291. The appeals were timely filed. Rule 4(a), Federal Rules of Appellate Procedure.

Appellants contend that the district court erred because (1) distribution of the deposited funds directly to the IRS conflicts with the bankruptcy distribution provision in 11 U.S.C. §1326(a)(2); and (2) the IRS levy is invalid, because the IRS impermissibly served a "notice of levy" on the trustee in bankruptcy.

This court reviews the bankruptcy court's interpretation of statutory language de novo. In re Claremont Acquisition Corp., 113 F.3d 1029, 1031 (9th Cir. 1997); In re Maya Constr. Co., 78 F.3d 1395, 1398 (9th Cir. 1996).

I.

In January 1993, the Beams sought relief from their outstanding debts by filing a petition for Chapter 13 bankruptcy in the Bankruptcy Court for the District of Oregon. Over the next four years, the Beams deposited approximately $24,000 towards their proposed Chapter 13 plan with the trustee in bankruptcy.

In April 1993, the IRS filed a proof of claim against the Beams for $137,821.50--the amount of their federal tax liabilities since 1981. In November 1995, after several years of litigation regarding the Beams' tax liability, the IRS filed its final amendment to its proof of claim.

In June 1997, the bankruptcy court denied confirmation of the Beams' Chapter 13 plan, but allowed them to pay all creditors and administrative expenses in full by August 11, 1997 or, alternatively, to file a modified plan providing for full payment, plus interest, of all outstanding debts. Instead of paying their debts or filing a modified plan, the Beams filed a motion to withdraw their bankruptcy petition in August 1997 and demanded the return of the $24,000 which they had deposited into the unconfirmed plan. The bankruptcy court granted Appellants' motion and issued a notice of dismissal on August 21, 1997. At that time the IRS served a notice of levy on the Chapter 13 trustee, directing him to pay the deposited funds directly to the IRS in partial satisfaction of the Beams' federal tax liability.

In response to the IRS's notice of levy, the Chapter 13 trustee filed a Motion for Order Directing Disbursement of Funds with the bankruptcy court and requested an emergency hearing to determine whether the Beams were entitled to the funds despite the IRS's notice of levy. On August 27, 1997, the bankruptcy court directed distribution to the Beams pursuant to the bankruptcy distribution provision for unconfirmed plans, 11 U.S.C. §1326(a)(2).

The IRS appealed from the bankruptcy court's distribution order. The district court reversed the bankruptcy court's order and directed the trustee to disburse the held funds directly to the IRS. In the district court's view, regardless of which statute controlled the distribution, the IRS ultimately held superior rights to the funds via its broad levy powers.

On May 26, 1998, the Beams filed a timely notice of appeal to this court and a motion to stay disbursement of the funds pending appeal. On July 2, 1998, the district court denied the Beams' motion to stay.

II.

The provisions of 26 U.S.C. §6331, when read in conjunction with §6334, authorize the IRS to collect unpaid taxes via a levy on the taxpayer's property, so long as the property is not specifically exempt from levy. In tension with the Internal Revenue statutes, §1326(a)(2) of the Bankruptcy Code mandates, if a plan is not confirmed, the trustee in bankruptcy shall return to the debtors any payment made pursuant to the proposed plan.

The payment distribution clause of section 1326(a)(2) provides:

[If a debtor's] plan is not confirmed, the trustee shall return any such payment to the debtor, after deducting any unpaid claim allowed under section 503(b) of this title.

11 U.S.C. §1326(a)(2).

Section 6334(a) identifies 13 categories of property exempt from an IRS levy. ¹ Section 6334(c) further provides:

Notwithstanding any other law of the United States . . ., no property or rights shall be exempt from levy other than the property specifically made exempt by subsection (a).

26 U.S.C. §6334(c).

Resolution of this statutory conflict directly impacts upon collection and enforcement policies of the IRS regarding unpaid taxes from debtors who have deposited funds into unconfirmed bankruptcy plans. If funds deposited into unconfirmed bankruptcy plans are returned to debtors who are also delinquent taxpayers, then the IRS would be required to pursue additional legal action to collect these outstanding taxes.

We are persuaded that Congress clearly intended to exclude from IRS levy only those 13 categories of property specifically-exempted in section 6334(a). In drafting the levy authority of the Internal Revenue Service, Congress set forth in unambiguous language that "no property or rights shall be exempt from levy other than property specifically made exempt by [§6334](a)." 26 U.S.C. §6334(c). Section 1326(a)(2) of the Bankruptcy Code is not listed among the 13 items exempt from levy under §6334(a).

Moreover, courts have construed the plain language of §6334 literally and have refused to exempt property from IRS levy which is not specifically exempted by the statute. See, e.g., United States v. Mitchell [71-1 USTC ¶9451], 403 U.S. 190, 204-205 (1971) ("[Section 6334(c)] is specific and it is clear and there is no room in it for automatic exemption of property that happens to be exempt from state levy. . . ."); Sea-Land Serv., Inc. v. United States [85-2 USTC ¶9833], 622 F. Supp. 769, 772-773 (D. N.J. 1985) (holding that the IRS could levy on the wages of seamen even though the wages were not subject to attachment under 46 U.S.C. §11109); In re Jones, 206 B.R. 614 (Bankr. D.C. 1997) (allowing the IRS to levy a Chapter 13 debtor's Thrift Savings Plan, even though 5 U.S.C. §8437(e)(2) specifically prohibited such a levy).

Accordingly, we reject Appellants' argument that the specific construct of §1326(a)(2) trumps the general language of §6334(c). While specific statutes normally trump conflicting, general statutes, see Green v. Bock Laundry Mach. Co., 490 U.S. 504, 524 (1989), such an argument ignores the specifically stated intent of Congress to limit the instances where an IRS levy may not attach.

III.

Appellants contend also that the IRS's service of a notice of levy on the trustee was improper and that the IRS agent exceeded his statutory levying powers under 26 U.S.C. §6301. These arguments also fail. A notice of levy served on a third-party custodian of property is tantamount to a levy under 26 U.S.C. §6331. See, e.g., United States v. Donahue Industries, Inc. [90-2 USTC ¶50,343], 905 F.2d 1325, 1330 (9th Cir. 1990). Furthermore, the IRS agent had authority to levy upon Appellants' property, because the agent's levy power is derived directly from the Treasury Secretary's statutorily prescribed power to collect taxes.

A.

We reject Appellants' contention that the IRS's "notice of levy," which was served on the Chapter 13 trustee, was invalid. Service of a notice of levy on a third-party is proper, indeed customary, when the third-party is in possession of the debtor's property, or where the third-party is obligated to the debtor. See United States v. National Bank of Commerce [85-2 USTC ¶9482], 472 U.S. 713, 720 (1985). Furthermore, the Treasury Regulations expressly provide that a "[l]evy may be made by serving a notice of levy on any person in possession of, or obligated with respect to, property or rights of property subject to levy." 26 C.F.R. §301.6331-1(a)(1); see also 26 U.S.C. §6332(a) ("[A]ny person in possession of (or obligated with respect to) property or rights to property subject to levy upon which a levy has been made shall, upon demand . . ., surrender such property or rights. . . ."). Because a trustee in bankruptcy represents the bankruptcy estate, see 11 U.S.C. §323, the trustee is therefore obligated to the estate. Accordingly, service of a notice of levy upon the trustee in bankruptcy for any obligations owed by the estate is proper. See United States v. Hemmen [95-1 USTC ¶50,210], 51 F.3d 883, 890 n.6 (9th Cir. 1995).

Here, the IRS served a notice of levy on the Chapter 13 trustee, because the trustee held the deposited funds and was obligated to the Beams as their representative in bankruptcy. Consequently, the IRS properly levied the funds by serving a notice of levy on the trustee.

B.

Appellants contend also that the IRS agent who served the notice of levy on the trustee acted outside the scope of his authority, because 26 U.S.C. §7608 does not provide for the use of levies to secure payment of unpaid taxes. Appellants' reliance on §7608 is misplaced because this provision applies only to criminal enforcement officers performing certain functions relating to undercover operations, subtitle E of the Internal Revenue Code and other laws relating to alcohol, firearms and tobacco. These matters are not implicated here. We conclude, therefore, that the IRS agent had authority to levy pursuant to 26 U.S.C. §6301. See Hughes v. United States [92-1 USTC ¶50,086], 953 F.2d 531, 536 (9th Cir. 1992) (concluding that Secretary's assignment of authority to local IRS employees constituted valid delegation of power).

AFFIRMED.

^* Ruggero J. Aldisert, Senior Judge , United States Court of Appeals for the Third Circuit, sitting by designation.

^** The panel unanimously finds this case suitable for decision without oral argument. Rule 34(a), Federal Rules of Appellate Procedure; 9th Cir. R. 34-4.

¹ The specific exemptions include wearing apparel and school books, fuel, necessary personal expenses up to $6250, books and tools up to $3125, unemployment benefits, undelivered mail, certain annuity and pension payments, workmen's compensation, judgments in support of minor children, minimum exemptions for wages and salary, certain service-connected disability payments, certain public assistance payments, assistance under the Job Training Partnership Act, residences exempt in small deficiency cases and principal residences and certain business assets exempt in absence of certain approval or jeopardy. 26 U.S.C. §6334(a)(1)-(13).

 

 

 

In re J. Greg Goodykoontz and Toni B. Goodykoontz, Debtors. J. Greg Goodykoontz and Toni B. Goodykoontz, Plaintiffs v. United States of America on behalf of its agency, the Internal Revenue Service, and The State of West Virginia on behalf of its agency, The WV Dept. of Tax and Revenue, Defendants

U.S. Bankruptcy Court, No. Dist. W.Va. , 00-10902, 5/30/2001

[Code Secs. 6321 , 6331 and 6871 ]

Tax liens: Property subject to tax liens: Bankruptcy: Levy and distraint: Property exempt from levy: Lien v. levy.--

Federal tax liens issued against the property of married debtors applied to property that was exempt from levy. The taxpayers unsuccessfully contended that the terms "lien" and "levy" had the same meaning under Code Sec. 6331 and, thus, the liens did not reach their exempt property. Although the Fourth Circuit had not addressed the issue, the court noted that the issue had arisen before courts within the Fourth Circuit, and those courts issued findings consistent with Seventh and Ninth Circuit opinions that liens and levy should be treated dissimilarly under the statute. Consequently, the tax liens attached to the debtors' exempt, as well as non-exempt, assets.

MEMORANDUM OPINION AND ORDER

FRIEND II, Bankruptcy Judge:

This matter is before the Court pursuant to the Plaintiffs' motion for summary judgment. The Plaintiffs, who are debtors in possession, filed this adversary proceeding to establish the validity of tax liens and to value property subject thereto. The Court has jurisdiction by virtue of 28 U.S.C. §1334 and the standing order of reference in this District. The matter before the Court is a core proceeding pursuant to 28 U.S.C. §157(b).

FACTS

The plaintiffs, J. Greg Goodykoontz and Tori B. Goodykoontz, ("debtors") filed for relief under Chapter 11 of the Bankruptcy Code on April 6, 2000 and were authorized to continue operating as debtors in possession. The parties have stipulated to the value of property owned by the debtors at the time of filing. Neither the prior consensual liens on this property nor the claimed exemptions are in dispute.

Property                    Value  Claimed Exemption  Prior Consensual Liens

Residence ................ 175,000            0             150,713.36

Cash .....................      50           50                      0

Checking, City Nat'l .....   1,000        1,000                      0

Checking, 

One
 
Valley

 .....      75           75                      0

Household Goods ..........   7,420        7,420                      0

Pictures .................   3,000        3,000                      0

Jewelry ..................  24,160        1,000                 24,000

Tea Set ..................   1,500            0                  7,500

Wearing apparel ..........   2,500        2,500                      0

Firearms .................     250          250                      0

401(k) ...................  20,000       20,000                 39,548

IRA ......................  15,000       15,000                  9,295

Partnership ..............  17,000       15,000                      0

Miata ....................   3,500        3,500                      0

Honda ....................  18,000            0              18,120.94

Audi .....................  13,000            0                 14,000

 

Prior to the bankruptcy filing, tax liens were filed by the United States of America on behalf of the Internal Revenue Service ("IRS"), and by the State of West Virginia on behalf of the Department of Tax and Revenue ("State Tax Department"). On August 21, 2000, the debtors filed an adversary proceeding against the IRS and the State Tax Department seeking to determine the validity of the tax liens. By agreed order entered November 8, 2000, the debtors and the West Virginia State Tax Department stipulated that the value of the assets involved was such that after the satisfaction of the consensual secured debt and the tax liens of the IRS, ¹ the state tax liens would be unsecured. The Court ordered that all tax liens filed pre-petition by the State Tax Department against the plaintiffs are of no further effect. The adversary proceeding continued with the IRS as the sole defendant.

The tax liens of the IRS are as follows:

Lien Amount  Period Ending  Assessed   Filed

$49,388.20      12/31/90     5/20/91   7/24/91

 49,762.17      12/31/91     5/25/92   7/23/92

 65,100.78      12/31/92     5/31/93    7/9/93

 92,281.29      12/21/93     5/30/94   2/15/95

 97,769.79      12/31/94     6/15/95   8/18/95

 68,296.08      12/31/96      2/2/99   6/21/99

 

Following a pretrial hearing on October 12, 2000, the plaintiffs and the IRS stipulated to the property values and were to submit briefs setting forth whether the liens of the IRS are limited to the value of the property subject to levy, or whether the value of property which may not be levied against should support the tax lien. The debtors filed a motion for summary judgment, and the IRS filed an objection to the motion and a cross motion for summary judgment. The Court then took this matter under advisement.

DISCUSSION

The Internal Revenue Code ("I.R.C.") provides that

If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount (including any interest, additional amount, addition to tax, or assessable penalty, together with any costs that may accrue in addition thereto) shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person.

28 U.S.C. §6321.

The Code further provides that the lien imposed by §6321 "shall arise at the time the assessment is made and shall continue until the liability for the amount so assessed . . . is satisfied or becomes unenforceable by reason of lapse of time." 26 U.S.C. §6322. The United States Supreme Court has stated that "[t]he statutory language 'all property and rights to property,' appearing in §6321 . . . is broad and reveals on its face that Congress meant to reach every interest in property that a taxpayer might have." United States v. National Bank of Commerce [85-2 USTC ¶9482 ], 472 U.S. 713, 719-720 (1985), cited by In re Voelker [95-1 USTC ¶50,028 ], 42 F.3d 1050 (7th Cir. 1994) ("The language of the statute unambiguously shows that the federal tax lien attaches to all of a debtor's property, without exception.").

The debtors argue that under 26 U.S.C. §6331, the tax lien does not apply to exempt property. Section §6331 provides that

(a) . . . If any person liable to pay any tax neglects or refuses to pay the same within 10 days after notice and demand, it shall be lawful for the Secretary to collect such tax . . . by levy upon all property and rights to property (except such property as is exempt under section 6334) belonging to such person or on which there is a lien provided in this chapter for the payment of such tax.

(b) The term "levy" as used in this title includes the power of distraint and seizure by any means.

(Emphasis added).

The debtors' position is based upon the equation of the terms "lien" and "levy." However, the Seventh and the Ninth Circuits have found that the two terms have distinctly different meanings, and should be treated dissimilarly under the statute. The Seventh Circuit Court of Appeals stated that

This dissimilarity in treatment makes sense, for as the Ninth Circuit discussed in Barbier, a lien and levy are different things. "A levy forces debtors to relinquish their property. It operates as a seizure by the IRS to collect delinquent incomes taxes." [citation omitted]. On the other hand, "a lien . . . is merely a security interest and does not involve the immediate seizure of property. A lien enables the tax payer to maintain possession of protected property while allowing the government to preserve its claim should the status of [the] property later change." [citation omitted]. Thus, if a debtor later sells the exempt property, the IRS could move to collect the proceeds from the sale.

Voelker [95-1 USTC ¶50,028 ], 42 F.3d at 1052, quoting United States v. Barbier [90-1 USTC ¶50,107 ], 896 F.2d 377 (9th Cir. 1990).

The court followed this analysis to the conclusion that a federal tax lien attached to all of a Chapter 13 debtor-taxpayer's property, without exception, even to personal property exempt from levy. Id. The Ninth Circuit Court of Appeals had previously reached a similar conclusion in United States v. Barbier [90-1 USTC ¶50,107 ], 896 F.2d 377, holding that the IRS' priority tax claim could be secured by Chapter 13 debtors' household effects and other property which were otherwise exempt from administrative levy.

The Fourth Circuit Court of Appeals has not addressed this issue. The issue has, however, arisen before several courts within the Fourth Circuit. The findings of these courts are consistent with the Seventh and Ninth Circuit opinions on the matter. See In re O'Gorman-Sykes [2000-1 USTC ¶50,174 ], 245 B.R. 815 (Bankr. E.D. Va. 1999) (tax refunds claimed exempt by debtor nevertheless subject to IRS' secured claim); In re Evans, Bankruptcy 94-00785-5-ATS, WL 760821 (Bankr. E.D. N.C. Nov. 7, 1999) (summary non-judicial seizure of property available to the IRS under the levy provision of §6331 is separate and discrete from the IRS power to create a lien on property of the debtor); In re Dinatale, 235 B.R. 569 (Bankr. D. Md. 1999) (federal tax liens can properly attach to exempt assets); In re Deel, No. 7-93-02602-HPB-13, WL 571997 (W.D. Va. June 20, 1995) (debtors could not avoid federal tax lien on exempt property, but IRS could not levy on property).

The Court finds, therefore, that the liens of the IRS attach to the debtors' exempt assets, as well as their non-exempt assets. The motion for summary judgment of the debtors is DENIED and the cross motion for summary judgment of the IRS is GRANTED.

It is accordingly SO ORDERED.

¹ The IRS tax liens were undisputedly prior in time to those of the State Tax Department.

 

 

 

 

 

In re Jerrie S. Colish, Debtor. Jerrie S. Colish, Plaintiff v. United States of America , Department of Treasury, Internal Revenue Service, Defendants. United States of America , Third-Party Plaintiff v. Jerrie S. Colish, Third-Party Defendant.

U.S. Bankruptcy Court, East. Dist. N.Y. ; 197-14664-608, 289 BR 523, October 23, 2002.

[ Code Sec. 6871]

Bankruptcy: Discharge of debt: Willful evasion of tax: Trust interest: Tax liens. --

A bankrupt tax attorney's tax, interest and penalty liabilities were not dischargeable in bankruptcy because he willfully attempted to evade the payment of taxes. The taxpayer failed to file timely returns for six tax years and did not pay his federal income taxes for 13 years, except to the extent tax was withheld by employers. Moreover, the attorney, who was familiar with offers-in-compromise, succeeded in delaying the government's collection efforts for more than five years by submitting offers that were clearly too low in relation to the tax obligations. Finally, although he was aware of his remainder interest in a trust at the time of filing the bankruptcy petition, the taxpayer failed to disclose his interest to the court, despite the fact Schedule B explicitly asked whether he had any contingent or future interests at the commencement of the case.


[ Code Secs. 6321 and 6871]

Bankruptcy: Discharge of debt: Willful evasion of tax: Trust interest: Tax liens. --

The government carried its burden of proof under the preponderance of the evidence standard that a debtor knowingly and fraudulently failed to report to the court or surrender to the Chapter 7 trustee his remainder interest in a trust and the cash and other property distributions he received from the maturing of his remainder interest pursuant to section 727(d)(2) of the Bankruptcy Code. Accordingly, the taxpayer's Chapter 7 discharge was revoked. The taxpayer's contention that his interest in the trust was nonassignable and not reachable by his creditors and, thus, should not be included in the property of the estate was rejected. Federal tax liens attached to the remainder interest in the trust at the time of the creation of the liens, which predated the bankruptcy.

Gary C. Fischoff, Fischoff and Associates, for debtor, plaintiff, third-party defendant. Wendy J. Kisch, Bartholomew Cirenza, Department of Justice, Washington, D.C. 20044, for defendants, third-party plaintiff.

DECISION AND ORDER

CRAIG, Bankruptcy Judge: This matter comes before the Court on the complaint of Jerrie S. Colish ("Colish" or "Debtor") to have his debt to the Internal Revenue Service ("Government") for his assessed federal income tax liabilities for years 1987 through 1992 declared dischargeable under 11 U.S.C. §523(a)(1) and, additionally, on the complaint of Government seeking a determination that Debtor's Chapter 7 discharge should be revoked pursuant to 11 U.S.C. §727(d)(2).

Procedural History

On April 29, 1997, Debtor filed a voluntary petition under Chapter 7 of the United States Bankruptcy Code (11 U.S.C.) and was granted a discharge of all dischargeable debts on August 19, 1997.

On August 8, 1997, Colish filed a complaint (Govt. Ex. R1.) to commence an adversary proceeding, wherein he requested that the Court issue an order declaring his assessed federal income tax liabilities for years 1986 through 1993 dischargeable under 11 U.S.C. §523(a)(1). On September 30, 1999, the Honorable Laura Taylor Swain, to whom this case was then assigned, determined that Debtor's 1993 assessed federal income tax liabilities were non-dischargeable priority liabilities pursuant to 11 U.S.C. §507(a)(8)(A)(ii). In the Matter of Jerrie S. Colish [ 99-2 USTC ¶50,906], 239 B.R. 670 (Bankr. E.D. N.Y. 1999). Hence, the only years for which dischargeability is still in dispute are tax years 1987 through 1992.

Subsequently, on October 26, 2000, the Government commenced an adversary proceeding seeking the revocation of Debtor's Chapter 7 discharge pursuant to 11 U.S.C. §727(d)(2) on the grounds that Debtor failed to disclose on Schedule B of the bankruptcy petition his remainder interest in a trust established by his father and that Debtor, additionally, failed to disclose and surrender to the Chapter 7 Trustee cash and other property distributions he received from the trust upon the maturing of his remainder interest. (Govt. Ex. S1.) On January 17, 2001, the Court denied the Government's motion to consolidate both adversary proceedings, but ordered that the two adversary proceedings be tried jointly. Consequently, on September 4 and 5 of 2001 and November 20, 2001, the above-entitled adversary proceedings were tried simultaneously. At the conclusion of the trial, the Court directed the parties to file post-trial briefs.

This Court has considered thoroughly all submissions, evidence, and arguments relating to this matter, and the decision rendered herein reflects such consideration.

Jurisdiction

This Court has jurisdiction over these proceedings pursuant to 28 U.S.C. §§151, 157 and 1334, and both these adversary proceedings are core proceedings pursuant to 28 U.S.C. §157(b)(2)(I) and (b)(2)(J).

Facts

Debtor's Work Experience and Education

Debtor is an attorney who holds a Juris Doctor (J.D.) degree from the University of Miami Law School and Masters of Law (LL.M.) degree in taxation from the University of Miami Law School. (T1 63.) ¹ In addition to his legal education, Debtor has a "Series 7" license to sell variable securities and a license to sell life insurance products. (JPTO ² ¶5(4).)

Debtor has substantial work experience in both private legal practice and in the sale of securities. From 1979 through October of 1985, Debtor practiced law, advising clients on federal tax issues and corporate and partnership formations. (JPTO ¶7.) Later, from 1985 to 1987, Debtor was hired by Equityline Securities as its vice president and general counsel, and worked in sales, marketing, analysis, due diligence and wholesaling. (JPTO ¶9.)

After an extensive period of time working as an independent wholesaler of securities, from October of 1987 through November 1994 (JPTO ¶10.), Debtor was employed by a Wall Street securities firm, D.H. Blair, as a retail sales broker, from late 1994 to late 1996. (JPTO ¶10.) Subsequently, starting in late 1996 and through the time of trial, Debtor has worked with a venture capital firm, Spencer Trask. (T1 at 67.)

At the time of trial, Debtor resided in a rented 4-bedroom apartment in Brooklyn , New York and had resided there since June 1993. (JPTO ¶32) From 1988 to 1993, Debtor resided in a rented apartment in Pennsylvania . Debtor leased a 1986 Buick Skylark from 1986 to 1991. (JPTO ¶31.)



Debtor's Expenses and Lifestyle

From 1986 to 1998, other than normal living expenses, Debtor's expenses mainly consisted of: 1) child support payments pursuant to a marriage settlement agreement, 2) tuition payments for private school education for his four children, and 3) charitable contributions and gifts made to his ex-wife and friends.

Pursuant to a marriage settlement agreement ("Agreement"), dated March 28, 1988, Debtor and his wife became legally separated. Debtor has four children. Under the terms of the Agreement, Debtor agreed to pay $375 per month, per child as support. (Debtor's Ex. 2 ¶7.) The Agreement further provides increases in the amount of support annually in the amount of "one-half of the excess of his net income from all sources over Sixty-Thousand ($60,000) Dollars" and that child support in no instance shall exceed $600 per month per child. (Debtor's Ex. 2 ¶7.) However, the $600 maximum allowance per month per child apparently could be modified "provided that the needs of the children ... require more." Furthermore, pursuant to ¶8 of the Agreement, Debtor was to pay for his children's college expenses provided that he was financially able to do so. ³ Nothing in the Agreement required the Debtor to fund the cost of private elementary or secondary school education.

Nevertheless, beginning in 1986 and continuing on through 1999, Debtor paid for his children's private school education. (T1 at 113, 124.) Although all four children graduated from Abrams Hebrew Academy in Yardley, Pennsylvania, one daughter attended boarding school (T2 at 45, 76) and one son went to public high school for two years. (T1 at 124.) The tuition at the private schools amounted to $16,000 in 1986, and steadily rose throughout the period at issue, reaching $33,000 in 1992. The tuition remained relatively constant from 1992 to 1997 at $33,000, before increasing substantially in 1998 to $48,500 due to one of Debtor's children attending college. ⁴

Furthermore, commencing in 1989 and continuing through 1998, Debtor made charitable contributions. (T2 at 20-21.) The contributions varied significantly from year to year, ranging from a low of $1,774 in 1997 to a high of $15,962 in 1993. (Govt. Ex. D3 through D12.)

In addition, Debtor gave substantial sums of money to close friends and his ex-wife. In 1998, Debtor gave his ex-wife $12,500. (Govt. Ex. PP; T2 93.) It was initially given as a loan, but later the Debtor forgave the loan, and it became a gift. (T2 at 93.) Debtor also felt responsible for the losses incurred by three friends who had invested and lost money on Debtor's advice. (T1 at 182-183.) As a result, Debtor gave three $20,000 nonrecourse loans each to the three friends. ⁵ Repayment was solely conditioned on the successful investment of the loans. (T1 at 182-183.)



Tax Return Filings: 1987-1998

On October 12, 1988, Debtor filed late his federal income tax return for the 1987 tax year in which he made a payment of $2,302 through employer withholding. (Govt. Ex. A1-A2.) His return reflected that he owed tax in the amount of $11,675, inclusive of interest and penalties, thus leaving a deficiency of $9,373. Id.

On April 15, 1989, Debtor timely filed his federal income tax return for the 1988 tax year in which he failed to make any payment. His return reflected that he owed tax in the amount of $6,579, inclusive of interest and penalties, thus leaving a deficiency in such amount. Id.

On March 18, 1991, Debtor filed late his federal income tax return for the 1989 tax year in which he made estimated payments of $3,250. His return reflected that he owed tax in the amount of $27,315, inclusive of penalties and interest, leaving a deficiency of $24,065. Id.

On June 3, 1991, Debtor timely filed his federal income tax return for the preceding year in which he made estimated payment of $100. His return reflected that he owed tax in the amount of $25,050, inclusive of interest and penalties, leaving a deficiency of $24,950. Id.

On April 10, 1992, Debtor timely filed his federal income tax return for the preceding year in which he did not make any payments. His return reflected that he owed tax in the amount of $16,207, inclusive of interest and penalties, leaving a deficiency in such amount. Id.

On April 15, 1993, Debtor timely filed his federal income tax return for the preceding year in which he made an estimated payment of $11,310. His return reflected that he owed tax in the amount of $27,042, leaving a deficiency of $15,732. Id.

On April 15, 1994, Debtor timely filed his federal income tax return for the preceding year in which he failed to make any payment. His return reflected that he owed tax in the amount of $38,913. Id.

On April 15, 1995, Debtor timely filed his federal income tax return for the preceding year in which he made an estimated payment of $9,250. His return reflected that he owed tax in the amount of $25,462, inclusive of interest and penalties, leaving a deficiency of $16,212. Id.

On April 15, 1996, Debtor timely filed his federal income tax return for the preceding year, and made a payment of $28,936 through employer withholding. His return reflected that he owed tax in the amount of $26,611, inclusive of interest and penalties, leaving an overpayment of $2,770, which was credited to his 1986 tax liability. Id.

On April 27, 1997, Debtor timely filed his federal income tax return for the preceding year, and made a payment of $27,009 through employer withholding. His return reflected tax in the amount of $12,516, inclusive of interest and penalties, leaving an overpayment of $14,493, which was credited to his 1986 tax liability. Id.

On June 25, 1998, Debtor filed late his federal income tax return for the preceding year, and made a payment of $20,826, through employer withholding. His return reflected tax in the amount of $12,324, inclusive of interest and penalties, leaving an overpayment of $8,502. Id.

On October 19, 1999, Debtor filed late his federal income tax return for the preceding year reporting no tax liability. On February 1, 2000, Debtor filed an Amended Return and made a $8,671 estimated payment as well as a $573 payment through employer withholding. His return reflected that he owed tax in the amount of $88,028, leaving a deficiency of $84,744. Id.



Serial Offers in Compromise

On April 30, 1992, Debtor submitted his first offer-in-compromise to the Government wherein he sought to compromise his tax liabilities for years 1986 through 1991, totaling $78,319, plus interest and penalties based on "doubt as to collectability" by offering to make future estimated tax payments and by paying $12,500. (Govt. Ex. F1.) The offer was amended on June 10, 1992 and again on April 5, 1993. (Govt. Ex. F2.) Under the revised offer, Debtor offered to pay $12,916 to compromise total reported tax liabilities of $85,241 for tax years 1987 through 1992. (Govt. Ex. F2.) On December 2, 1993, the Government rejected Debtor's first offer, as amended, based on Debtor's statement to the Government that the funds were no longer available. (Govt. Ex. F4.)

On April 20, 1994, Debtor submitted his second offer-in-compromise, seeking to pay only $12,500 for his total reported unpaid liabilities of $123,464 for tax years 1987 through 1993. (Govt. Ex. C.) The Debtor was, in effect, submitting the same amount as previously offered but attempting to satisfy an additional tax year as well. The Government determined that the Debtor actually had over $119,447 in net equity from which to collect outstanding tax liabilities of $130,780. ( See attachment to Govt. Ex. G3.) As a result, the Government formally rejected that offer on August 19, 1994, after determining that a much larger amount was collectible by the it. (Govt. Ex. G2.)

On September 15, 1994, Debtor submitted his third offer-in-compromise, which was amended on May 18, 1995. (Govt. Ex. H1.) As amended, Debtor offered to pay $20,000 to compromise total reported liabilities of $147,64. (Govt. Ex. H2.) The Government rejected Debtor's offer by letter dated June 22, 1995, and afforded him the opportunity to protest the decision. Debtor's final offer was rejected by letter on May 14, 1997 because a larger amount was deemed collectible. (Govt. Ex. H6.)



The Mannie S. Colish Trust

Mannie S. Colish, Debtor's father, established the Mannie S. Colish Trust ("Trust") on October 25, 1979. (Govt. Ex. W, X1, X2, Y.) The Trust provided a life estate interest to Lorraine S. Colish, Debtor's mother, and equal vested remainder interests to Debtor and his sister, Julie Colish. Mannie Colish died on January 11, 1981. (T1 at 140.) Upon his father's death, Debtor learned that he was a beneficiary of the Trust (Govt. Ex. W, X1, X2, Y.) The Trust provided that Lorraine Colish had a testamentary power of appointment, which permitted her, by her last Will and Testament, to divest either remainder interest in the Trust. (Govt. Ex. W, X1, X2, Y.)

At the time of filing the bankruptcy petition, Debtor failed to disclose his remainder interest in the Trust in schedules filed with this Court. (Govt. Ex. P, Sch. "B", lines 18, 19; T1 at 145.) The Government contends that it only became aware of Debtor's interest in the Trust during settlement negotiations with the Debtor for adversary proceeding no. 97-1399, after which it commenced an adversary proceeding to revoke Debtor's discharge pursuant to 11 U.S.C. §727(d)(2). (T4 at 18-19.)

On December 20, 1997, Lorraine Colish died and the Debtor became entitled to collect his remainder interest. (T1 at 140-141; Ex. AA.) Subsequently, from January 1998 through June 1998, Debtor received cash and other property distributions from the Trust, totaling $718,000. (T1 at 142.) As part of the distributions, Debtor received $479,631 from a land contract held by the Trust. (T1 at 165-1661; Govt. Ex. OO.) On January 13, 1998, Debtor wire-transferred his share of these proceeds from his Citizens Bank account in Flint, Michigan to an account he maintained with Chase Bank in New York. (T1 at 169.) Next, Debtor transferred $450,000 from the Chase account to a savings account opened at Citibank. ( Id. ) On January 27, 1998 Debtor transferred $200,000 from the Citibank savings account into Citibank checking account and $245,335 into a 7-day CD. (T1 at 170.) Debtor then transferred $100,000 of the $200,000 in the Citibank checking account to a personal account at Spencer Trask (held by Schroeder Bank). (T1 at 184.)

On March 23, 1998, Debtor created a Nevada Limited Partnership, Phoenix Samson Associates, L.P. in which Debtor was named a general partner and limited partner, holding a 96% interest of the partnership and the Jerrie Saul Colish Irrevocable Children's Trust ("Irrevocable Trust"), a limited partner, holding the other 4% interest. (Govt. Ex. J; T1 at 180.) Debtor funded the partnership with cash and property valued at $740,625, including his Spencer Trask account, his newly opened Citibank accounts, numerous stock warrants, various general and limited partnership interests acquired from the Trust and extensive personal property. ⁶ Of the contributed funds, Debtor treated $711,000 (96% interest in partnership) as coming from himself and the other $29,625 coming from the Irrevocable Trust. However, the entire amount clearly came from Debtor's interest in the Trust. (T1 at 160-161.)

Discussion

Pursuant to 11 U.S.C. §523(a)(1)(C), Debtor's 1987 through 1992 Assessed Federal Income Tax Liabilities Are Non-Dischargeable

A discharge in bankruptcy does not discharge debtor of all debts.

§523(a)(1)(C) provides in relevant part:

Section 523. Exceptions to Discharge

 

(a) A discharge under §§727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual Debtor from any debt --

 

(1) for a tax or customs duty --

 

(C) with respect to which Debtor made a fraudulent return or willfully attempted in any manner [italics to highlight] to evade or defeat such tax.

The two exceptions to dischargeability in §523(a)(1)(C) are to be read in the disjunctive. "Nondischargeability under [§523(a)(1)(C) is not limited to finding a fraudulent return." In re Fernandez, 112 B.R. 888, 891 (Bankr. N.D. Ohio 1990); In re Tudisco [ 99-2 USTC ¶50,669], 183 F.3d 133 (2d Cir. 1999). Therefore, in order to prevail, the Government must prove that the Debtor either made a fraudulent return or the Debtor willfully attempted to evade or defeat payment of taxes. In re Lilley [ 93-2 USTC ¶50,427], 152 B.R. 715, 720 (Bankr. E.D. Pa. 1993); In re Griffith , 161 B.R. 727 (Bankr. S.D. Fla. 1993).

At issue in Adversary Proceeding No. 197-1399 is whether Debtor willfully attempted in any manner to evade or defeat payment of taxes for tax years 1987 through 1992. The Second Circuit has recently held that the "willfulness exception consists of a conduct element (an attempt to evade or defeat taxes) and a mens rea requirement (willfulness)." In re Tudisco [ 99-2 USTC ¶50,669], 183 F.3d 133, 136 (2d Cir. 1999).

The burden of proof is the ordinary civil standard; the government must show by a preponderance of the evidence that the claim should be excepted from discharge. Grogan v. Garner, 498 U.S. 279 (1991); Langlois v. United States [ 93-2 USTC ¶50,364], 155 B.R. 818, 820 (N.D. N.Y. 1993). We also bear in mind that exceptions to discharge are construed in favor of the Debtor. In re Birkenstock, 87 F.3d 947, 951 (7th Cir. 1996).

The Second Circuit has recently declined to decide whether more than a simple nonpayment of taxes is required to satisfy §523(a)(1)(C)'s conduct requirement or whether §523(a)(1)(C) "encompasses both acts of commission as well as culpable omissions." In re Tudisco [ 99-2 USTC ¶50,669], 183 F.3d at 137 (quoting Bruner v. United States (In re Bruner) [ 95-2 USTC ¶50,356], 55 F.3d 195, 200 (5th Cir. 1995) (holding that §523(a)(1)(C) "encompasses both acts of commission as well as culpable omissions")). However, the Second Circuit, in Tudisco, has joined the majority of the courts in holding that a failure to pay a known tax duty is, at a minimum, "relevant evidence which a court should consider in the totality of conduct to determine whether ... the debtor willfully attempted to evade or defeat taxes." Dalton v. IRS, 77 F.3d 1297, 1301 (10th Cir. 1996). Nonpayment of tax coupled with concealment of assets or income, or a pattern of failure to file returns is sufficient to establish conduct aimed at "evading or defeating taxes." See, e.g., In re Tudisco [ 99-2 USTC ¶50,669], 183 F.3d 133 (nonpayment of tax, failure to file and submission of false affidavit to employer intended to establish exemption from withholding), In re Birkenstock, 87 F.3d 947 (nonpayment of tax, failure to file, creation of shell trust); Dalton v. Internal Revenue Service, 77 F.3d 1297 (concealing assets and underestimating ownership interest in property on bankruptcy schedule).

The Second Circuit has interpreted "willfully" for purposes of §523(a)(1)(C) to require that debtor's attempts to avoid his tax liability be undertaken "voluntarily, consciously or knowingly, and intentionally." In re Tudisco [ 99-2 USTC ¶50,669], 183 F.3d 133, 137 (2d Cir. 1999) (quoting Dalton , 77 F.3d at 1302).

Because direct proof of intent is rarely found, courts look to circumstantial evidence to determine debtor's intent. Such evidence may include evidence outside the tax years in question, "if sufficiently related in time and character to be probative." In re Birkenstock, 87 F.3d at 951 (quoting United States v. Birkenstock [ 87-2 USTC ¶9416], 823 F.2d 1026, 1028 (7th Cir. 1987).

In the case at bar, there are a number of facts which, when taken together, show that the Debtor intended to evade or defeat taxes. Debtor, an attorney with an LL.M. in tax, despite the knowledge that he was required to pay estimated taxes and to fully pay his tax liabilities by April 15th of each year (T1 at 137), did not pay his federal income taxes for thirteen years, except to the extent tax was withheld by his employers, and his tax obligation has accumulated over this period, resulting in total tax liabilities to date of $228,277.60. (Govt. Ex. A1-A2.) Debtor failed to fully pay his tax liabilities for tax years 1986 through 1998, with the exception of tax years 1995 through 1997 when his employer was withholding taxes from his wages. (Govt. Ex. C, D9-D11; T1 at 131-32.)

Second, Debtor failed to timely file returns for tax years 1986, 1987, 1989, 1996, 1997 and 1998. It was only from tax years 1990 through 1995 that Debtor timely filed his tax returns. However, during this period, Debtor was negotiating three separate offers-in-compromise with the IRS and was required to comply with Internal Revenue Service Regulations, which included timely filing returns as a condition of acceptance of the offers-in-compromise. Moreover, Debtor attempted to thwart or at the very least delay the collection of his tax liabilities by filing serial offers-in-compromise from 1990 to 1995. In re Meyeres [Myers] [ 98-1 USTC ¶50,195], 216 B.R. 402 (6th Cir. 1998) (finding that §523(a)(1)(C)'s modifying phrase "in any manner" is "broad enough to encompass attempts to thwart the payment of taxes"). The undisputed evidence shows that Debtor, an intelligent, highly educated tax attorney who was familiar with the offer-in-compromise process, succeeded in delaying the Government's collection efforts for more than five years by submitting offers which were clearly too low in relation to the tax obligations owed. ⁷ In addition, Debtor knew that, while the offers were pending, he could forestall collection of all tax liabilities under consideration, which permitted him to delay filing bankruptcy and seeking discharge of his taxes. (Govt. Ex. F1-G1 (¶4), H1, H2 (¶7(d).)

Third, Debtor, aware of his remainder interest at the time of filing the bankruptcy petition, failed to disclose this interest to this Court despite the fact that Schedule B explicitly asked whether Debtor had any contingent or future interests at the commencement of the case. Debtor's failure to list his remainder interest in the Trust prevented the Government from asserting a secured claim position based on tax liens that had attached to all of Debtor's property.

As the Government pointed out at trial, had the Debtor reported his remainder interest in the bankruptcy schedules, even if he had reported the value as zero, the Trustee and the Government would have had an opportunity to inquire as to its value and the Government would have asserted a secured claim on this interest, permitting the Government to receive the value of the remainder interest at the time the interest matured post-petition. (T3 at 47-54.) As a general matter, federal tax liens survive bankruptcy and, to the extent that they are secured by the liened property, they remain enforceable against the liened property, despite the fact that the underlying obligations are dischargeable. See, e.g., In re Isom [ 90-1 USTC ¶50,216], 901 F.2d 744 (9th Cir. 1990); In re Dillard, 118 B.R. 89 (Bankr. N.D. Ill. 1990); U.S. v. Alfano [ 99-1 USTC ¶50,303], 34 F.Supp.2d 827 ( E.D. N.Y. 1999). The omission further enabled the Debtor to receive $718,000 in distributions, which he channeled to various accounts and ultimately a limited partnership in Nevada in an attempt to conceal his assets from the Government and thwart the collection of his tax obligations.

Fourth, Debtor did not even fully pay his $88,000 tax liability for the 1998 tax year when he received over $718,000 in distributions from the Trust, nor did he even make any effort to pay his tax obligations owed for prior years.

Debtor argues that an inference of intent to evade or defeat taxes should not be drawn from these facts, for the following reasons.

First, Debtor contends that he did not pay his 1998 tax obligations because he had future obligations, and because he was attempting to reach a settlement with the Government on prior taxes. (T1 at 114-115, and at 118-119.) The existence of future obligations is no excuse not to pay current tax obligations, In re Haesloop [ 2000-2 USTC ¶50,757], 2000 WL 1607316 (Bankr. E.D. N.Y. 2000), and it is not clear how a desire to reach a settlement on prior taxes would preclude payment of current taxes. Additionally, Debtor argues that the reason he did not pay his prior tax obligations when he received the Trust distributions was that he thought these prior taxes were discharged already. However, this is a weak argument, as Debtor knew that his 1994 tax liability was a priority tax liability and did not attempt to challenge it in his complaint for Adversary Proceeding No. 197-1399. (Govt. Ex. R1.)

Second, Debtor argues that the reason he did not pay his taxes each year was because, by the time April 15 came around each year, he did not have enough money on hand to pay his taxes. (T1 at 9, 102, 109-110.) This argument fails to convince this Court. Debtor did have the funds to pay his tax liabilities. The evidence shows that Debtor could have easily paid his tax obligations had he spent less money on tuition payments, gifts, charitable contributions and child support payments in excess of his obligations under the court-ordered arrangement with his ex-wife. From 1986 to 1999, Debtor spent $420,000 on tuition payments, spent approximately $62,725 on excess child support payments, made charitable contributions in the amount of $68,389, gave gifts to his ex-wife and close friends totaling $72,500 and made highly speculative investments in which he lost $269,000. In comparison, Debtor accumulated total tax liabilities of $288,277.60 of which a significant portion, if not all, could have been paid within a reasonable amount of time had Debtor refrained from spending all his money on the above-listed discretionary expenses. In a recent case, under a similar set of facts, the Debtor, an attorney, channeled money that could have been used for his tax liabilities to personal expenses, such as paying his daughter's "Ivy League" education, maintaining a country house and paying his wife's tax liabilities. In re Haesloop [ 2000-2 USTC ¶50,757], 2000 WL 1607316 (Bankr. E.D. N.Y. 2000). In that case, the court found that had debtor made reasonable adjustments to his standard of living he could have easily paid his tax debt in full and held that the debtor willfully attempted to evade or defeat his tax obligations within the meaning of §523(a)(1)(C). The fact that the debtor's income, in Haesloop, was $275,000 per year and Debtor's income, on average during the relevant period, was $67,000 per year, makes no difference. Had Debtor refrained from spending more than half his income on discretionary expenses such as private education and excess child support payments, he would have easily been able to pay his tax obligations within a reasonable period of time.

Furthermore, this Court rejects Debtor's related argument that he led a frugal modest lifestyle and that he was faced with "Hobson's Choice" between payments of his tax obligations on the one hand, and financial contributions and support to his family on the other. (Debtor's Post-Trial Memorandum of Law, at 5.) Courts have held that a debtor has willfully evaded his taxes under §523(a)(1)(C) where he had the wherewithal to pay his tax obligations but chose to apply his income to discretionary expenses such as private education for his children and financial support to his family members. In re Haesloop [ 2000-2 USTC ¶50,757], 2000 WL 1607316, In re Wright, 191 B.R. 291, 295 (S.D. N.Y. 1995) (debtor spent "thousands of dollars" on tuition payment for Ivy League education for his children, paid substantial credit card charges of wife and daughter, and helped support his brother and mother); In re Eleazar, 271 B.R. 766 (Bankr. D. N.J. 2001) (debtor paid substantial credit card debt of his family member). Debtors do not owe a duty to supply their children with nonessential luxuries such as private education absent some evidence that the debtor's children would not be served by a public school education. In Re Griffith , 209 B.R. 823, 828 (Bankr. N.D. N.Y. 1996).

Debtor claims that as an Orthodox Jew he has an obligation to send his children to Jewish day schools. (T1 at 113.) While there is no case directly addressing whether a debtor has a constitutional right to send his children to religious school, courts have held that a debtor does not have a constitutional right to make charitable contributions under the free exercise clause of the First Amendment. In re Griffith , 209 B.R. 823, 828 (Bankr. N.D. N.Y. 1996), Church of Lukumi Babalu Aye., Inc. v. Hialeah , 508 U.S. 520 (1993). This Court sees no basis for finding a right, constitutional or otherwise, to pay religious school tuition in preference to tax obligations.

If this Court were to permit every debtor to receive a discharge of his or her tax liabilities every time a debtor decided to spend income on discretionary personal expenses at the expense of tax obligations, claiming that he or she was faced with conflicting monetary obligations, then §523(a)(1)(C) would be meaningless. In this case, Debtor had the wherewithal to pay his taxes had he not spent most of his income on discretionary expenses and taken affirmative steps, after receipt of distributions from his father's trust, to place his assets beyond the reach of creditors.

This is not a case where Debtor was ignorant of his tax obligations. Indeed, like the debtors in Haesloop and Wright, Debtor, an intelligent attorney with an LL.M. in tax, clearly knew he had a duty to pay his tax obligations and voluntarily and consciously chose to ignore these obligations. At trial, the Debtor testified that "the IRS came at the bottom of his list along with three or four hundred thousand worth of other creditors" (T3 at 24) because they didn't "scream loud enough" (T3 at 24) and that he would pay "whichever creditors were yelling the loudest" (T2 at 16) and that his "landlord, car payments and child support payments" were timely made so that his "ex-wife wouldn't yell at me." (T2 at 16.)

Section 523(a)(1)(C) renders nondischargeable attempts in any manner to evade or defeat a tax. The totality of the Debtor's conduct here constitutes a scheme of willful evasion and conduct to defeat the payment of his tax liabilities.

In conclusion, the Court, having considered the totality of Debtor's conduct, finds that Plaintiff willfully attempted to evade or defeat his tax obligations within the meaning of §523(a)(1)(C) of the U.S. Bankruptcy Code. Accordingly, the principal amount of Debtor's outstanding tax debt and the interest and penalties hereon, for each of the tax years in dispute, 1987 through 1992, are non-dischargeable.



Pursuant to 11 U.S.C. §727(d)(2), Debtor's Discharge Should Be Revoked

Section 727(d)(2) of the United States Bankruptcy Code (11 U.S.C.) provides in pertinent part:

(d) On request of the trustee, a creditor, or the United States trustee, and after notice and hearing, the court shall revoke a discharge granted under subsection (a) of this section if --

 

(2) the debtor acquired property that is property of the estate, or became entitled to acquire property of the estate, and knowingly and fraudulently failed to report the acquisition of or entitlement to such property, or to deliver or surrender such property to the trustee.

The burden of proof under §727(d)(2) is preponderance of the evidence, and not, as Debtor's counsel argues, the clear and convincing standard. Although this Court, in In re Kirschner, 46 B.R. 583 (Bankr. E.D. N.Y. 1985), held that the appropriate standard in a §727(d)(1) case was clear and convincing evidence, the U.S. Supreme Court in Grogan v. Garner, 498 U.S. 279 (1991), applied the preponderance of evidence standard to dischargeability issues under 11 U.S.C. §523. Several other courts have subsequently applied the preponderance of evidence standard to discharge revocation proceedings under 11 U.S.C. §727 because similar considerations of intent are involved in both provisions. See, e.g., In re Serafini, 938 F.2d 1156 (10th Cir. 1991); In re Bowman, 173 B.R. 922 (9th Cir. BAP 1994); In re Sylvia, 214 B.R. 437, 440 (Bankr. D. Conn. 1997); In re Barr, 207 B.R. 168 (Bankr. N.D. Ill. 1997); In re Frost, 164 B.R. 740 (W.D. Bankr. Mich. 1994); In re Wolfson, 139 B.R. 279 (Bankr. S.D. N.Y. 1992).

The Government contends that Debtor's remainder interest in the Trust was property of the estate at the time of the filing of the petition, and should have been disclosed on Schedule "B". (Plaintiff's Post-Trial Brief, at 40.) In addition, the Government asserts that Debtor failed to report acquisitions of cash from and maturing of Debtor's remainder interest to the Court or the Trustee. (Plaintiff's Post-Trial Brief, at 40.) In response, Debtor advances two arguments. First, he contends that his interest in the Trust was both subject to a discretionary power of appointment by the income beneficiary, Lorraine Colish, and also non-assignable and thus was not property of the estate. (Debtor's Post-Trial Memorandum of Law, at 10-14.) Second, he argues that he relied on his attorney's advice in not listing his remainder interest in the Trust in the schedules of his bankruptcy petition, and therefore that his failure to disclose the interest in his bankruptcy filing was not "knowing and fraudulent". (Debtor's Post-Trial Memorandum of Law, at 10-14.)

Both Debtor's counsel and the Government agree that the scope of property of the estate under §541 of the U.S. Bankruptcy Code includes "all legal or equitable interests of the debtor in property as of the commencement of the case". 11 U.S.C. §541. This provision has been broadly construed. In re Yonikus, 996 F.2d 866, 869 (7th Cir. 1993) ("every conceivable interest of the debtor, future, nonpossessory, contingent, speculative, and derivative, is within the reach of §541"). Although §541 defines the scope of the property of the estate, applicable state law determines the issue of whether debtor has a legal or equitable interest in property. Butner v. United States , 440 U.S. 48, 54 (1979).

Both parties also agree that since the Trust was established in Michigan , Michigan law applies. Under Michigan law, the trustee holds legal title to the corpus and the beneficiaries hold the equitable interest. In re Page, 239 B.R. 755, 763 (Bankr. W.D. Mich. 1999). In the case at bar, the Trust provided that testator's wife, Lorraine Colish, would be the income beneficiary of the Trust assets during her life, and Debtor and his sister, Julie Colish, had remainder interests in the trust assets which would mature on the death of Lorraine Colish. The Trust contained two provisions which are of particular importance in this case. First, Section 5B.3(d) of the Trust provides that Lorraine Colish had a special power to appoint, only by specific reference in her Will, the trust assets to any of testator's children or their descendants as she would determine in her sole discretion ⁸ . Second, Section 7.4 of the Trust contains a clause which essentially prevents the assignment or transfer of the beneficiary's interest in the trust's principal and income to his beneficiaries unless the trustee determines that such transfer is in the best interest of the beneficiary.

Debtor relies on two cases, In re Knight, 164 B.R. 372 (Bankr. S.D. Fla. 1994), and In re Hicks, 22 B.R. 243 (Bankr. N.D. Ga. 1982), for the proposition that where an interest is subject to a testamentary special power of appointment, the potential beneficiary does not have an interest that would be property of the estate. (Debtor's Post-Trial Memorandum of Law, at 10-13.) In Knight, the debtor scheduled certain property as contingent unvested interests in trusts and the issue was whether these trust interests were included as property of the estate. Debtor's parents established two separate trusts, the Dorothy Trust and the Charles Trust, which was later divided into Charles A trust and Charles B Trust. The Dorothy Trust provided that upon the death of Dorothy, the life beneficiary, the trust principal would be distributed equally to debtor and his sister, if they were alive. The Charles A Trust provided that Dorothy would receive all her income from this trust during her life and also permitted Dorothy, by power of appointment exercisable by Dorothy alone and in her sole discretion, to name debtor or his sister as beneficiaries. The court held that debtor's interest in the Charles A Trust was too remote to have value and did not constitute property of the estate. In re Knight, 164 B.R. at 376. However, the debtor's interest in the Dorothy Trust was held to be property of the debtor's estate, despite the existence of contingencies, which the court acknowledged reduced the actual value of the interest.

In Hicks, the debtor alleged that he had a vested remainder interest in his father's trust. Debtor's father died ten years prior to debtor's filing of his bankruptcy petition and debtor's mother was given a life estate in the residuary trust as well as a power of appointment, which enabled her to direct the trustee to turn over the trust assets to any descendant of her late husband. As of the bankruptcy filing date, the mother had not exercised her power of appointment and was still alive. The court held that debtor's interest would only vest upon the occurrence of two contingencies: 1) the mother's exercise of the power of appointment naming debtor as beneficiary and 2) the debtor surviving his mother. The court reasoned that it could not compel debtor's mother to exercise her power of appointment naming him as beneficiary and further that under Georgia law, the debtor's interest would only vest on the death of the mother, the life tenant. In re Hicks, 22 B.R. at 245.

The case at bar is distinguishable from the above cases. First, unlike Knight, the debtor in this case was actually named as a beneficiary under the Trust and was to receive 50% of the trust assets upon the death of the life beneficiary, Lorraine Colish. (Govt. Ex. W, X1, X2, Z1 and Z2.) In contrast, in Knight, the Charles A Trust did not provide that debtor was to receive the principal or income upon the death of the life beneficiary (unlike the Charles Part B Trust and the Dorothy Trust, which were held to be property of the estate), but merely permitted the life beneficiary to name any descendant of the testator upon her death, pursuant to the power of appointment. Second, Lorraine Colish, unlike the life beneficiaries in both Knight and Hicks, actually did exercise her power of appointment in her Last Will, prior to the filing of the bankruptcy petition. On January 8, 1985, Lorraine Colish executed a Last Will and Testament under ITEM XVII in which she refrained from exercising any power of appointment that she may have had at the time of her death. (Govt. Ex. CC1.) Further, on October 29, 1997, she executed a First Codicil to her Last Will and Testament in which she did not change ITEM XVII in the Last Will. (Govt. Ex. CC2.) Consequently, the Debtor's argument that the Court could not compel the life tenant to refrain from divesting Debtor of his interest in the Trust or to name him as beneficiary is unavailing: in this case there was no need to do so. Third, the court in Hicks placed emphasis on the fact that under Georgia law, the debtor's interest would only vest on the death of the life tenant, who happened to be still alive at the time of the filing of the bankruptcy petition. Here, in contrast, although the life beneficiary was still alive at the time of the bankruptcy filing, the Debtor's interest had already vested, because under Michigan law, as the Government properly notes, a remainderman's interest vests at the time of the death of the testator, not the life tenant. ( United States Post-Trial Brief, at 43.) In re Hurd's Estate, 6 N.W.2d 758, 760 ( Mich. 1942) (listing cases in support of the long-standing preference for vested estates); In re Childress Trust, 486 N.W.2d 141, 143 ( Mich. 1992).

For these reasons, this Court concludes that Debtor's interest in the Trust was not too remote or speculative to not be included in the property of the estate. Furthermore, although subject to possible divestment by the life beneficiary, Debtor's interest was a vested remainder interest. Even if Debtor's interest was found to be a contingent remainder interest, this alone would not preclude it from being property of the estate, provided the interest was not circumscribed by a spendthrift provision. See, e.g., In re Neuton, 922 F.2d 1379 (9th Cir. 1990) (fact that debtor's interest in trust was contingent on surviving life tenant did not preclude it from being property of estate); In re Dias, 37 B.R. 584, 586-587 (Bankr. D. Idaho 1984) (a beneficial interest is an equitable interest under §541(a)(1) despite the fact that at the time of filing petition it was contingent).

Debtor further argues that pursuant to both Section 7.4 of the Trust and §541(c)(2) of the U.S. Bankruptcy Code, his interest in the Trust was non-assignable and not reachable by his creditors and thus should not be included in the property of the estate. ⁹

Michigan law recognizes the validity of restrictions on the transfer of beneficial interests in spendthrift trusts. In re Edgan Estate, 137 Mich. App. 419, 357 N.W.2d 867 (1984). The United States Supreme Court has ruled that in accordance with the plain meaning of §541(c)(2), property is excluded from the estate when 1) debtor has a beneficial interest in a trust, 2) there is restriction on the transfer of such interest, and 3) the restriction is enforceable under applicable nonbankruptcy law. Patterson v. Shumate, 504 U.S. 753, 757-758, 1992).

This Court finds that the spendthrift provision in the Trust constitutes a valid spendthrift provision. Under Michigan law, the provisions of the trust instrument must demonstrate grantor's intent to "provide a fund for the maintenance of the beneficiary and at the same time to secure the fund against his improvidence or incapacity." In re Barnes, 2001 WL 815360 (Bankr. E.D. Mich. 2001) (quoting Black's Law Dictionary). In the case at bar, the main purpose of the spendthrift clause was to provide a source of income for the testator's wife, Lorraine , and secure the fund against any improvidence or incapacity of the wife or other beneficiaries by delegating complete control over the distribution of the funds to the trustee. ¹⁰ As a result, in the case at bar, Debtor's vested remainder interest in the spendthrift trust would be excluded from the estate pursuant to §541(c)(2), were it not for the effect of federal tax law.

The Bankruptcy Code recognizes federal tax law as "applicable nonbankruptcy law" for purposes of enforcing a §541(c)(2) exemption. Patterson, 504 U.S. at 758-759 ("Plainly read, the provision encompasses any relevant nonbankruptcy law, including federal law"); United States v. Dallas National Bank [ 46-1 USTC ¶9117], 152 F.2d 582, 585 (5th Cir. 1945) (holding that Internal Revenue statutes are federal laws). It is well-settled that courts draw from "Federal tax lien law as a source of `applicable nonbankruptcy' law that overrides any state law restriction on the Government's reaching the debtor's rights." In re Lyons , 148 B.R. 88, 93 (Bankr. D. D.C. 1992); see, e.g., Bank One v. United States [ 96-1 USTC ¶50,188], 80 F.3d 173, 176 (6th Cir. 1996) ("Under the great weight of federal authority, however, such restraints on alienation [referring to spendthrift provisions in a trust] are not effective to prevent a federal tax lien from attaching under 26 U.S.C. §6321.") Section 6321 of the Internal Revenue Code (26U.S.C.) provides that "if any person liable to pay a tax neglects or refuses to pay the same after demand, the amount shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person." 26 U.S.C. §6321; United States v. National Bank of Commerce [ 85-2 USTC ¶9482], 472 U.S. 713, 719-20 (1985) (the language of §6321 is broad and is reflective of a congressional intent to "reach every interest in property that a taxpayer may have"). Thus, although the spendthrift clause prevented creditors of the Debtor from reaching his remainder interest in the Trust, the United States' federal tax lien can be satisfied against any income distributions of the Trust provided that the liens attached to Debtor's property prior to the Debtor's bankruptcy filing, the liens were properly filed federal tax liens and Debtor's remainder interest constitutes a legal or equitable right defined as "property" or "rights to property" subject to attachment under federal law. Jones v. Internal Revenue Service [ 97-1 USTC ¶50,408], 206 B.R. 614, 621 (Bankr. D. D.C. 1997) (observing that certain property has "a split personality by remaining property of the estate for purposes of federal tax claims even though it is not property of the estate for purposes of other creditors' claims"); In the Matter of Orr [ 99-2 USTC ¶50,668], 180 F.3d 656 (5th Cir. 1999) (holding that federal tax liens attached to future distributions from the spendthrift trust at the time of the creation of the lien, which predated and survived the bankruptcy, and not at the time that each distribution was made).

In this case, the United States filed Notices of Federal Tax Liens for each of the years 1987 through 1993, thereby making each of those liabilities secured claims in the Chapter 7 case. (Govt. Ex. A1, A2.); 11 U.S.C. §506(a). Generally, the federal tax lien arises at the time the assessment is made and continues until the liability is satisfied or becomes unenforceable by reason of lapse of time. 26 U.S.C. §6332; United States v. City of New Britain [ 54-1 USTC ¶9191], 347 U.S. 81 (1954) (describing federal tax lien as general lien when attached at the time of assessment to all of the taxpayer's property, was thus perfected). Furthermore, under Michigan law, a debtor's interest in a spendthrift trust, be it contingent or remainder, is "property" or "rights to property" under 26 U.S.C. §6321. Bank One v. United States [ 96-1 USTC ¶50,188], 80 F.3d at 175. In addition, the Government's lien on the property of the taxpayer, when taxpayer fails to pay taxes after assessment, notice and demand, attaches to all property and rights to taxpayer's property, including property subsequently acquired by taxpayer. 26 U.S.C.A. §§6321, 6322.

As a result, the federal tax liens attached to Debtor's vested remainder interest in the Trust at the time of the creation of the liens, which predated the bankruptcy, and the liens attached to Debtor's after-acquired property, namely the maturing of Debtor's remainder interest and the resulting distributions from the Trust post-discharge.

The only question remaining before this Court is whether Debtor knowingly and fraudulently failed to report to the Court or surrender to the Chapter 7 Trustee his remainder interest in the Trust and the cash and other property distributions he received from the maturing of his remainder interest pursuant to §727(d)(2) of the U.S. Bankruptcy Code. ¹¹

To find the requisite degree of fraudulent intent under §727(d)(2), the court must find the debtor knowingly intended to defraud, or engaged in such reckless behavior as to justify the finding of fraud. In re Puente, 49 B.R. 966, 969 (Bankr. W.D. N.Y. 1985). The requisite fraudulent intent or recklessness may be proven by evidence of the debtor's awareness of the omitted asset and by showing that the debtor knew that failure to list the asset could seriously mislead the trustee or creditors or that the debtor acted so recklessly in not reporting the asset that fraud is implied. 4 Collier on Bankruptcy ¶727.15[4] (1992). As direct evidence of the debtor's intent can rarely be found, the courts have relied on the inferences drawn from a course of conduct and all surrounding circumstances in finding fraudulent intent. Matter of Reed, 700 F.2d 986, 991 (5th Cir. 1983) (debtor's whole pattern of conduct supports the court's finding of fraudulent intent); In re Kindorf, 105 B.R. 685, 689 (Bankr. M.D. Fla. 1989) (in determining debtor's actual intent, court considered all circumstances, including debtor's systematic transfer of excess of $143,000 to his wife, comprising his salary, income from partnership interest and gifts from parents, as well as debtor's failure to disclose the existence of a Swiss bank account in his schedules in which he held a substantial sum), In re Yonikus, 974 F.2d 901, 905 (7th Cir. 1992).

In the case at bar, Debtor became aware of his remainder interest in his father's estate soon after his father's death on January 11, 1981. (T1 at 140.) On December 20, 1997, Debtor's mother, Lorraine Colish, died. Despite knowledge of his remainder interest in the trust, debtor failed to disclose his interest in the schedules filed with this Court. Rather, Debtor, on Schedule "B" of the bankruptcy petition, expressly denied possessing any "future" interest or any "contingent and non contingent interests in estate of a decedent ... or trust." (Gov. Ex. P. Declaration Concerning Debtor's Schedules.) Debtor testified that he "didn't read the particular item[s] concerning future interest, life estates, contingent and noncontingent interest in estates" and that "had [he] read that, [he] would have never signed this petition." (T1 at 147.) Furthermore, Debtor claims that he told his attorney, William Bryk, about his interest in the Trust and that he decided not to disclose such interest on Schedule B of the bankruptcy petition upon advice of counsel. (T1 at 148.) These explanations are not credible and, in addition, lack merit.

It is well established that the advice of counsel is a complete defense to a charge of fraud where a full and fair disclosure of the facts is made. Jones v. Gertz, 121 F.2d 782, 784 (10th Cir. 1941); In re Topper, 229 F.2d 691 (3rd Cir. 1956); In re Stone, 52 F.2d 639 (D. N.H. 1931). However, the reliance must be in good faith and any protection based on reliance on debtor's counsel will only act as a protection to the extent the reliance was reasonable. In re Weber, 99 B.R. 1001, 1018 (Bankr. D. Utah 1989).

In Jones, the debtor was to provide architectural services on certain public construction contracts but later filed bankruptcy because he did not have sufficient funds to pay his necessary travel expenses to supervise the work. Debtor was owed a small sum from Adams County and the City of Walden ($461 and $95 respectively), which he assigned to a bank and a finance corporation. Debtor relied on his attorney who did not list the sums on his schedules because he thought the "assignments conclusive" and the debtor had no interest in the fund. The court held that debtor failed to list the fund because he honestly believed that there was nothing "coming to him from the assignments" rather than because he wanted to defraud the creditors. Jones v. Gertz, 121 F.2d at 784. In Topper, the debtor had no assets at the time he filed bankruptcy or after his discharge was denied. In re Topper, 229 F.2d at 692. Although debtor owed money to a few retail accounts, and two small loan companies, he only listed the debt owed to his landlord. As explanation, debtor said he only wished to discharge the debt to the landlord but that he intended to pay his other creditors. The court found that debtor had little to gain from the omission because debtor did not have any assets, and held that there was an absence of fraudulent intent necessary for denial of discharge due to false oath under Title 18 U.S.C.A. Section 152. In a more recent case, the debtor's attorney failed to list certain debts on the bankruptcy petition because he was either confused about the questions, or because he considered the debts to be family-related and of no value. In re Ellingson, 63 B.R. 271, 275-276 (Bankr. N.D. Iowa 1986). However, debtor and his attorney promptly amended the schedules after they learned of their errors at the first creditors meeting. Id. at 276. The court held that creditors had failed to show that material omissions from the schedules were made with fraudulent intent pursuant to 11 U.S.C. Section 727.

The case at bar is clearly distinguishable from the above cases. Unlike the debtor in Topper, who had no assets before and after the discharge, Colish concealed his interest in the Trust despite the near certainty that he would eventually come into possession of large monetary distributions. Similarly, the sums owed to the debtor in Jones pale in comparison to the distributions from the Trust, and, in addition, the debtor in Jones had actually assigned his interest in these funds to other entities, unlike Colish. Had the Debtor taken a similar approach to the debtor in Ellingson and voluntarily divulged his remainder interest in the Trust subsequent to his discharge, and prior to dissipating the Trust proceeds, this Court might have been more sympathetic to Debtor's pleas of mistake and reliance on counsel. However, the Government only became aware of Debtor's interest in the Trust during settlement negotiations with the Debtor for Adversary Proceeding No. 97-1399. (T4 at 18-19.) At trial, Debtor and his attorney, Mr. Bryk, submitted conflicting testimony concerning whether Debtor's trust interest was divulged to Mr. Bryk. Debtor testified that he disclosed his remainder interest to Mr. Bryk and Mr. Bryk told him he did not need to report such interest. (T1 at 148.) In contrast, Debtor's attorney, Mr. Bryk, testified that he never discussed a family trust nor did he remember the debtor informing him about any interest in a trust (T2 at 99-101 and T2 at 102, 103.) Attorney Bryk further testified that he typically made inquiries concerning items 18 and 19 of Schedule "B" (concerning future interests and interests in trusts). (T2 at 100.) It is unlikely that an attorney who considers himself a specialist in consumer bankruptcy law, and who has represented debtors in over one hundred cases (some involving substantial tax liabilities) would expose himself to malpractice liability by not listing Debtor's interest in a trust in the petition. (T2 at 103.) Given the conflicting testimony, this Court chooses to give credence to Mr. Bryk's testimony, especially in light of Debtor's conduct subsequent to receiving distributions from the Trust in January.

On January 13, 1998, Debtor received nearly $500,000 from the sale of land pertaining to the Trust and immediately thereafter engaged in a series of unexplained transfers and reallocation of these funds to several banks and accounts. (T1 at 169.) From January 1998 through December 1998, Debtor received distributions from the Trust totaling approximately $713,000. In addition, in March, 1998, Debtor created a Nevada Limited Partnership which he named Phoenix Samson Associates, L.P. and into which he transferred his Spencer Trask account, his newly opened Citibank accounts, various partnership interests in his father's Trust as well as practically all his personal property, all totaling $740,625. ¹² (Govt. Ex. J.) When asked at trial why he created this partnership in Nevada and why he transferred virtually all his property into it, Debtor replied that he was concerned about potential suits from clients. (T1 at 155.) This explanation is dubious at best. The Debtor's testimony in this regard was glib and lacking in credibility. Moreover, given the Debtor's history with the Internal Revenue Service, detailed above, any assertion that this convoluted series of transfers was not motivated in substantial measure by an intent to frustrate the Government's collection efforts defies credulity. In addition, the fact that Debtor did not pay his pending taxes for prior years nor even fully pay his 1998 taxes, when he received the distributions from the Colish Trust, provide additional support for an inference of fraudulent intent. Debtor's claims that he did not read the schedules carefully, and relied on his attorney's advice are ultimately not credible in light of Debtor's conduct and the fact that Debtor is an attorney, with an LL.M. in tax, and a sophisticated businessman.

Based on all the circumstances described above, this Court finds that the Government has carried its burden of proof under the preponderance of evidence standard enunciated in Grogan v. Garner and that Debtor knowingly and fraudulently failed to report to the Court or surrender the Chapter 7 Trustee his remainder interest in the Trust and the cash and other property distributions he received from the maturing of his remainder interest pursuant to §727(d)(2) of the U.S. Bankruptcy Code.

Conclusion

For all of the foregoing reasons, the United States has sustained its objection to the Debtor's discharge pursuant to §727(d)(2). Accordingly, Debtor's discharge is REVOKED. Furthermore, the United States has sustained its objection to the dischargeability of Debtor's outstanding tax debt for each of the tax years in dispute, 1987 through 1992, pursuant to §523(a)(1)(C). Accordingly, Debtor's outstanding tax debt, and interest and penalties thereon, for the tax years 1987 through 1992, are non-dischargeable.

IT IS SO ORDERED.

¹ References to T1 refer to the September 4, 2001 transcript. References to T2 refer to the September 5, 2001 transcript. References to T3 and T4 refer to the morning and afternoon transcripts from November 30, 2001.

² References to "JPTO" are to the Joint Pre-Trial Order approved by the Court on September 4, 2001.

³ Debtor and his former wife agreed:

to contribute to the reasonable cost of undergraduate college education ... debtor's obligation is conditioned on: 1) his being consulted with respect to the choice of educational institutions..., and 2) upon the children making application for any financial aid [Debtor] deems appropriate, and 3) upon [debtor's] financial ability to pay.

Paragraph 8, Marriage Settlement Agreement, Debtor's Exhibit 2, at 6.

⁴ In 1998, Debtor's oldest daughter began attending Philadelphia College of Science and Textiles, a private school in Philadelphia , Pennsylvania . See Trial Transcript (9/5/01) at 42.

⁵ One $20,000 check was returned.

⁶ The debtor contributed several items of personal property, including furniture, household items, clothing, furs, jewelry, musical instruments, silverware, china, crystal, paintings, books, collectibles, electronic audio and video equipment, computers, appliances and other property. (T1 at 157-180, Ex. J.)

⁷ Under Debtor's offer, as revised, he was to pay only $12,916 to compromise total reported unpaid liabilities of $85,241 for the tax years 1987 through 1992 (Govt. Ex. C). Based on Debtor's reported income, this was not a legitimate offer.

⁸ Section 5B.3(d) of the trust states: "Spouse's Special Power. My spouse shall have a special testamentary power of appointment to appoint outright, in a trust or otherwise, with such estates, powers, limitations or conditions as she shall determine, to any one or more of my children or to their descendants (..,) such amounts as my spouse, in my spouse's sole discretion shall determine, provided this power shall not be exercised for the purpose of discharging my spouse's legal obligations. (...) This power shall only be exercisable only by specific reference thereto in my spouse's will."

⁹ §541(c)(2) states in relevant part:

(c)(1) Except as provided in paragraph (2) of thus subsection, an interest of the debtor in property becomes property of the estate ... notwithstanding any provision in any agreement, transfer instrument, or applicable nonbankruptcy law

(c)(2) A restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title.

¹⁰ The spendthrift clause clearly states that the principal and income of the trust are to be free from interference of the creditors of any beneficiary and not subject to assignment or anticipation by any beneficiary unless the trustee determines this to be in the best interest of the beneficiary. See Section 7.4 of the Trust (Creditor's Clause).

¹¹ Although there is disagreement whether Section 727(d)(2) applies only to post-petition entitlement or receipt of property or whether it applies to both pre-petition property and post-petition property, this issue does not affect this Court's analysis because the debtor's pre-petition remainder interest in the Mannie S. Colish Trust actually matured, and the proceeds of the trust were distributed to him, after his discharge in bankruptcy. Compare In re Argiannis, 183 B.R. 307 (Bankr. M.D. Fla. 1995), In re Puente, 49 B.R. 966, 968 (Bankr. W.D. N.Y. 1985) (holding that Section 727(d)(2) applies only to entitlement or acquisition of post-petition property) with In re Barr, 207 B.R. 168 (Bankr. N.D. Ill. 1997) (holding that §727(d)(2), by its plain reading, is not limited to property acquired post-petition, but extends to property acquired pre-petition).

¹² His personal property included: "All furniture, household items, clothing, furs jewelry, musical instruments, silverware, china, crystal, paintings, antiques, books, collectibles, electronic audio and video equipment, computers, telephones, appliances, and all other personal property..." (T1 157-180, Govt. Ex. J.)

 

 

In re Thomas Gene Ready and Barbara M. Ready, Debtors

U.S. Bankruptcy Court, Mid. Dist. Fla., Tampa Div., 99-7964-8G7, 9/7/2001

[Code Secs. 6321 and 6871 ]

Bankruptcy: Federal tax liens: Property subject to tax liens: Real property: Equitable interest: Discharge of personal tax liability.--

Married debtors who were equitable owners, but not owners of record, of a residence at the time they filed a bankruptcy petition could not avoid a federal tax lien against the property even though their personal liability for the underlying tax had been discharged. Pursuant to state ( Florida ) law, the debtors acquired a beneficial or equitable interest in the residence when they entered into a purchase agreement. Their equitable ownership of the residence was evidenced by their possession of the property and their payment of all related expenses. Despite the fact that they did not become owners of the residence until after filing their bankruptcy case, the lien remained attached to their equitable interest and was enforceable following the discharge of their personal liability.

FINDINGS OF FACT, CONCLUSIONS OF LAW, AND MEMORANDUM OPINION

GLENN, Bankruptcy Judge:

THE CASE came before the Court for final evidentiary hearing to consider the Motion for Order to Show Cause filed by the Debtors, Thomas Gene Ready and Barbara M. Ready.

The Debtors filed a petition under chapter 7 of the Bankruptcy Code on May 14, 1999, and received their Discharge on August 26, 1999. In the Motion under consideration, the Debtors assert that the Internal Revenue Service (IRS) willfully violated the permanent injunction contained in the Discharge by virtue of its failure to release a tax lien on property acquired by the Debtors after the entry of the Discharge. Consequently, the Debtors request that the Court determine whether the IRS should be sanctioned as a result of such willful violation.

In response, the IRS contends that it is entitled to enforce its tax lien against the Debtors' property because the Debtors had acquired a right or interest in the property prior to the filing of the chapter 7 petition. According to the IRS, such right or interest is subject to the lien pursuant to §6321 and §6322 of the Internal Revenue Code and §522(c)(2)(B) of the Bankruptcy Code.

Background

Prior to July of 1984, the Debtors owned and lived in a home located at 4728 Luce Road in Lakeland , Florida .

Also prior to July of 1984, David and Joy Lively (collectively, the Livelys) owned and lived in a home located at 514 Laurel Lane , Lakeland , Florida .

On July 31, 1984, the Debtors and the Livelys entered an Agreement. The Agreement provided:

WHEREAS, both parties are owners of certain real property located in Polk County Florida. Each property has an existing Mortgage attached to it and further these Mortgages cannot be assumed until both parties have qualified and both parties wish to obtain occupancy of the other parties property prior to qualifying (sic).

It is mutually agreed by and between both parties on this date to execute Warranty Deeds, each party conveying their respective property to the other party. Until such time as both parties qualify for the assumption of the respective mortgages these Deeds will not be recorded but will be held in escrow.

Until such time as the parties qualify for the respective Mortgages READY will pay to LIVELY the sum of $1,150.00 per month which will be in turn paid by LIVELY to his mortgage company as payment of the monthly installment. LIVELY will pay to READY the sum of $440.95 per month which will be in turn paid by READY to his mortgage company as payment of the monthly installment.

Further, that each party agrees that this agreement constitutes an escrow closing and that the above referenced Deeds will be recorded at the expense of READY at the time of the Mortgage assumptions. . . .

. . .

READY has provided LIVELY with a check in the amount of $10,000.00 and the above referenced Warranty Deed as payment in full for LIVELY property. LIVELY has provided the above referenced Warranty Deed as payment in full for READY property.

(IRS Exhibit 2; Debtors' Exhibit 1). The Debtor, Mr. Ready, testified that he paid the Livelys the sum of $10,000 at the time of the transaction, as set forth in the Agreement.

Also on July 31, 1984, apparently in connection with the Agreement, the Livelys signed a Warranty Deed related to the Laurel Lane property. (IRS Exhibit 9; Debtors' Exhibit 2). The Warranty Deed states that the Livelys "granted, bargained and sold" the Laurel Lane property to the Debtors for good and valuable consideration. The disposition of the original Warranty Deed is unclear from the record, although it appears that the Deed may have been delivered to an escrow agent and subsequently lost. In any event, the Warranty Deed was never recorded.

The following year, on May 13, 1985, the Debtors signed a Warranty Deed related to the Luce Road property. (IRS Exhibit 12). According to this Warranty Deed, which was also signed in connection with the Agreement, the Debtors transferred the Luce Road property to an individual identified as Tom A. Benefield. After the Debtors had agreed to convey the Luce Road property to the Livelys pursuant to the Agreement, the Livelys had assigned their interest in the property to Mr. Benefield. The Warranty Deed from the Debtors directly to Mr. Benefield was recorded on May 21, 1985.

The Debtors obtained possession of the Laurel Lane home in August of 1984, shortly after the Agreement with the Livelys was executed. Since that time, a period of more than sixteen years, the Debtors have lived in the property as their home, and have paid the mortgage payments, property taxes, and insurance premiums on the property. The mortgage obligation, property tax records, and insurance policies remained in the name of the Livelys for the entire sixteen-year period, however, notwithstanding such payment by the Debtors. In addition to the mortgage, taxes, and insurance, the Debtors also paid all maintenance expenses with respect to the property, and deducted the mortgage interest payments on their federal income tax returns.

The IRS contends that the Debtors failed to pay income taxes for the 1990 tax year in the approximate amount of $42,003.66. The taxes were assessed on February 3, 1992, and a Notice of Federal Tax Lien was filed on June 12, 1992. (IRS Exhibit 5).

On August 4, 1992, the Debtor, Mr. Ready, signed a letter addressed to the Livelys. The letter states:

As per your request I hereby acknowledge that all financial responsibility regarding the property located at 514 Laurel Lane , Lakeland , Florida are solely that of mine, Thomas Gene Ready and my wife, Barbara M. Ready.

(IRS Exhibit 3).

On January 9, 1995, a second Notice of Federal Tax Lien was filed by the IRS. (IRS Exhibit 6). The second Notice relates to income taxes assessed for the 1991 tax year in the amount of $25,543.55.

On May 14, 1999, the Debtors filed a petition under chapter 7 of the Bankruptcy Code. The Laurel Lane property was not listed as an asset either on the Debtors' Schedule of Real Property, or on the Debtors' "Schedule C--Property Claimed as Exempt." The property is identified on the Statement of Financial Affairs, however, as "property held for another person," and 514 Laurel Lane is listed as the Debtors' residential address.

On June 24, 1999, the Debtors filed a Complaint against the IRS in the Bankruptcy Court to determine the dischargeability of their tax liability for 1990 and 1991. On October 27, 1999, a Final Judgment was entered in the adversary proceeding. The Final Judgment provided that the Debtors' income tax liabilities for the 1990 and 1991 tax years were not excepted from the Debtors' discharge, and therefore were dischargeable in their chapter 7 case. The Final Judgment further provided:

Any federal tax liens with respect to the plaintiffs' assessed federal income tax liabilities for the years 1990 and 1991, notices of which have been properly filed, shall remain in full force and effect as to any property, and any rights to property, belonging to the plaintiffs as of the filing of plaintiffs' bankruptcy petition.

(Final judgment on Complaint to Determine Dischargeability, Adv. No. 99-380, Doc. 21).

The Debtors received their Discharge on August 26, 1999.

In November of 1999, the Debtors employed Stephen H. Artman, Esquire, to represent them in connection with the Laurel Lane property.

On December 30, 1999, the Livelys signed a Quitclaim Deed that had been prepared by attorney Artman. Pursuant to the Quitclaim Deed, the Livelys transferred the Laurel Lane property to the Debtors. The Quitclaim Deed was recorded on March 6, 2000. (IRS Exhibit 1; Debtors' Exhibit 5).

On January 25, 2000, the Debtor, Gene Ready, signed a letter addressed to David Lively. In the letter, the Debtor stated as follows:

David Lively and I entered into a contract to purchase his home at 514 Laural [sic] Lane in Lakeland FL. I was unable to qualify for a mortgage. David allowed me to make the payments until I could qualify. It was my responsibility to make the monthly payments, not Davids. . . .

(IRS Exhibit 4). Mr. Ready testified that he intended to purchase the Laurel Lane home at the time that the Agreement was originally executed in July of 1984. At that time, he was a member of the State House of Representatives, and was confident that he would be able to refinance the property. Mr. Ready was defeated in his bid for re-election shortly after the Agreement was signed, however, and experienced financial setbacks as a result of the loss. Consequently, the Debtors were unable to qualify for refinancing or assumption of the mortgage, as contemplated by the Agreement.

Issue

The issue in this case is whether the IRS is entitled to enforce its tax lien on the Laurel Lane property, after the Debtors' personal liability for the underlying tax has been discharged, even though the Debtors did not have record ownership of the property at the time that they filed their chapter 7 petition. If the Debtors had acquired a right or interest in the property prior to the filing of the bankruptcy case, however, and such right or interest is sufficient to entitle the IRS to enforce the lien, the IRS has not violated the permanent injunction contained in the Debtors' discharge, and the Debtors' request for sanctions should be denied.

Discussion

Section 6321 of the Internal Revenue Code provides:

Chapter 64--Collection

Subchapter C--Lien for Taxes

§6321. Lien for taxes

If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount (including any interest, additional amount, addition to tax, or assessable penalty, together with any costs that may accrue in addition thereto) shall be a lien in favor of the United States upon all property and right to property, whether real or personal, belonging to such person.

(Emphasis supplied). The lien imposed by §6321 arises at the time that the tax is assessed. 26 U.S.C. §6322.

Where a Notice of Federal Tax Lien has been filed, the lien attaches to "all property and rights to property" belonging to the taxpayer. If the taxpayer subsequently commences a bankruptcy case, the lien remains attached to all property owned by the taxpayer at the time that the bankruptcy petition was filed. It is well-established that any such existing lien survives the bankruptcy case with respect to the prepetition property, even if the debtor's personal liability for the underlying tax is discharged ¹ in the bankruptcy case.

[T]he Supreme Court ruled that a pre-existing lien on property remains enforceable against that property even after an individual's personal liability has been discharged. Dewsnup v. Timm, 502 U.S. 410, 112 S.Ct. 773, 116 L.Ed.2d 903 (1992). Although the IRS cannot proceed to collect from the Debtor personally, it may satisfy the lien by levying against the Debtor's property.

In re Deppisch [99-1 USTC ¶50,429], 227 B.R. 806, 808 (Bankr. S.D. Ohio 1998). See also In re Dinatale, 235 B.R. 569, 573-74 (Bankr. D.Md. 1999).

Pursuant to the terms of the statute, the lien applies to "all property and rights to property" of the taxpayer. The language of §6321 "is broad and reveals on its face that Congress meant to reach every interest in property that a taxpayer might have." Drye v. United States [99-2 USTC ¶51,006], 528 U.S. 49, 56 (1999) (quoting United States v. National Bank of Commerce [85-2 USTC ¶9482], 472 U.S. 713, 719-20 (1985)). "Stronger language could hardly have been selected to reveal a purpose to assure the collection of taxes." Glass City Bank v. United States [45-2 USTC ¶9449], 326 U.S. 265, 267 (1945).

A. "Property and rights to property" under Florida law.

The nature and extent of a taxpayer's property and nights to property are determined in accordance with state law. "The United States Supreme Court ruled that the extent to which a taxpayer has 'property' or 'rights to property' to which a tax lien can attach is determined by state law." In re Jeffrey [2001-1 USTC ¶50,387], 261 B.R. 396, 398 (Bankr. W.D. Pa. 2001) (citing Aquilino v. U.S. [60-2 USTC ¶9538], 363 U.S. 509, 512-13 (1960)). "Thus, in order to determine whether property is subject to a federal tax lien, 'state law controls in determining the nature of the legal interest which the taxpayer had in the property.' " Craft v. The United States [98-1 USTC ¶50,305], 140 F.3d 638, 641 (6th Cir. 1998) (citing Aquilano, supra, and Morgan v. Commissioner [40-1 USTC ¶9210], 309 U.S. 78 (1940)).

In this case, the Debtors and the Livelys entered into a written Agreement dated July 31, 1984. The Agreement provided that it was "mutually agreed by and between both parties on this date to execute Warranty Deeds, each party conveying their respective property to the other party." The Agreement further provided that the Debtors had provided the Livelys with the sum of $10,000 and a Warranty Deed to their former home "as payment in full for the Lively property." Finally, the Agreement provided that the Warranty Deeds that were to be exchanged would be held in escrow until the properties were refinanced. There are two subscribing witnesses to the Agreement.

The Agreement constitutes a contract pursuant to which the Debtors agreed to purchase the Laurel Lane property from the Livelys in exchange for their former home located on Luce Road plus the sum of $10,000. The Debtors took possession of the property, and have paid all expenses associated with the home, since shortly after the Agreement was entered. The Deed to the home was not recorded, however, due to the Debtors' inability to obtain refinancing. Nevertheless, the Debtors continued to occupy the Laurel Lane property, and were paying all expenses related to the home, in May of 1999 when they filed their bankruptcy case.

The Court finds that the Debtors were the equitable owners of the property at the time that they filed their chapter 7 petition. The Agreement constitutes a contract by the Debtors to purchase the Laurel Lane property.

Under Florida law, a contract for the purchase and sale of real property creates an equitable interest in the purchaser, and the purchasers become the beneficial owners of the property. Waldorff Insurance and Bonding, Inc. v. Eglin National Bank, 453 So.2d 1383, 1385 (Fla. 1st DCA 1984). A purchaser under an agreement to convey real property acquires equitable title to the property. Department of Revenue v. Mesmer, 345 So.2d 384, 386 (Fla. 1st DCA 1977).

When a seller executes a contract to convey property, the purchaser becomes the "real beneficial owner" of the property. Arko Enterprises, Inc. v. Wood, 185 So.2d 734, 737-38 (Fla. 1st DCA 1966). Such real, beneficial ownership carries with it certain rights generally incident to property ownership. The beneficial interest acquired by a purchaser, for example, would be subject to sale on execution, could be made the subject of a trust, would pass to the purchaser's heirs upon his death, and would entitle the purchaser to recover damages for any trespass to the property. Arko Enterprises, Inc. v. Wood, 185 So.2d at 737-38 (Fla. 1st DCA 1966).

The Debtors acquired a beneficial or equitable interest in the Laurel Lane property as a result of the Agreement dated July 31, 1984.

B. Application of federal tax lien.

As set forth above, §6321 is purposefully broad and designed to reach every interest in property that a taxpayer might have. Drye v. United States [99-2 USTC ¶51,006], 528 U.S. at 56.

The lien imposed pursuant to §6321 of the Internal Revenue Code attaches to equitable interests acquired by taxpayers.

In Crough v. Scheets [94-2 USTC ¶50,426], 1994 WL 409628, at 2 (D.Kan.), for example, the taxpayer had contracted to purchase certain real property from a seller. The taxpayer took possession of the property, although the seller retained legal title. The Court found that the taxpayer acquired an equitable interest in the property at the time of the contract with the seller. The Court further found that tax liens "attach to the equitable interest in real property." Crough v. Scheets [94-2 USTC ¶50,426], 1994 WL 409628, at 2. The primary issue in that case involved the relative priorities as between the tax lien and other interests in the property.

Similarly, in Cardinal v. United States [93-1 USTC ¶50,263], 817 F.Supp. 647 (E.D. Mich. 1993), the taxpayer had entered a contract to purchase certain real property, and the IRS subsequently filed a Notice of Federal Tax Lien. The Court found that the taxpayer was "vested with equitable title" to the property at the time that the Notice of Federal Tax Lien was filed as a result of the purchase contract previously entered. The Court further found that a creditor of the taxpayer could "attach a lien to the vendee's [taxpayer's] equity interest" in the property. Consequently, the Court concluded that "the federal tax lien attached to whatever equity interest [the taxpayer] had built up in the property." Cardinal v. United States [93-1 USTC ¶50,263], 817 F.Supp. at 652.

See also United States v. Big Value Supermarkets, Inc. [90-1 USTC ¶50,160], 898 F.2d 493 (6th Cir. 1990) (Tax lien attached to interest acquired by a taxpayer pursuant to a purchase contract).

The tax lien asserted by the IRS applies to the Debtors' equitable interest in the Laurel Lane property.

Conclusion

The Debtors entered an Agreement on July 31, 1984, pursuant to which they agreed to purchase a home located on Laurel Lane in Lakeland , Florida . As a result of the Agreement, the Debtors became the beneficial or equitable owners of the property in 1984. Their equitable interest is further evidenced by the Debtors' possession of the property, and by the fact that they paid all of the expenses attendant to the property for more than sixteen years.

The IRS filed a Notice of Federal Tax Lien in 1992. The IRS subsequently filed a second Notice of Federal Tax Lien in 1995.

The Debtors filed their petition under chapter 7 on May 14, 1999.

The Court concludes that the Debtors held a beneficial or equitable interest in the Laurel Lane property at the time that they filed the bankruptcy petition. The Court further concludes that the tax liens of the IRS had attached to the Debtors' equitable interest in the property at the time that the bankruptcy case was filed. Finally, the Court concludes that the liens remain attached to the equitable interest even though the Debtors' personal liability for the underlying tax has been discharged, and even though the Debtors did not acquire record ownership of the property until after the bankruptcy case was filed.

Since the IRS should be entitled to enforce its tax lien on the Laurel Lane property, the IRS has not violated the permanent injunction contained in the Debtors' discharge by declining to release the liens, and the Debtors' request for sanctions should be denied.

Accordingly:

IT IS ORDERED that the Motion for Order to Show Cause filed by the Debtors, Thomas Gene Ready and Barbara M. Ready, is denied.

¹ Of course, the discharge of the Debtors does not extinguish the debt; the discharge operates as an injunction against the recovery of the debt as a personal liability of the Debtors. 11 U.S.C. §524(a)(2).

 

 

 

In re Virginia L. Jeffrey, Debtor. Virginia L. Jeffrey, Plaintiff v. United States of America , Internal Revenue Service, Defendants

U.S. Bankruptcy Court, West. Dist. Pa. , 99-26533-JFK, 4/12/2001, 2001 Bankr. LEXIS 337.

[Code Secs. 6321 , 6334 and 6871 ]

Bankruptcy: Collection of taxes: Levy v. lien: Exempt property: Personal property.--

Federal tax liens attached to, and the IRS had a secured interest in, a debtor's personal property. The debtor unsuccessfully argued that, because her personal property was exempt from levy under Code Sec. 6334 , the IRS's tax liens were unsecured. A tax lien may be secured by property of a debtor that is exempt from levy. While certain specified property is exempt from IRS levy, tax liens generally can attach to all of the property of a delinquent taxpayer. A levy involves the immediate seizure of property, while a lien is merely a security interest in property. Thus, the limitation on the IRS's ability to seize the taxpayer's property did not bar the IRS from asserting a security interest in such property.

[Code Sec. 6321 ]

Tax liens: Bankruptcy: Tort claims: Future proceeds: State ( Pennsylvania ) law.--

A federal tax lien attached to a debtor's unliquidated medical malpractice claim and would also attach to the proceeds ultimately realized with respect to the claim. Pursuant to state ( Pennsylvania ) law, a tax lien can attach to the proceeds of a personal injury action where the IRS has filed liens against a debtor's property for unpaid taxes. Moreover, the Bankruptcy Code provides an extremely broad definition of "property" that includes debtors' interests in causes of action.

[Code Sec. 6321 ]

Tax liens: Bankruptcy: Pension plans.--

A federal tax lien attached to all of a debtor's rights in her pension benefits, including the right to future payments. Her right to receive future payments qualified as a "right to property." Thus, the government was secured to the extent of the present value of the debtor's retirement benefits.

Robert R. Druzisky, for debtor. Richard Bedford, for Ronda J. Winnecour, Pittsburgh, Pa., Chapter 13 Trustee., D. Brian Simpson, Julia L. Wahl, Special Assistant to the United States Attorney, Paul Skirtich, Assistant United State Attorney, Pittsburgh, Pa., for I.R.S.

MEMORANDUM OPINION ¹

Background

FITZGERALD, Chief Bankruptcy Judge:

Before the Court are Cross-Motions for Summary Judgment on Debtor's Amended Adversary Complaint to Determine the Secured Status of the Internal Revenue Service ("IRS") in Virginia L. Jeffrey's ("Debtor") property. Debtor asserts that the IRS' federal tax lien cannot attach to various items because the items are not "property" B or because she has no equity in the property. The Debtor filed a voluntary petition under Chapter 13 of the Bankruptcy Code on September 2, 1999. The IRS filed its original proof of claim on October 8, 1999, and an amended proof of claim on November 3, 1999. The amended proof of claim was for two tax liens totaling $37,988.65 for taxes, penalties, and interest resulting from unpaid taxes for 1991, 1992, 1993, and 1995. The IRS filed Notice of Tax Lien on November 6, 1995, for the 1991--1993 deficiencies ($29,619.97) in Beaver, Pennsylvania , and on February 27, 1998, for the 1995 deficiency ($8,368.68) in Cuyahoga , Ohio . The Amended Complaint seeks to determine the secured status of the IRS tax liens on Debtor's residence, automobile, household goods, unliquidated medical malpractice claim and pension.

The parties stipulated to the existence and present value of the Debtor's assets on July 31, 2000: residence, $38,000 ²; 1997 Dodge Neon, $5,560; 401(k) pension plan, $6,291.09; personal property, $2,630.00; and a medical malpractice claim no value stipulated. On her Schedule B, the Debtor listed the approximate value of her medical malpractice claim as $10,000 and the IRS did not dispute this figure. However, the parties agreed that if the IRS is secured in the medical malpractice asset, its lien would attach to whatever Debtor collects on that claim During oral arguments on November 3, 2000, the IRS conceded that there is no equity in Debtor's residence or vehicle to support its lien, but continued to assert its secured position through a lien attached to her personal property, medical malpractice claim and pension. There was no dispute between the parties as to whether the liens were perfected.

In her Complaint, the Debtor states that she has no equity in the household goods to which the IRS lien can attach. Additionally, the Debtor argues that her medical malpractice claim is contingent and unliquidated and, therefore, under Pennsylvania law is not property to which the IRS lien can attach. Furthermore, the Debtor claims that the terms of her ERISA-qualified pension do not subject it to attachment by creditors, including the IRS.

Discussion

In order to determine the secured status of the IRS in Debtor's property the court must first determine to what property the IRS lien can attach. Section 6321 of the Internal Revenue Code states that one who fails to pay taxes shall have a lien placed "in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person." 26 U.S.C.A. §6321. The United States Supreme Court ruled that the extent to which a taxpayer has "property" or "rights to property" to which a tax lien can attach is determined by state law. Aquilino v. U.S. [60-2 USTC ¶9538], 363 U.S. 509, 512-513, 4 L.Ed.2d 1365, 80 S.Ct. 1277 (1960), citing Morgan v. Commissioner [40-1 USTC ¶9210], 309 U.S. 78, 82, 84 L.Ed. 585, 60 S.Ct. 424 (1940). Upon assessment, the lien survives until it is "satisfied or becomes unenforceable by reason of lapse of time," 26 U.S.C. §6322, and may attach "to all the property that the tax debtor subsequently acquired." Glass City Bank v. U.S. [45-2 USTC ¶9449], 326 U.S. 265, 268, 90 L.Ed. 56, 66 S.Ct. 108 (1945), quoting Graves v. Commissioner [CCH Dec. 4001], 12 B.T.A. 124, 133, 1928 WL 482 (1928).

The Bankruptcy Code defines a "lien" as a "charge against or interest in property to secure payment of a debt or performance of an obligation." 11 U.S.C. §101(37). Additionally, in determining the secured status of a lien the Bankruptcy Code provides that "an allowed claim of a creditor secured by a lien on property in which the estate has an interest . . . is a secured claim to the extent of the value of such creditor's interest in the estate's interest in such property . . ." 11 U.S.C. §506(a). In order for Debtor to have her Chapter 13 plan confirmed by the court the plan must provide that "with respect to each allowed secured claim provided for by the plan . . . the value, as of the effective date of the plan, of property to be distributed under the plan on account of such claim is not less than the allowed amount of such claim . . ." 11 U.S.C. §1325(a)(5)(B)(ii). The IRS is secured to the extent of the present value of the property and Debtor must pay the entire amount through her Chapter 13 Plan. ³

I. Personal Property ⁴

Debtor argues that the IRS is unsecured in her personal property. The parties stipulated that Debtor's personal property has a value of $2,630.00. Debtor asserts that her personal property includes: household goods, ⁵ furniture, books, clothes, jewelry, pets, and a swimming pool. She acknowledges in her Brief in Support of Motion for Summary Judgment that exemptions provided in the Bankruptcy Code are irrelevant to the secured status of the IRS' tax lien in her personal property, but argues that the property is protected by the exemptions from levy provided in the Internal Revenue Code. Section 6334 of the Internal Revenue Code details property that is exempt from levy by the IRS. Specifically, subparts (a)(1) and (a)(2) exempt "Wearing apparel and school books" and "Fuel, provisions, furniture, and personal effects" from levy.

The Court of Appeals for the Ninth Circuit explained:

The difference between a levy and a lien also suggests why a lien should still attach to property exempt from levy. A levy forces debtors to relinquish their property. It operates as a seizure by the IRS to collect delinquent income taxes. . . . The IRS's levying power is limited because a levy is an immediate seizure not requiring judicial intervention. . . . A levy connotes compulsion or a forcible means of extracting taxes from a recalcitrant taxpayer.' . . . A taxpayer subject to an IRS levy is provided certain protections such as notice and an opportunity to pay the taxes due before the seizure. . . .

A lien, however, is merely a security interest and does not involve the immediate seizure of property. A lien enables the taxpayer to maintain possession of protected property while allowing the government to preserve its claim should the status of property later change. If, for instance, the debtor later sells his exempt personal property for cash, the IRS would be entitled to obtain such proceeds.

U.S. v. Barbier [90-1 USTC ¶50,107], 896 F.2d 377, 379 (9th Cir. 1990) (citations omitted). See also In re Blackerby, 208 B.R. 136, 141 (Bankr. E.D. Pa. 1997) (prepetition liens remain enforceable against property after personal liability is discharged). While Debtor is correct that §6334 exempts certain property from levy, it does not preclude attachment of a valid tax lien, nor does it preclude payment of the claim through the bankruptcy. The only way Debtor's property will be released from the lien is through Debtor's payment to the IRS of the value of the encumbered goods.

II. Medical Malpractice Claim

Debtor listed an unliquidated medical malpractice claim valued at approximately $10,000 on her Schedule B. She argues that it is exempt under 11 U.S.C. §522(d)(11)(D) ⁶ or, in the alternative, that Debtor's medical malpractice claim is not property under applicable Pennsylvania law and, therefore, the IRS cannot attach a tax lien.

The argument that the medical malpractice claim is exempt from attachment by a tax lien has no merit under federal bankruptcy law. Section 522(c)(2)(B) of the Bankruptcy Code states, in part:

(c) Unless the case is dismissed, property exempted under this section is not liable during or after the case for any debt of the debt or that arose, . . . before the commencement of the case, except B (2) a debt secured by a lien that is B . . . (B) a tax lien, notice of which is properly filed . . .

Notice of the tax liens were filed in the Beaver County Prothonotary's Office for the 1991, 1992, and 1993 tax deficiencies on November 6, 1995, and in the Office of the Recorder of Cuyahoga County for the 1995 tax deficiency on February 27, 1998, and Debtor does not assert that these filings are improper.

The Debtor relies on Pennsylvania case law dealing with divorces to support her argument that the medical malpractice claim is not property to which the IRS lien can attach. The Debtor asserts the Pennsylvania Superior Court ruled on this issue in DeMasi v. DeMasi, 366 Pa. Super. 19, 530 A.2d 871 (Pa. Super. 1987), appeal denied, 539 A.2d 811 ( Pa. 1988), and in Hurley v. Hurley, 342 Pa. Super. 156, 492 A.2d 439 ( Pa. Super. 1985). ⁷ These cases stand for the proposition that, under the Pennsylvania Divorce Code as it existed at the time, property acquired after separation is not marital property. In Hurley, the wife's personal injury cause of action arose before the parties separated, but the action was tried and the claim liquidated after separation. Under the Pennsylvania Divorce Code, then in effect, only property acquired before separation constituted marital property. 23 P.S. §401(e) (repealed). Because Pennsylvania law generally provides that "[a] right of action strictly personal is not assignable" and the right is "not . . . a property right, capable of assignment, prior to liquidation", the court found the proceeds of the action not to be marital property. Hurley at 441, quoting Sensenig v Pa. Railroad Co., 229 Pa. 168, 78 A. 91, 92 ( Pa. 1910). In DeMasi, also a divorce case, the wife sought a determination that insurance proceeds acquired after separation were marital property because they were paid pursuant to a contract. The wife distinguished Hurley, arguing that it applied only to tort causes of action. The Superior Court agreed with the wife. Debtor's reliance on these cases is misapplied.

In 1988, §401 of the Divorce Code was replaced by 23 Pa.C.S. §3501(a)(8) and now provides that the relevant time for determining whether a cause of action is marital property is when the cause of action accrues. Nuhfer v. Nuhfer, 410 Pa. Super. 380, 599 A.2d 1348, 1349 ( Pa. Super. 1991). Thus, the cases upon which Debtor relies do not reflect the current state of Pennsylvania law.

Furthermore, although state law governs the nature of the interest which a taxpayer has in property, whether the right or interest created under state law constitutes "property" or a "right to property" subject to a §6321 tax lien is a matter of federal law. Drye Family 1995 Trust v. U.S. [98-2 USTC ¶50,651], 152 F.3d 892, 894 (8th Cir. 1998), aff'd. [99-2 USTC ¶51,006], 528 U.S. 49, 145 L.Ed.2d 466, 120 S.Ct. 474 (1999). In Simon v. Playboy Elsinore Associates, 1991 U.S. Dist. LEXIS 5729, 1991 WL 71119 (E.D. Pa. 1991), an IRS lien was held to have attached to the proceeds of a personal injury action where the IRS had filed liens against the debtor's property for unpaid taxes. "State and federal courts outside of Pennsylvania have recognized that, for federal tax purposes, the right to assert a tort claim is a chose in action,' constituting intangible personal property subject to the federal tax lien." Id. at *2. Furthermore, §541 of the Bankruptcy Code provides an extremely broad definition of property which includes Debtor's interests in causes of action. We find that the unliquidated medical malpractice cause of action is property in which the Debtor has an interest under Pennsylvania law and under the Bankruptcy Code. Thus, the tax lien attaches to the cause of action and will attach to its proceeds.

III. Pension Plan

Debtor relies on U.S. v. Dallas Nat. Bank [46-1 USTC ¶9117], 152 F.2d 582 (5th Cir. 1945), in support of her assertion that the IRS lien does not attach to her pension because she cannot sell her interest in it nor does she have the right to receive a distribution from it at this time. She argues in her brief that the pension is "never fully her property" until it becomes payable to her. In Dallas Nat. Bank the IRS sought to lien the taxpayer's interest in a testamentary trust. Under the terms of the will the taxpayer did not have legal title to the trust corpus, she had only an income therefrom The court held that even though the testator's intent was to create an estate immune from seizure, the IRS' lien still attached to the income to which the taxpayer was entitled at the time the income became payable to her.

This court recognized in In re Fuller, 204 B.R. 894, 900 (Bankr. WD. Pa. 1997), "that a federal tax lien attaches to the Debtor's right to receive future pension plan payments from an ERISA qualified plan at the time such payments are distributed or become due." The court further held: "The IRS is a secured creditor to the extent of the present value of the Debtor's right to lifetime pension benefits." Id. at 902.

In In re Wesche [96-1 USTC ¶50,265], 193 B.R. 76 (Bankr. MD. Fla. 1996), the debtor did not dispute that the tax lien attached to the right to receive pension benefits, but questioned the extent of the liens on those payments. The court held that the lien attached to all post-petition future payments. "The IRS claim is valued as the present value of the future payments over Debtor's lifetime." Id. at 79.

[Debtor] has a present right to receive payments in the future, which is a 'right to property' to which the tax lien attaches. . .. The right to future benefits exists in the present, and, most importantly, existed on the date of the filing of the petition in bankruptcy. Accordingly, the federal tax lien attached to all of [Debtor's] rights in the pension benefits, including the right to future payments. The United States , thus, is secured to the extent of the present value of [Debtor's] retirement benefits.

Id. at 79.

The parties have stipulated that the present value of the Debtor's pension is $6,291.09. Therefore, the IRS lien attaches to this value for purposes of this Chapter 13.

Conclusion

This court finds the IRS liens attach to Debtor's personal property to the extent of her equity in same, to the value of the medical malpractice claim and to the present value of her right to receive future payments from her pension. The IRS liens are secured to the extent of Debtor's equity in her personal property, valued at $2,630.00 and $6,291.09 in the Debtor's pension. Because the parties have stipulated as to the value of household goods as $2,630.00, this opinion assumes the IRS' lien in those assets is secured to that extent. The court will adjust the calculation, however, as explained in note 5, supra, if this assumption is in error. The Debtor must pay these amounts to the IRS through the plan in order to terminate the lien in those assets. Additionally, the IRS is secured in the Debtor's medical malpractice claim to the extent that she receives a damage award from the action, but not to exceed $28,437.56. ⁸ By agreement of the parties, the IRS' lien shall remain attached to the cause of action and shall not be paid through the Chapter 13 Plan, since its exact value cannot be determined until the Debtor's claim is liquidated.

An appropriate order will be entered.

ORDER

AND NOW to-wit, this 12th day of April, 2001, for the reasons expressed in the foregoing Memorandum Opinion,

It is ORDERED, ADJUDGED, and DECREED that plaintiff's Motion for Summary Judgment is DENIED and the Internal Revenue Service's Cross-Motion for Summary Judgment is GRANTED.

It is FURTHER ORDERED that the Internal Revenue Service's claim is secured to the extent of $6,291.09 in the Debtor's pension.

It is FURTHER ORDERED that the IRS's claim is secured to the extent of $2,630 in Debtor's household goods. However, within 20 days hereof the Debtor and/or the Internal Revenue Service shall file a stipulation as to the value of the IRS' secured claim in the Debtor's personal property and the value of the IRS' lien in the medical malpractice cause of action in accordance with this court's memorandum opinion. See notes 5 and 8 of the memorandum opinion and accompanying text therein.

It is FURTHER ORDERED that the Internal Revenue Service is secured in the Debtor's medical malpractice claim to the extent that she receives a damage award from the action, but not to exceed $28,437.56. This amount will be adjusted upward by any decrease in the IRS' secured claim on household goods.

It is FURTHER ORDERED that Debtor shall amend her Chapter 13 plan on or before May 21, 2001, and serve the U.S. Trustee, the Internal Revenue Service, and any other creditor affected thereby. Objections to the amended plan shall be filed and served on or before June 11, 2001. A conciliation conference is scheduled for June 19, 2001, at 9:00 a.m in Courtroom A, 54th Floor USX Tower , 600 Grant Street , Pittsburgh , PA. 15219. If the parties are not able to resolve the confirmation dispute, a contested hearing will be held on June 26, 2001, at 1:30 p.m in Courtroom A, 54th Floor USX Tower , 600 Grant Street , Pittsburgh , PA. 15219.

¹ The court's jurisdiction was not at issue. This Memorandum Opinion constitutes our findings of fact and conclusions of law.

² This value was determined in an appraisal obtained by the Debtor on March 8, 2000, by order of this Court.

³ If Debtor completes all plan payments and receives a discharge, her personal liability for the remaining tax debt will be discharged. However the lien remains viable until the obligation is paid in full. In re Blackerby 208 B.R. 136, 141 (Bankr. E.D. Pa. 1997).

⁴ During oral argument on November 3, 1999, the court granted the IRS' request to file a supplemental brief concerning household goods. The IRS filed a supplemental brief within the two weeks granted by the court, but the Debtor did not file a response to the IRS' brief.

⁵ In an answer to the IRS' Interrogatory #8, Debtor disclosed that some of her household goods are encumbered by a purchase money security interest to Heilig-Meyers, leaving no equity to the extent of that loan. She also conceded in her answer to the IRS' Interrogatory that the lien attaches to property not encumbered by the purchase money security interest. This statement was not discussed in the briefs of either party or in any other proceeding before the court. Debtor separately itemized certain household goods (mattress, bed, lamps, and shelves) with a claimed value of $860.00 in her Schedule B. These items are over-encumbered by Heilig-Meyers' purchase money security on a total claim of $1542.00. Thus, Heilig-Meyers has an unsecured claim of $682.00. As we understand the parties' stipulations, the IRS' lien attaches to different household goods as also separately itemized in Schedule B worth $2,630.00. If the $2,630.00 actually includes the $860 value of goods subject to the secured claim by Heilig-Meyers, then the IRS' lien attaches only to the value of $1,768.00. See note 3, supra.

⁶ 11 U.S.C. §522(d)(11)(D) states, in part: "The following property may be exempted under subsection (b)(1): . . . (11) The debtor's right to receive, or property that is traceable to B (D) a payment, not to exceed $16,150, on account of personal bodily injury, not including pain and suffering or compensation for actual pecuniary loss, of the debtor or an individual of whom the debtor is a dependent . . ." Effective April 1, 2001, that amount increases to $17,425.00. 11 U.S.C. §104(b). However, the lesser amount was in effect when Debtor filed this case.

⁷ The above cases did not determine 'what is property,' but determined 'what is marital property' under the Pennsylvania Divorce Code. Hurley, which DeMasi used as a basis for its decision on this point, began its analysis by asking the question: "Did the legislature intend to require that a spouse's unliquidated claim for personal injuries in tort be deemed marital property?" Hurley at 442.

⁸ This figure was calculated by subtracting the IRS' security interest in Debtor's household goods ($2,630.00) and pension ($6,291.09) from the total amount of the IRS' liens ($37,988.65). This figure will be adjusted upward if the assumption as to the extent of the IRS' lien in household goods is in error. See, note 5, supra.

 

 

 

In re William A. Herreras, Debtor. United States of America (Internal Revenue Service), Appellant v. Michael S. Kogan, Chapter 7 Trustee, Appellee

U.S. District Court, Cent. Dist. Calif., CV 00-05959 CAS, 11/7/2000, Reversing an unreported Bankruptcy Court decision

[Code Sec. 6321 ]

Tax liens: Bankruptcy: Proceeds of property: Work in progress: State (California) law: Attorney.--Proceeds from the sale of a bankrupt attorney's prepetition work in progress were proceeds of property and, thus, subject to a preexisting tax lien. State ( California ) law treated an attorney's work in progress as a valuable asset. Thus, work that the debtor was performing on a contingent basis was part of his present estate and subject to the IRS lien.

I. Introduction

SNYDER, District Judge:

This matter is an appeal from an order of the bankruptcy court. The question presented is whether proceeds, which are held by the trustee, of the sale of an attorney's pre-petition work in progress, are proceeds of "property" subject to a federal tax lien under I.R.C. §6321. The debtor attorney surrendered the assets of his law practice, including the work in progress, to the trustee after filing his Chapter 7 petition. Subsequently, the debtor repurchased the law practice from the trustee pursuant to a settlement agreement. The Internal Revenue Service ("IRS") then filed a proof of claim, seeking to enforce a preexisting tax lien against the proceeds in the hands of the trustee. The trustee objected to the application to the tax lien of that part of the proceeds which was attributable to the work in progress. The bankruptcy court sustained the objection, holding that the tax lien did not attach to those proceeds, on the ground that the debtor did not have an unqualified right to receive fees from the in-progress cases at the time the petition was filed. The IRS filed this appeal. For the reasons stated in this order, the Court reverses the order of the bankruptcy court.

II. Standard of Appellate Review

The district court reviews decisions of the bankruptcy court in the same manner as would the Court of Appeals. See In re George, 177 F3d 885, 887 (9th Cir. 1999). Thus, the Court reviews the bankruptcy court's conclusions of law de novo, and reviews its factual findings for clear error. Id. Mixed questions of law and fact are also reviewed de novo. In re Chang, 163 F3d 1138, 1140 (9th Cir. 1998).

III. Facts

There is no dispute regarding the essential facts of the case. On February 21, 1997, debtor William A. Herreras filed for protection under chapter 7 of the Bankruptcy Code. See Docket, Appellant's Excerpts of Record ("E.R.") Ex. 16. The bankruptcy estate included the debtor's pre-petition business assets, consisting of his law library, business equipment, bank accounts, life insurance, accounts receivable, appellate accounts receivable, goodwill, and work in progress. See Settlement Agreement, E.R. Ex. 12 ¶1. The debtor was a workers' compensation lawyer who generally handled cases on a contingent fee basis. See Letter of Sandra K. Fahey, Debtor's Attorney, Proposing Settlement Terms, May 29, 1997. E.R. Ex. 8, Bates Stamp No. 108. ¹ The debtor agreed to pay $113,852.00 to recover these assets from the estate, pursuant to a settlement agreement reached by the parties and approved by the bankruptcy court on September 17, 1997. See Settlement Agreement, E.R. Ex. 12 ¶2; Order Approving Compromise of Controversy, E.R. Ex. 13. Of the total amount, the parties attributed $66,232.00 to the work in progress. See Fahey Letter, E.R. Ex. 8, Bates Stamp No. 108.

The IRS filed a proof of claim in bankruptcy court on August 20, 1997. The proof of claim listed secured claims totaling $707,469.61 in assessed taxes, penalties and interest, based on five tax liens filed on December 22, 1992, and July 6, 1993. The claim also listed an unsecured priority claim of $15,373.00 for unassessed taxes. Thus the IRS, total claim was for $722,942.61. See Proof of Claim, E.R. Ex. 1, Bates Stamp No. 15. On January 24, 2000, the trustee filed a motion objecting to the secured portion of the IRS' claim. See Motion Objecting to Claims, E.R. Ex. 1, Bates Stamp No. 1. The trustee apparently believed that the lien could not attach to money the estate obtained pursuant to the settlement agreement, but only to the law practice assets themselves, which had been transferred back to the debtor:

[T]he tax lien obtained by the IRS was for a security interest in all property and rights to property of the Debtor, however, the assets of the estate resulted from the sale of the Debtor's law practice back to the Debtor. The Trustee is not in possession of any assets or proceeds of assets from which the claimant may satisfy its claim. Any property with which the IRS may satisfy its claim is in the possession of the Debtor.

Id. at Bates Stamp No. 6-7.

On March 29, 2000, the bankruptcy court held a hearing on the trustee's motion. After hearing argument, the court continued the hearing to allow the parties to submit supplemental briefing on the question of which assets' proceeds the tax lien attached to. See Transcript of Proceedings, March 29, 2000, E.R. Ex. 14 at Bates Stamp No. 137-41. At a subsequent hearing on May 16, 2000, the bankruptcy court ruled from the bench that the tax lien attached to the debtor's bank accounts, life insurance, accounts receivable, and appellate accounts receivable, with a total value of $47,620.00, and did not attach to work in progress, valued at $66,232.00 See Transcript of Proceedings, May 16, 2000, E.R. Ex. 15, at Bates Stamp No. 150. The court relied on In re Connor [94-2 USTC ¶50,296], 27 F3d 365 (9th Cir. 1994). See id. at Bates Stamp No. 150. In Connor, the Ninth Circuit held that post-petition payments of a state judge's pension were property to which a pre-petition tax lien attached because the pension had vested before the debtor filed his Chapter 7 petition; as a result the debtor had an unqualified pre-petition right to collect the pension payments. See id. at Bates Stamp 148. The court interpreted Connor to mean that the existence of an unqualified right to be paid is "the test . . . for what future monies are subject to the tax lien in bankruptcy." Id. The court concluded that the debtor Herreras did not have an unqualified right to collect any money in his pending cases; therefore, the tax lien could not attach to the proceeds of the work in progress held by the trustee. See id. at Bates Stamp No. 150.

On June 1, 2000, the bankruptcy court entered an order stating that the tax lien is limited to assets collected by the trustee in the amount of $47,620.00, and does not attach to the additional $66,232.00 collected by the trustee representing work in progress. The government's appeal followed. ²

IV. Analysis

A. The Amount to Which the Tax Lien Attaches

The IRS argues in this appeal that the tax lien should attach to the proceeds of the work in progress. The trustee argues that it should not.

The failure to pay taxes owing to the federal government after demand creates a lien in favor of the United States, in an amount including the taxes owed, penalties, interests and costs, "upon all property and rights to property, whether real or personal, belonging to" the taxpayer. I.R.C. §6321. In general, a federal tax lien attaches not only to property owned by the taxpayer at the time the lien is created, but to all after-acquired property as well, until the lien's expiration. Glass City Bank of Jeanette v. United States [45-2 USTC ¶9449], 326 US 265 (1945). An exception to this rule, however, is that the lien does not attach to property acquired by the taxpayer after the taxpayer files a bankruptcy petition. In re Connor [94-2 USTC ¶50,296], supra, 27 F3d at 366; In re Braund [70-1 USTC ¶9237], 423 F2d 718, 719 (9th Cir. 1970). The only question before the Court is whether Herreras' work in progress was "property" or "rights to property" within the meaning of I.R.C. §6321 before Herreras' bankruptcy filing.

California law supports the IRS' view that the work in progress was property for purposes of I.R.C. §6321 before filing of the bankruptcy petition. A lawyer's work in progress is treated as a valuable asset under California law in other contexts, primarily the context of division of marital property. See In re Marriage of Morrison, 20 Cal.3d 437, 453 (1978) (holding that in determining the value of a law practice for purposes of marital property division, the assets considered should include work in progress partially completed but not billed as a receivable, work completed but not billed, and goodwill); Kilbourne v. Kilbourne, 232 Cal.App.3d 1518, 1522 (1991) (same). California courts recognize that "[a]t any given moment the major assets of most law firms are not capital assets, but those related to the direct rendering of professional services, most particularly accounts receivable and work in process." In re Marriage of Green, 213 Cal.App.3d 14, 21 (1989).

The proposition that a lawyer's work in progress is property under California law is insufficient on its own, however, to show that it is property for purposes of §6321. The Supreme Court has stated:

As restated in [ United States v.] National Bank of Commerce [85-2 USTC ¶9482], [472 US 713, 727 (1985)]: "The question whether a state-law right constitutes 'property' or 'rights to property' is a matter of federal law," [85-2 USTC ¶9482], 472 US , at 727, 105 SCt 2919. We look initially to state law to determine what rights the taxpayer has in the property the Government seeks to reach, then to federal law to determine whether the taxpayer's state-delineated rights qualify as "property" or "rights to property" within the compass of the federal tax lien legislation. Cf. Morgan v. Commissioner [40-1 USTC ¶9210], 309 US 78, 80, 60 SCt 424, 84 L.Ed 1035 (1940) ("State law creates legal interests and rights. The federal revenue acts designate what interests or rights, so created, shall be taxed.").

Drye v. United States [99-2 USTC ¶51,006; 99-2 USTC ¶60,363], 120 SCt 474, 481 (1999). In some instances, federal law treats as "property" for purposes of §6321 rights that do not constitute property under state law. See, e.g., West Lancaster v. Main Line Restaurant, Inc. [86-2 USTC ¶9516], 790 F2d 354, 357-58 (3d Cir. 1986) (holding that although a liquor license was not regarded as property under state law, it was property for purposes of §6321, and was subject to a federal tax lien). In other, apparently rarer instances, federal law declines to treat as "property" for tax lien purposes rights treated as property rights under state law. See, e.g., Aquilino v. United States [60-2 USTC ¶9538], 363 US 509, 513-16 (1960) (remanding case for determination whether a contractor's rights to the funds at issue constituted a "beneficial interest" as opposed to "bare legal title" under state law; if they were only bare legal title, they would not constitute "property" under §6321).

In determining whether a state-law right constitutes "property" under §6321, the Court bears in mind that the language of §6321 "is broad and reveals on its face that Congress meant to reach every interest in property that a taxpayer might have." National Bank of Commerce [85-2 USTC ¶9482], supra, 472 US at 719-20. Furthermore, "[w]hen Congress so broadly uses the term 'property,' we recognize . . . that the Legislature aims to reach every species of right or interest protected by law and having an exchangeable value." Drye [99-2 USTC ¶51,006; 99-2 USTC ¶60,363], supra, 120 SCt at 480 (citations and internal quotation marks omitted).

It is on the basis of these principles that interests of uncertain status have often been held to be "property" for purposes of a §6321 tax lien. See, e.g., Plymouth Saving Bank v. United States [99-2 USTC ¶50,807], 187 F3d 203 (1st Cir. 1999) (holding that federal tax lien attached to contract rights at the time the contract was made, even though the right to receive money under the contract would not become unconditional until the contract was subsequently performed); Atlantic National Bank v. United States [76-2 USTC ¶9483], 536 F2d 1354 (CtCl 1976) (holding that tax lien presently attached to monies due or to become due in the future under contract); United States v. Hubbell [63-2 USTC ¶9724], 323 F2d 197 (5th Cir. 1963) (holding that a subcontractor's claim against a building owner for duress was not contingent merely because it would take a lawsuit to reduce it to judgment or to collect it, and was not subject to any infirmity that would prevent attachment of a federal tax lien); In re Weninger [90-2 USTC ¶50,510], 119 B.R. 238 (D. Colo. 1990) (holding that a chose in action is property for purposes of tax lien); In re Nevada Environmental Landfill, 81 B.R. 55 (D. Nev. 1987) (holding that the fact that a taxpayer's right to proceeds of a contract may be dependent on performance of the contract does not mean that the proceeds are not property or rights to property of taxpayer subject to federal tax lien).

The attorney's work in progress at issue in this case is similar to the interests at stake in the cases cited above. As noted above, there is some dispute as to whether all or only some of Herreras' cases in progress were contingent fee cases. If any were hourly fee cases, Herreras was entitled pre-petition to be paid for hours already worked. But even if all were contingent fee cases, Herreras had a right to be paid contingent on a future event, and this is sufficient under Plymouth Savings Bank and Nevada Environmental Landfill, supra. Moreover, Herreras' conditional rights were "protected by law and [had] an exchangeable value," Drye [99-2 USTC ¶51,006; 99-2 USTC ¶60,363], supra, 120 US at 480. Such rights are protected by law in that they are enforceable upon the happening of the condition and are treated as valuable assets in such contexts as that of marital property division; and it is clear that they had an exchangeable value because Herreras purchased them from the trustee. The trustee argues that Herreras' pending files could not have commanded a price on the market because purchasers would have known that Herreras intended to remain in the same market and the clients could return to him notwithstanding the sale; but if this were really a reason why the work in progress had no value, Herreras himself would have had no reason to buy the work in progress from the estate.

The trustee points out that the Supreme Court has stated that "[i]n recognizing that state-law rights that have' pecuniary value and are transferrable fall within §6321, we do not mean to suggest that . . . . an expectancy that has pecuniary value and is transferable under state law would fall within §6321 prior to the time it ripens into a present estate." Drye [99-2 USTC ¶51,006; 99-2 USTC ¶60,363], supra 120 SCt at 482 n.7. California law, however, treats a lawyer's work in progress as a valuable asset. Herreras' work in progress was thus a present estate, and not a mere expectancy, before he filed his bankruptcy petition.

The trustee also argues that Connor, supra, and Fuller v. United States [92-1 USTC ¶50,119], 134 B.R. 945 (9th Cir. BAP 1992) show that the work in progress is not property under §6321. The trustee is incorrect. In Connor, the lien attached to the future pension payments because the debtor had an unconditional pre-petition right to receive the payments. [94-2 USTC ¶50,296], 27 F3d at 366. The fact that an unconditional pre-petition right to receive payments is a property right for purposes of §6321, however, does not imply that a conditional pre-petition right is not a property right for purposes of §6321. The cases cited above, concerning the status under §6321 of conditional contract rights, indicate that conditional rights can be subject to a §6321 lien as well as unconditional rights.

In Fuller, the court held that a pre-petition federal tax lien could not attach to an inheritance the debtor received pursuant to a will, where the testator died after the bankruptcy filing. The inheritance was not property within the meaning of 9 6321 because at the time the petition was filed, the testator was alive, and the debtor had no interest in the inheritance at all, conditional or unconditional. See [92-1 USTC ¶50,119], 134 B.R. at 947-48. The fact that a right having no pre-petition existence at all is not subject to a §6321 lien does not imply that a right that is conditional before filing of the petition is not subject to such a lien. Herreras had a conditional contractual right to receive fees from his contingent fee clients, and would have retained a contingent right to recover in quantum meruit even if the clients had discharged him, see Fracasse v. Brent, 6 Cal.3d 784, 791 (1972).

B. The Form of the Proceeding

The government makes an alternative argument that the proceedings below regarding the tax lien ought not to have gone forward as a motion objecting to a claim; instead, the government argues, the trustee should have been required to bring an adversary proceeding. Because the Court has held for the government on other grounds, it is unnecessary to reach this issue.

Conclusion

The order of the Bankruptcy Court for the Central District of California entered June 1, 2000, limiting the Internal Revenue Service's tax lien to $47,620.00 of the assets collected by the trustee, is reversed. The Court hereby orders that the Internal Revenue Service shall have a tax lien attaching to $113,852.00 of assets collected by the trustee, constituting all the proceeds of the sale of the assets of debtor's law practice to debtor.

IT IS SO ORDERED.

¹ The IRS disputes the contention that all the debtor's cases were handled on a contingency basis, stating that "at least some" were not. See Appellant's Reply Brief at 3-4. The question whether some or all of the debtor's cases were contingent fee cases is immaterial. The IRS prevails even if all the cases were contingent fee cases.

² It should be noted that far less than $66,232.00 is actually at stake in this appeal. The effect of the Court's decision about the tax lien depends on the priority of the other creditors' claims. The government concedes that even if 100% of the proceeds of the sale of the debtor's law practice were exempted from the lien, the other creditors would still receive only $3,416.00. See Appellant's Reply Brief at 1.

 

 

 

Richard R. Morgan, Sandra S. Morgan, Debtors

U.S. Bankruptcy Court, East. Dist., N.C., Wilson Div., 00-02529-8-JRL, 6/20/2000

220 F3d 353.

[Code Secs. 6321 , 6334 and 6871 ]

Bankruptcy: Tax liens: Avoidance of: State exemption laws: North Carolina. --

Married debtors' motion to avoid two federal tax liens pursuant to section 522(f)(1) of the Bankruptcy Code was denied. That provision allows debtors to avoid judicial liens to the extent that they impair exemptions to which the debtors would otherwise be entitled; however, exempt property remains encumbered by perfected prepetition tax liens. Bankruptcy Code section 522 cannot be used to avoid federal tax liens, which do not qualify as judicial liens because they arise by operation of law and not by virtue of any judgment. Moreover, the applicable state ( North Carolina ) exemptions statute does not apply to claims of the federal government or its agencies; instead, tax liens are governed by exemptions from levy set forth in Code Sec. 6334 .

ORDER

LEONARD, Bankruptcy Judge:

This chapter 13 case is before the court on the debtors' motion to avoid two federal tax liens pursuant to §522(f)(1) of the Bankruptcy Code. This motion is appropriate for decision without a hearing.

The two tax liens at issue have an aggregate value of $35,323 and are identified in paragraph 2 of the motion as "judicial tax liens." The liens are subsequently described in more detail as: 1) a "filed . . . tax lien" in the approximate amount of $6,851, recorded in Book 79, Page 252 in the Wayne County Courthouse, and 2) a "judgment" in the approximate amount of $28,472, recorded in Book 77, Page 126 in the Wayne County Courthouse. Because the debtors' motion is brought under §522(f)(1), the court assumes for purposes of this motion that both liens have been reduced to judgment. ¹

A federal tax lien arises by operation of law if the taxpayer fails to pay a tax liability after the Internal Revenue Service ("Service") makes a demand for payment. 26 U.S.C. §6321. The lien arises in favor of the United States and attaches to "all property and rights to property" belonging to the taxpayer. Because it is created by operation of law, a federal tax lien is not valid as to third parties "until notice thereof" has been filed in the manner provided by state law. 26 U.S.C. §§6321(a) and (f). Thus, tax liens are created and perfected through a two step process. The assessment of taxes by the Service creates a tax lien that is valid as between the taxpayer and the United States . The Service then perfects this lien as to the rest of the world by properly filing a Notice of Federal Tax Lien.

Like most states, North Carolina has adopted the Uniform Federal Lien Registration Act. See N.C. Gen. Stat. §44-68.10 and following. Under this statute, the Service perfects a federal tax lien as to real property by filing a Notice of Lien in the office of the clerk of superior court of the county in which the real property is located. N.C. Gen. Stat. §44-68.12(b). After the Notice of Lien is filed, the Service's lien rights in the taxpayer's property are fixed, without need for the entry and docketing of any subsequent judgment. It follows that a federal tax lien is a statutory lien, as opposed to a judicial lien--even if the underlying tax debt is subsequently reduced to judgment. See, e.g., Rench v. United States (In re Rench), 129 B.R. 649 (Bankr. D. Kan. 1991).

Section 522 of the Bankruptcy Code recognizes the special nature of tax liens, specifically providing that the debtor's exempt property remains encumbered by a pre-petition "tax lien, notice of which is properly filed. . . ." 11 U.S.C. §522(c)(2)(B). North Carolina 's exemptions statute, N.C. Gen. Stat. §1C-1601, expresses this concept as well. Section 1C-1601(e)(1) provides that "[t]he exemptions provided . . . are inapplicable to claims . . . [o]f the United States or its agencies as provided by federal law." As a result of this section, the North Carolina exemptions statute has no application to federal tax liens, which are instead governed by the separate set of exemptions from levy contained in the Internal Revenue Code. See 26 U.S.C. §6334.

Section 522(f)(1)(A) allows a bankruptcy debtor to avoid a judicial lien to the extent that lien impairs an exemption to which the debtor would otherwise be entitled. There are two distinct reasons why this section cannot be used to avoid a federal tax lien. First, tax liens--which arise by operation of law and not by virtue of any judgment--are not judicial liens. See also 11 U.S.C. §101(36). Second, because §522 and North Carolina 's exemptions statute have no application to tax liens, it is impossible for a tax lien to impair an exemption to which the debtor would otherwise be entitled.

Based on the foregoing, the debtors' motion to avoid tax liens is denied.

So Ordered.

¹ Taxes are not normally collected by judgment. Instead, §6331 of the Internal Revenue Code gives the Service the right to collect taxes by levy if notice is given in the manner provided by statute. 26 U.S.C. §6331.