Contributed by Yvanna Custodio and Max Goodman
In our previous blog entry on Everett Associates v. Commissioner, we discussed the background of the case and the Tax Court’s rulings on postpetition and postconfirmation interest on secured tax claims. Today, we discuss the Tax Court’s rulings on (i) postconfirmation interest on unsecured priority tax claims, (ii) whether the IRS may assess tax penalties during the pendency of a debtor’s bankruptcy case, and (iii) the dischargeability of tax penalties.
Postconfirmation Interest on Priority Tax Claims
Both Everett and the IRS agreed that the IRS’s priority tax claims did not accrue postpetition (preconfirmation) interest, but disagreed as to whether the IRS was entitled to postconfirmation interest pursuant to a bankruptcy plan provision that said that such claims would be “paid in full” from the liquidation of certain assets. In the IRS’s view, such provision effectively provided for the deferred payment of its priority tax claims, entitling it to postconfirmation interest until paid in full.
Agreeing with the IRS, the Tax Court began its analysis with section 1129(a)(9)(C) of the Bankruptcy Code. According to section 1129(a)(9)(C), if a plan provides for deferred payments on a priority tax claim, the plan must give the creditor “value, as of the effective date of the plan, equal to the allowed amount of such claim.” The Tax Court observed that bankruptcy courts have almost uniformly ruled that, in order to comply with section 1129(a)(9)(C), interest must be accrued on such claim throughout the payment period. The Tax Court then turned to the terms of Everett’s confirmed bankruptcy plan, which provided for payment “in full” from the proceeds of Everett’s assets without specifying any payment date, and questioned whether the phrase “in full” could be interpreted to call for deferred payments. After devoting a section of the opinion to a survey of cases cited by Everett and the IRS, the Tax Court (i) rejected Everett’s attempt to apply section 1129(a)(9)(C) differently to liquidating plans (Everett’s characterization of its plan) than to plans of reorganization, (ii) in accord with the reasoning in In re Arrow Air and In re Collins, concluded that the phrase “in full” was ambiguous and should be construed against the debtor-drafter, and (iii) found instructive the observation of the Eleventh Circuit in In re Fawcett that “[i]f a debtor submits a generalized statement that it will pay . . . in full-100%, creditors are entitled to interpret that statement as guaranteeing the payment of each and every part of the creditor’s claim.”
Although the Tax Court upheld the accrual of postconfirmation interest, the court observed that it could not determine the propriety of the interest rate utilized by the IRS, largely because the IRS was uncertain as to the manner in which the assessed interest had been calculated. Significantly, because the bankruptcy case was filed prior to the 2005 amendments to the Bankruptcy Code, the applicable interest rate was not dictated by now section 511 of the Bankruptcy Code (which specifies that the appropriate rate is the applicable nonbankruptcy rate for the month in which the plan is confirmed). Accordingly, looking to prior case law, the Tax Court acknowledged that courts varied in their determination of the appropriate postconfirmation rate of interest on priority tax claims, and indicated that the controlling Ninth Circuit case law required a “case-by-case determination of what interest rate the reorganizing debtor would have to pay a creditor in order to obtain a loan on equivalent terms in the open market.” Because neither party submitted evidence as to the appropriate market rate of interest, the Tax Court was unable to rule on the propriety of the assessments of interest. (The Tax Court, however, did find that the IRS Office of Appeals abused its discretion in not properly considering Everett’s administrative challenge to the rate of interest charged by the IRS.)
Postpetition Tax Penalties and Their Discharge
Everett disputed the IRS’s assessment of postpetition failure-to-pay penalties on its priority tax claims on the basis that (i) the penalties ceased to accrue upon the filing of the bankruptcy petition, (ii) even if the penalties did not cease to accrue, reasonable cause existed to abate the penalties, and (iii) even if the penalties were proper, they were discharged pursuant to Everett’s bankruptcy plan and the bankruptcy court’s confirmation order. Although the Tax Court upheld the imposition of the postpetition penalties, it ultimately concluded that the penalties were discharged.
Section 6658 of the Internal Revenue Code generally provides that failure-to-pay penalties cannot be assessed against a debtor while its bankruptcy case is pending. However, a statutory exception to this general rule exists for any tax penalty that arises from the failure to pay or deposit a tax withheld or collected from others. Because Everett’s tax deficiencies were employment tax liabilities, the Tax Court found that the failure-to-pay penalties properly accrued postpetition. As for Everett’s assertion that reasonable cause existed to abate the tax penalties, the Tax Court found that Everett was unable to demonstrate a correlation between the causes it had cited and its failure to pay the taxes as they came due.
As to the issue of discharge, the court sided with Everett and rejected the IRS’s argument that Everett’s bankruptcy plan was a “liquidating plan” for which a discharge was not available under section 1141(d)(3) of the Bankruptcy Code. The court explained that under such section, “a corporate debtor which is liquidated under chapter 11 and does not continue in business after its chapter 11 plan goes into effect does not receive a bankruptcy discharge.” In contrast, although Everett’s plan was labeled a “plan of liquidation” and provided for the liquidation of some assets, overall, the provisions of Everett’s plan supplemented by the confirmation order made clear that the purpose of the plan was a corporate reorganization. Moreover, the court noted the uncontroverted testimony that Everett continued to operate more than eight years after its plan confirmation. Thus, seeing as the plan did not provide for the postpetition penalties, the court held that the bankruptcy plan effectively discharged such penalties.
If our two-part blog entry has piqued your interest, you may find a more detailed discussion of postpetition and postconfirmation interest and penalties on secured tax claims and unsecured priority tax claims in Chapter 10 of Henderson & Goldring, Tax Planning for Troubled Corporations: Bankruptcy and Nonbankruptcy Restructurings (CCH 2012 ed.).