Contributed by Yvanna Custodio and Max Goodman
Our loyal readers might recall that on Tax Day, we published the first installment of our four-part series on United States v. Bond, a decision from the United States District Court for the Eastern District of New York, which examines actions for federal income tax refunds sought by three affiliated telecommunications entities (collectively referred to in this series as “PT-1”). In this installment, we examine the court’s discussion of whether sections 106(a) and 106(b) of the Bankruptcy Code had waived the sovereign immunity of the Internal Revenue Service with regard to tax refund actions filed by the trustee of the liquidating trust that succeeded to PT-1’s assets. In our third installment, we will discuss whether the bankruptcy court had jurisdiction to compel the IRS to accept a tax return filed by PT-1. Finally, our fourth installment will focus on whether the bankruptcy court had jurisdiction to enjoin the IRS from its future exercise of setoff or recoupment rights against the trustee.
Waiver of Sovereign Immunity
Faced with the issue of whether sovereign immunity had been waived concerning tax refund actions filed by the liquidating trustee, the bankruptcy court ruled that it was and relied on both section 106(a) and section 106(b). The district court agreed that section 106(a) applied (although for somewhat different reasons), but disagreed that section 106(b) applied.
The district court observed that section 106 of the Bankruptcy Code is a statute that expressly waives sovereign immunity “both with respect to proceedings under various provisions of the Bankruptcy Code [citing subsection (a)] and for claims that are property of the estate and arise out of the same transaction or occurrence as a proof of claim filed by a Governmental unit in the bankruptcy proceeding [citing subsection (b)].” The court then analyzed the decision of the bankruptcy court and the arguments of the liquidating trustee and the IRS regarding subsections (a) and (b) of section 106.
Regarding section 106(a), the bankruptcy court had held that the tax issues before it fell under section 505(a) of the Bankruptcy Code, one of the sections enumerated in section 106(a), which therefore waived sovereign immunity with respect to such tax issues. (We discussed section 505(a) in our February “Breaking the Code” entry, which you can find here.)
On appeal, the IRS argued that section 505(a)(2)(B), which limits the bankruptcy court’s authority to rule on tax refund actions until the earlier of 120 days after the trustee properly requests such refund from the government or an adverse determination of such request by the government, precludes the bankruptcy court from ruling on actions that are brought on behalf of a liquidating trust (because it is not a bankruptcy estate contemplated by the section) and by a liquidating trustee (because it is not a bankruptcy trustee contemplated by the section). The district court rejected both arguments, finding that (i) PT-1’s chapter 11 plan provided that actions belonging to the debtors would be transferred to the liquidating trust, (ii) the liquidating trustee represented the remainder of the estate in such actions pursuant to section 1123(b)(3)(B), and (iii) section 505(a)(2)(B) does not limit the court’s authority to adjudicate tax disputes solely to those brought by bankruptcy trustees. Rather, the district court concluded that section 505(a)(2)(B) is a “timing and exhaustion of remedies provision” and observed that every decision cited by the parties on this point rejected the IRS’s narrow reading of the section.
The IRS also argued that by not properly filing a refund request with the IRS prior to filing its tax refund actions for the Postpetition 2001 Period in the bankruptcy court, the liquidating trustee failed to comply with section 505(a)(2)(B). The trustee had filed such request with the IRS only after bringing the refund action. Section 7422(a) of Title 26 of the United States Code, which courts have construed to be incorporated in the phrase “properly filed,” requires the filing of a claim for refund or credit with the IRS prior to maintaining a suit or proceeding for the recovery of a federal tax refund. The bankruptcy court, relying upon a line of cases and legislative history, had held that this requirement does not apply to a refund suit filed as a counterclaim in a bankruptcy case. The district court disagreed, viewing the language of section 505(a)(2)(B) as unequivocal in not providing any such exception. Nevertheless, the district court observed that section 505(a)(2)(B) merely states that the bankruptcy court “may not so determine” a tax refund action before a request for refund has been filed with the government, and that 26 U.S.C. § 7422(a) merely provides that no suit “may be maintained” until such request has been filed. Relying upon the statutes’ use of the words “determine” and “maintained” rather than use of language prohibiting the filing of a suit, the district court held that the trustee’s failure to comply with section 505(a)(2)(B) was not an absolute jurisdictional bar, that his subsequent filing of the refund request with the IRS was sufficient to exhaust administrative remedies, and that his attachment of this administrative request to his motion for summary judgment amounted to an amendment of or supplement to his initial pleading, thus curing the defect.
Regarding section 106(b) of the Bankruptcy Code, the bankruptcy court had held that the IRS, by filing a claim against PT-1 for unpaid taxes and penalties for the Postpetition 2001 Period, waived its sovereign immunity. Section 106(b) waives sovereign immunity for counterclaims arising out of the same transaction or occurrence as the claim set forth in the government’s proof of claim. The district court agreed with the IRS that the IRS’s assertion of administrative expenses (as opposed to prepetition claims, all of which were withdrawn by the IRS six months after filing) did not waive sovereign immunity under section 106(b) because the section refers to proofs of claim, which are filed by “creditors” under section 501 of the Bankruptcy Code. Because “creditors” are defined in section 101(10) of the Bankruptcy Code as entities with claims arising prepetition (subject to certain exceptions not relevant here), the district court held that requests for administrative expenses could not serve as a predicate for a waiver of sovereign immunity under section 106(b).
For a further discussion of sections 106 and 505(a), see Sections 1005.1 and 1013, respectively, of Henderson & Goldring, Tax Planning for Troubled Corporations: Bankruptcy and Nonbankruptcy Restructurings (CCH 2013 ed.). In the meantime, stay tuned for the third installment of our four-part series on United States v. Bond.