Contributed by Yvanna Custodio and Max Goodman
A recent Tax Court opinion, Everett Associates v. Commissioner, entered the foray of bankruptcy and discussed at length a number of bankruptcy issues pertaining to postpetition and postconfirmation interest on secured and unsecured priority tax claims, as well as postpetition tax penalties and their discharge. We will explore the Tax Court’s decision in a two-part blog series. In today’s blog entry, we discuss the Tax Court’s rulings on postpetition and postconfirmation interest on secured tax claims. In the second part of the entry, we will 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.
During Everett’s chapter 11 case, which was filed in the United States Bankruptcy Court for the Northern District of California in November 2001, the IRS filed a proof of claim asserting a secured claim, an unsecured priority claim, and a general unsecured claim (the general unsecured claim consisted of penalties on the unsecured priority claim as of the petition date) stemming from deficiencies in Everett’s employment taxes. As part of its bankruptcy case, Everett formulated a chapter 11 plan that contemplated continuing its business, but which provided for the liquidation of some of its assets, including the sale of an unimproved lot (referred to in the opinion as the “Santa Rosa lot”). The plan contemplated the use of the sale proceeds to satisfy the liens of secured creditors asserting liens on the Santa Rosa lot, including the IRS’s junior lien. The bankruptcy court confirmed the debtor’s plan, and the chapter 11 case was closed in March 2005. Delays in the sale of the lot, however, ultimately resulted in a December 2006 foreclosure sale. Upon satisfaction of the senior lien of a secured creditor on the Santa Rosa lot, the remaining sale proceeds were delivered to the IRS.
The IRS sought to levy upon Everett’s assets, asserting that Everett had defaulted on its bankruptcy plan and would therefore be liable for unpaid tax liabilities (including interest and penalties), and Everett elevated the dispute to the Tax Court. Finding that the IRS’s properly-filed proof of claim and Everett’s lack of objection thereto precluded inquiry into the prepetition tax claims, the Tax Court focused instead on the interest and penalties accruing on the secured and priority tax claims that corresponded to the postpetition and postconfirmation periods.
Postpetition Interest on Secured Tax Claims
Applying bankruptcy principles, the Tax Court ruled that because the IRS’s claim was oversecured, the IRS was entitled to postpetition (preconfirmation) interest on the secured claim (which accrued at the general underpayment rate set forth in section 6621 of the Internal Revenue Code).
In reaching its conclusion concerning postpetition interest, the Tax Court laid out the rule embodied in section 506(b) of the Bankruptcy Code that secured creditors are entitled to postpetition interest only to the extent they are oversecured. Under section 506(a), a claim is secured only to the extent of the value of the debtor’s interest in the property and is unsecured as to the remainder. Although the parties disputed whether the IRS’s secured claim was fully secured during Everett’s chapter 11 case, the Tax Court concluded that there was no need to address the valuation of the Santa Rosa lot, the property securing the IRS’s federal tax lien. The Tax Court reasoned that because the IRS had validly executed a proof of claim classifying the claim as entirely secured, and because Everett failed to object to the claim and did not move to value the alleged secured and unsecured portion of the claim during the case, Everett would be estopped under the Bankruptcy Code from raising the issue of valuation.
Moreover, although Everett’s plan “provided for the retained jurisdiction of the bankruptcy court to determine the validity, priority, and extent of liens[,]” Everett neither contested the valuation of the claim before the close of its bankruptcy case nor moved to reopen the case under section 350(b) of the Bankruptcy Code and Bankruptcy Rule 5010 subsequent to the closing of the case. Therefore, the Tax Court held that the IRS’s proof of claim was dispositive of the amount of the secured claim.
Postconfirmation Interest on Secured Tax Claims
Aside from postpetition interest, the Tax Court also held that the IRS was entitled to postconfirmation interest on its secured tax claim. In so ruling, the court relied on the terms of Everett’s confirmed plan, which “unambiguously provided” that the IRS’s secured claim would be paid with interest. Moreover, the plan provided that interest would be paid as “provided by law.” The court interpreted this statement to refer to applicable nonbankruptcy law and, therefore, held that the applicable interest rate also would be the general underpayment rate in section 6621 of the Internal Revenue Code.
Keep your interest piqued: Stay tuned for Part Two of our blog article, in which 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 a debtor’s bankruptcy case, and (iii) the dischargeability of tax penalties.