In re Richards

• Decision Date: 29 April 2020
• Docket Number: CASE NO 18-3418-RLM-12
• Citation: 616 B.R. 879
• Court: U.S. Bankruptcy Court — Southern District of Indiana
• Parties: IN RE: Eric S. & Catherine E. RICHARDS, Debtors

616 B.R. 879

IN RE: Eric S. & Catherine E. RICHARDS, Debtors

CASE NO 18-3418-RLM-12

United States Bankruptcy Court, S.D. Indiana, Indianapolis Division.

Signed April 29, 2020

Wendy D. Brewer, Fultz Maddox Dickens PLC, Indianapolis, IN, for Debtors.

Joseph M. Black, Jr., Office of Joseph M. Black, Jr., Seymour, IN, pro se.

ORDER SUSTAINING, IN PART, DEBTORS' OBJECTION TO 2^nd AMENDED CLAIM FILED BY THEIRS

Robyn L. Moberly, United States Bankruptcy Judge

Eric and Catherine Richards ("Debtors") objected to the amended Proof of Claim filed by the Internal Revenue Service ("IRS") in their chapter 12 bankruptcy. The IRS filed a response to that objection and a hearing was held in the court on February 18, 2020. For the reasons stated below, the Court sustains the Debtors' objection to the extent the actions taken by the IRS were contrary to the provisions of the confirmed plan. However, the objection is overruled to the extent it requests additional relief.¹

Among the far-reaching changes made to the Bankruptcy Code by BAPCPA² was the addition of § 1222(a)(2)(A). That section dealt with the requirement a chapter 12 plan must provide for full payment of § 507 priority claims, but carved out an exception for claims owed to a governmental unit that arose as a result of the sale, transfer, exchange, or other disposition of any farm asset used in the debtor's farming operation. If such a claim otherwise would have been entitled to § 507 priority, the new § 1222(a)(2)(A) provided, instead, that it would be treated as a general unsecured claim subject to discharge. This was a huge advantage to farmers who sought chapter 12 relief, as stated in In re Ficken , 430 B.R. 663, 666 (10th Cir. BAP 2010) rev'd on other grounds , 433 Fed. Appx. 682 (10th Cir. 2011) :

The new provision attempts to mitigate the tax expense often incurred by farmers who have significant taxable capital gains or depreciation recapture when their low basis farm assets are foreclosed, sold, or otherwise disposed of by their creditors. Formerly, these dispositions created large priority tax claims that barred confirmation of Chapter 12 plans. By stripping these claims of their priority status and rendering them unsecured claims for distribution and discharge purposes, the drafters of BAPCPA sought to facilitate farmers' use of Chapter 12.

A split among the circuits arose as to whether § 1222(a)(2)(A) covered taxes from the post-petition sale of farm assets during the pendency of the chapter 12 case. See, Knudsen v. IRS , 581 F.3d 696 (8th Cir. 2009) (holding that § 1222(a)(2)(A) applied to post-petition sales); cf., In re Dawes , 652 F.3d 1236 (10th Cir. 2011) and U.S. v. Hall , 617 F.3d 1161 (9th Cir. 2010) (both holding that § 1222(a)(2)(A) did not apply to post-petition sales). That question was answered in the negative. Hall v. United States , 566 U.S. 506, 132 S. Ct. 1882, 182 L.Ed.2d 840 (2012). Hall noted that, for § 1222(a)(2)(A) to apply, the tax first had to be a tax that otherwise would be entitled to § 507 priority. Of the several priority categories under § 507, only two addressed taxes. Section 507(a)(8) covered pre-petition taxes and didn't apply. Section 507(a)(2) covered administrative expenses allowed under § 503(b). Section 503(b)(1)(B)(i) covered administrative taxes, but a prerequisite to that section was the tax had to be "incurred by the estate". Unlike chapter 7 and chapter 11 cases³ , Section 1399 of the Internal Revenue Code ("IRC") provided that no separate taxable estate is created upon a chapter 12 filing, and thus, chapter 12 administrative taxes are not "incurred by the estate". Consequently, taxes arising from disposition of farm assets during the pendency of the chapter 12 case did not enjoy § 1222(a)(2)(A) treatment. Id. , 566 U.S. at 512, 132 S.Ct. at 1887. In October 2017, Congress enacted legislation that took out subsection (A) from § 1222(a)(2) and added new § 1232.⁴ The "priority stripping" attributes of former § 1222(a)(2)(A) were carried over to § 1232 and extended to taxes arising from post-petition sales, thus effectively overruling Hall .

Debtors filed their chapter 12 case in May 2018 after the enactment of § 1232. Their chapter 12 plan was confirmed in October 2018. The confirmed plan provided the IRS's priority claim for 2016 was $0 and its priority claim for 2017 was $5,681. While the tax liability for 2018 had not yet become due, the plan provided that there would be additional liquidation of farm assets in 2018 and occurring during the pendency of the case that would qualify for treatment under § 1232.

The plan also provided the exclusive means by which "any and all claims" were to be paid post-petition, as follows:

Section 11.03. Exclusive Collection Action. The means of payment described in this Plan are, absent an event of default of this Plan, the exclusive means of post-petition payment of any and all claims, and no creditor shall take action to collect on any claim, whether by offset or otherwise, unless specifically authorized by this Plan. Any action taken on or between the Petition Date and Confirmation Date shall be reversed and refunded to the appropriate entity if such action is not specifically authorized by this Plan. This paragraph does not curtail the exercise of a valid right of setoff permitted under § 553.

The IRS did not object to the plan and it was confirmed on October 22, 2018.

In March 2019, Debtors filed their 2019 federal tax return which included taxes attributable to the sale of farms assets during 2018. To single out those § 1232 taxes from other taxes incurred during 2018, Debtors filed both a 2018 pro forma 1040 federal tax return⁵ and a 1040 federal tax return. The pro forma return indicated that Debtors were entitled to a $6414 refund for 2018 (the "2018 Refund"). In October 2019, the IRS amended its claim (the "2^nd Amended Claim") which indicated that it had offset the 2018 Refund against Debtors' 2018 unsecured § 1232 taxes. At the hearing on the objection, counsel for the IRS indicated that the 2018 Refund had been applied to the 2016 priority taxes and the § 1232-related general unsecured claim arising from the 2018 sale of farm assets. Debtors objected to the 2^nd Amended Claim and their objection is in two parts: (1) asserting the setoff was prohibited by the express terms of the confirmed plan and (2) seeking an order from this Court directing the IRS to issue the 2018 Refund to Debtors.

Discussion

Sovereign Immunity

Debtors' objection to the 2^nd Amended Claim recites that it is pursuant to § 502(b). To the extent the issue before the Court is a claims objection wherein the Court has authority to determine and allow the amount of a claim under § 502(b), this Court has jurisdiction to do so. Sovereign immunity is abrogated as to government units with respect to § 502 matters under § 106(a). Furthermore, Section 10.01(d) of the confirmed plan provides that the Court retains jurisdiction "to hear and determine any objections to claims filed both before and after confirmation".

Debtors' claim objection is premised on the IRS's violation of the terms of the confirmed plan that spell out how the tax claims are to be paid. Section 10.01(i) provides the Court retains jurisdiction to "hear and determine disputes arising from the Plan or its implementation." Furthermore, the IRS is bound by the terms of the confirmed plan under § 1227(a). Section 106(a) abrogates sovereign immunity as to governmental units with respect to § 1227, as well as § 502.

IRS's Right to Setoff under the Confirmed Plan

Section 553 preserves a creditor's right to setoff that exists under nonbankruptcy law. In re Baucom , 339 B.R. 504, 505 (Bankr. W.D. Mo. 2006). Section 553 requires that only mutual, pre-petition obligations can be set off against each other. Citizens Bank of Maryland v. Strumpf , 516 U.S. 16, 116 S.Ct. 286, 289, 133 L.Ed.2d 258 (1995). 26 U.S.C. § 6402(a) (hereinafter "IRC") is the "nonbankruptcy law" that allows the IRS to set off tax overpayments against tax liabilities.

Courts are divided as to whether a confirmed plan under § 1141, § 1227 or § 1327⁶ bars the IRS from exercising its § 553 setoff rights. Courts within the Seventh Circuit have held that, absent an express plan provision extinguishing such rights, a creditor's § 553 rights survive confirmation. Section 553 provides that "this title does not affect any right of a creditor to offset a mutual debt" and courts have reasoned that the "effect of confirmation" provisions are contained in "this title" (Title 11) and thus, do not affect the creditor's § 553 rights. U.S. v. Munson , 248 B.R. 343, 346 (C.D. Ill. 2000) (§ 553 trumps § 1327); In re Bare , 284 B.R. 870, 874-75 (Bankr. N. D. Ill. 2002) ("confirmation of a debtor's plan...does not extinguish prepetition setoff rights, especially ...where the plan does not specifically treat those setoff rights"). However, a creditor's § 553 setoff rights may be extinguished by express provision under a confirmed plan. Daewoo Int'l (America) Corp. Creditor Trust v. SSTS Am. Corp. , No. 02 Civ. 9629 (NRB), 2003 WL 21355214 at *4 (S.D.N.Y. 2003) ("[i]ndeed, where there is a specific provision in the confirmation order prohibiting setoff claims, courts have indicated that the right to setoff may not survive the confirmation plan"); IRS v. Driggs , 185 B.R. 214, 215 (D Md. 1995) ; In re Lykes Bros. Steamship Co. , 217 B.R. 304, 310 (Bankr. M.D. Fla. 1997) (holding that § 1141 takes precedence over § 553 where plan of reorganization specifically prohibited setoff).

Debtors' plan specifically provided that "no creditor shall take action to collect on any claim, whether by offset or otherwise, unless specifically authorized by this Plan". That same paragraph later recites that "[t]his paragraph does not curtail the exercise of a valid right of setoff permitted under § 553". While this paragraph contains incongruities, they need not be resolved here because the type of setoff exercised by the IRS here was...