In re West Texas Marketing Corp.

• Decision Date: 22 June 1993
• Docket Number: Bankruptcy No. 182-10034-7,Adv. No. 192-1018.
• Citation: 155 BR 399
• Parties: In re WEST TEXAS MARKETING CORPORATION, Debtor. Walter KELLOGG, Trustee for West Texas Marketing Corporation, Plaintiff, v. UNITED STATES of America, Defendant.
• Court: U.S. Bankruptcy Court — Northern District of Texas

155 B.R. 399 (1993)

In re WEST TEXAS MARKETING CORPORATION, Debtor Walter KELLOGG, Trustee for West Texas Marketing Corporation, Plaintiff, v. UNITED STATES of America, Defendant.

Bankruptcy No. 182-10034-7, Adv. No. 192-1018.

United States Bankruptcy Court, N.D. Texas, Abilene Division.

June 22, 1993.

Brett B. Flagg, Gardere & Wynne, L.L.P., Dallas, TX, for plaintiff.

Dinah L. Bundy & Mr. Michael S. Copeland, Attys., Tax Div. Dept. of Justice, Dallas, TX, for IRS.

Walter Kellogg, Trustee-in-Bankruptcy, Dallas, TX, Chapter 7 Trustee.

MEMORANDUM OF OPINION ON POSTPETITION INTEREST ON UNSECURED CLAIMS

JOHN C. AKARD, Bankruptcy Judge.

QUESTIONS PRESENTED

I. Whether in a case under Chapter 7 of the Bankruptcy Code,¹ the Debtor can accrue postpetition interest expense deductions for federal income tax purposes on undisputed and resolved general unsecured (prepetition) claims. The court concludes that the Debtor cannot accrue postpetition interest expense on prepetition claims for federal income tax purposes.²

II. Whether § 505(b) bars assessment of an estimated tax penalty on the Debtor's estate because the Internal Revenue Service (IRS) assessed the penalty more than 60 days after the estate requested a prompt determination of unpaid tax liability and did not select the Debtor's income tax return for examination. The court concludes that the IRS assessment of the estimated tax penalty was proper, that § 505(b) does not bar collection, and that the Debtor's estate is liable for the penalty.

FACTS³

West Texas Marketing Corporation (WTMC) is incorporated under the laws of Texas. WTMC maintained its accounting records and calculated its federal income tax liability using the accrual method of accounting. On May 14, 1982, WTMC filed a voluntary petition under Chapter 11 of the Bankruptcy Code. On December 7, 1983, the court converted WTMC's reorganization to a Chapter 7 liquidation. Plaintiff did not accrue interest expense deductions for WTMC's undisputed and resolved general unsecured (prepetition) claims on the U.S. Corporation Income Tax Returns (Forms 1120) filed for WTMC's taxable year(s) ended (TYE) September 30, 1982 through September 30, 1989.

Plaintiff reflected postpetition interest expense deductions on prepetition claims on WTMC's Amended U.S. Corporation Income Tax Returns (Forms 1120X) for TYE September 30, 1988 and September 30, 1989. Likewise, part of the net operating loss (NOL) deductions claimed on WTMC's Forms 1120X for TYE September 30, 1988 and September 30, 1989 were the result of accruals of interest expense for WTMC's prepetition claims for WTMC's TYE September 30, 1982 through September 30, 1987.

On WTMC's Forms 1120X for TYE September 30, 1988, September 30, 1989, and September 30, 1991, Plaintiff computed postpetition interest expense deductions on its prepetition claims using the six percent Texas "legal rate."

During WTMC's TYE September 30, 1982 through September 30, 1987, and September 30, 1989 through September 30, 1991, total filed claims, as well as undisputed and resolved claims in WTMC's bankruptcy proceedings alone, exceeded WTMC's assets. On the other hand, during WTMC's TYE September 30, 1988, WTMC's assets exceeded undisputed and unsecured claims but not total filed claims.

On June 15, 1990, Plaintiff timely filed a Form 1120 for WTMC's TYE September 30, 1989 reflecting a tax liability of $366,468, payments of $367,000, and requested a refund of $532, the difference between the two amounts. This Form 1120 reported that WTMC was not liable for any estimated tax penalties. Also, Plaintiff filed this Form 1120 with a request for prompt determination pursuant to § 505(b).

On July 17, 1990 the IRS accepted WTMC's Form 1120 for TYE September 30, 1989 as filed. This IRS acceptance of WTMC's Form 1120 for the TYE September 30, 1989, meant that the IRS did not select the tax return for examination.

On October 1, 1990, the IRS assessed an estimated tax penalty of $23,044.58 against WTMC for its TYE September 30, 1989, because WTMC did not make estimated tax payments for that taxable year as required by law. On November 4, 1991, the IRS set off the $23,044.58 against a refund due to WTMC for TYE September 30, 1988. On October 25, 1991, Plaintiff timely filed a Form 1120X for WTMC's TYE September 30, 1988, which reflected previously unreported interest expense deductions and constituted a claim for refund in the amount of $1,999,887. Such figure also included two allowed deductions by the IRS: $39,910 for previously omitted percentage depletion deductions and a $1,270,185 NOL carryback.

On the same date, Plaintiff timely filed a Form 1120X for WTMC's TYE September 30, 1989, which reflected postpetition unreported interest expense deductions on prepetition claims and constituted a claim for refund in the amount of $366,468, the tax liability originally reported on Form 1120. On November 6, 1991, Plaintiff timely filed a Form 1120 for WTMC's TYE September 30, 1991 reflecting no tax liability. The IRS timely notified Plaintiff that the IRS selected WTMC's Form 1120 for that period for examination.

On or about January 31, 1992, the District Director of Internal Revenue mailed Plaintiff a Notice of Determination of Additional Tax and Disallowance of Refund Claims. The IRS notice disallowed WTMC's refund claims in Forms 1120X for TYE September 30, 1988 and September 30, 1989 for postpetition interest expense deductions on prepetition claims. Additionally, the IRS notice informed Plaintiff that IRS had determined WTMC owed $83,885 in additional taxes for TYE September 30, 1991.

POSITIONS OF THE PARTIES

I. Plaintiff argued that postpetition interest accrues on allowed prepetition claims at the "legal rate" pursuant to § 726(a)(5). Alternatively, Plaintiff argued that state law determines the validity of creditors' claims and that the claims bear interest at the statutory rate. Therefore, Plaintiff sought to recover refunds and corresponding interest on federal taxes overpaid by WTMC to the IRS for TYE September 30, 1988 and September 30, 1989. Additionally, Plaintiff disputed the IRS determination of additional federal income tax due for WTMC's TYE September 30, 1991 based on the same arguments discussed above.

The IRS argued that WTMC could not accrue interest expense deductions for federal income tax purposes for its prepetition claims in any of WTMC's taxable years ending September 30, 1982 through 1991.

II. Pursuant to § 505(b), Plaintiff sought to compel the turnover of a portion of an approved refund of federal income taxes for WTMC's TYE September 30, 1988 erroneously set off against an improper assessment of estimated tax penalties for WTMC's TYE September 30, 1989.

The IRS contended that assessment and collection of the estimated tax penalty for WTMC's TYE September 30, 1989 was proper and was not barred by § 505(b).

STATUTES

11 U.S.C. § 501 states in pertinent part:

(a) A creditor or an indenture trustee may file a proof of claim.

11 U.S.C. § 502 states in pertinent part:

(a) A claim . . . filed under § 501 of this title, is deemed allowed, unless a party in interest . . . objects.

(b) If such objection to a claim is made, the court . . . shall allow such claim in such amount except to the extent that—

. . . .

(2) such claim is for unmatured interest.

11 U.S.C. § 505(b) states in pertinent part:

(b) A trustee may request a determination of any unpaid liability of the estate for any tax incurred during the administration of the case. . . . Unless such return is fraudulent, or contains a material misrepresentation, the trustee, the debtor, and any successor to the debtor are discharged from any liability for such tax—

(1) upon payment of the tax shown on such return if—

(A) such governmental unit does not notify the trustee, within 60 days after such request, that such return has been selected for examination.

11 U.S.C. § 726 states in pertinent part:

(a) Property of the estate shall be distributed —

. . . .

(5) fifth, in payment of interest at the legal rate from the date of the filing of the petition, on any claim paid under paragraph (1), (2), (3), or (4) of this subsection.

TEX.REV.CIV.STAT.ANN. art. 5069-1.03 states:

When no specified rate of interest is agreed upon by the parties, interest at the rate of six percent per annum shall be allowed on all accounts and contracts ascertaining the sum payable, commencing on the thirtieth (30th) day from and after the time when the sum is due and payable.

I.R.C. § 163(a) states in pertinent part: (a) There shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness.

I.R.C. § 448 states in pertinent part:

(a) In the case of a—

(1) C corporation,

. . . .

taxable income shall not be computed under the cash receipts and disbursements method of accounting.

I.R.C. § 461(h) states in pertinent part:

(1) In determining whether an amount has been incurred with respect to any item during any taxable year, the all events test shall not be treated as met any earlier than when economic performance with respect to such item occurs.

Treas.Reg. § 1.461-1(a)(2)(i) states:

(2) Taxpayer using an accrual method— (i) In general. Under an accrual method of accounting, a liability . . . is incurred, and generally is taken into account for Federal income tax purposes, in the taxable year in which all the events have occurred that establish the fact of the liability, the amount of the liability can be determined with reasonable accuracy, and economic performance has occurred with respect to the liability.

DISCUSSION

I. Both state law and bankruptcy law are sources of liability for postpetition interest on general unsecured claims. In Federal Sav. & Loan Ins. Corp. v. Moneymaker (In re A & L Properties), 96 B.R. 287 (C.D.Cal.1988), the court interpreted the "legal rate" at which interest must be paid pursuant to § 726(a)(5) to be the contract rate where applicable and, alternatively, the...