U.S. v. Kearns, 98-2569

• Decision Date: 01 June 1999
• Docket Number: No. 98-2569,98-2569
• Parties: -2632, 99-1 USTC P 50,573 UNITED STATES OF AMERICA, Appellee, v. Richard Lee KEARNS, Appellant.
• Court: U.S. Court of Appeals — Eighth Circuit

Page 706

177 F.3d 706

83 A.F.T.R.2d 99-2632, 99-1 USTC P 50,573

UNITED STATES OF AMERICA, Appellee, v. Richard Lee KEARNS, Appellant.

No. 98-2569.

United States Court of Appeals, Eighth Circuit.

Submitted March 8, 1999.

Filed June 1, 1999.

Kevin R. McManaman, Omaha, NE, argued (William T. Foley, on the brief), for appellant.

Robert J. Branman, Washington, D.C., argued (Loretta C. Argrett, Gilbert S. Rothenberg, on the brief), for appellee.

Before: BEAM and HEANEY, Circuit Judges, and GOLDBERG, ¹ Judge of the U.S. Court of International Trade.

HEANEY, Circuit Judge.

Richard Lee Kearns, debtor in bankruptcy, appeals from a decision by the bankruptcy appellate panel ruling that the bankruptcy court was without subject matter jurisdiction to determine Kearns' federal tax liability for the 1990 through 1994 tax years. The bankruptcy court had determined Kearns' post-petition tax liability for the 1990, 1991, 1992, 1993, and 1994 tax years, permitting an offset against the proof of claim filed by the Internal Revenue Service (IRS) for 1989 federal income taxes. Because we conclude that the bankruptcy court had subject matter jurisdiction to determine Kearns' tax liability, we now reverse.

I.

From 1975 Richard Lee Kearns was trustee of the Lincoln Land Trust, of which his wife, Carol Kearns, was one of four beneficiaries. In 1989 Kearns made three unauthorized disbursements of funds from the trust. First, Kearns withheld $460,000 of the proceeds realized on a February 1989 sale of trust land, using the money to purchase stock in Wen-Neb., Inc., an owner of Wendy's restaurants in Nebraska. In April 1989 Kearns withdrew $24,508 from a trust bank account and used the money to repay a personal loan. Finally, in August of that same year, ² he withdrew an additional $35,000 in trust moneys to repay a joint obligation owed by his wife and himself.

The beneficiaries other than Kearns' wife discovered the misappropriations in early 1990 and threatened legal action. On April 6, 1990, a settlement was reached between Kearns and the trust beneficiaries. Pursuant to the settlement, Wen-Neb., Inc., repurchased the stock from Kearns for $460,000 and Kearns assigned his interest in the proceeds to the beneficiaries other than his wife. ³ The two unauthorized disbursements were treated as trust distributions to Carol Kearns for tax purposes. Additionally, Carol Kearns, in an attempt to discourage criminal charges against her husband, gave up her entire interest in the trust.

On August 24, 1990, Kearns filed for Chapter 11 bankruptcy. Following an examination of the debtor's 1989 tax return, the IRS filed a proof of claim in the amount of $142,718. The amount of tax owed was based on the unreported 1989 embezzlement income of $519,508. Kearns objected to the characterization of the moneys as embezzlement income, claiming that the restitution agreement transformed the unauthorized withdrawals into loans. The bankruptcy court conducted a hearing on the issue and found, in a journal entry dated November 10, 1994, that Kearns had embezzled the funds and that the funds constituted income to him. The court further found, however, that Kearns had made restitution to the victims, thus giving rise to deductions for the years in which the restitution was made. The court, therefore, indicated that it would reconsider the IRS's claim, insofar as deductions may be appropriate, upon a Bankruptcy Rule 3008 motion.

After negotiating with the IRS for two years, Kearns filed a motion for reconsideration under Bankruptcy Rule 3008. See Fed.R .Bankr.P. 3008. In the motion, Kearns alleged that he was entitled to an offset against the IRS's tax claim in an amount equal to the tax savings attributable to deductions taken for the restitution payments. ⁴ Additionally, Kearns claimed that since he and his wife filed joint income tax returns, he should be entitled to take a theft-loss deduction for amounts Carol Kearns had lost as a twenty-five percent beneficial owner of the trust and offset that amount against the 1989 tax liability. The bankruptcy court granted the motion and scheduled a trial.

The IRS argued that Kearns' claim for a restitution deduction was inappropriate because Kearns failed to file for the refund in the proper year and was barred by the statute of limitations. See 26 U.S.C. § 6511(a). Additionally, the IRS asserted that since Kearns had not timely filed for a refund, the bankruptcy court lacked subject matter jurisdiction under 11 U.S.C. § 505(a)(2) to determine tax liability, including any offsets. The bankruptcy court rejected these arguments, finding in favor of Kearns on both issues. As an initial matter, the court concluded that the Kearns had already reported $59,508 of the embezzlement income on their 1989 tax return, and accordingly reduced the amount of unreported income to $460,000. The court then ruled that Carol Kearns was entitled to a theft-loss deduction of $129,877, representing her one-fourth share of the trust. ⁵ The court also ruled that Kearns was entitled to deductions for the restitution payments made in tax years 1990 through 1994 and allowed the resulting offset of $22,944 to be taken against the IRS's allowed claim for income tax owing from the 1989 tax year.

The United States, on behalf of the IRS, appealed to the Bankruptcy Appellate Panel for the Eighth Circuit (Panel). The IRS challenged allowance of the theft-loss deduction only as to amount, asserting that $35,000 of the embezzled funds had been used to satisfy an obligation for which Carol Kearns was jointly liable and thus could not be considered a loss. As to jurisdiction, the IRS again argued that the bankruptcy court lacked subject matter jurisdiction to make any determination of the joint tax liabilities of Kearns or his wife for tax years subsequent to 1989, both as to the theft loss and the claimed restitution payments, because no claim for refund had been filed for any of those years. The Panel agreed that the bankruptcy court lacked jurisdiction over tax years 1990 through 1994, vacated the bankruptcy court's opinion, and remanded the matter with instructions to allow the IRS claim in its entirety. ⁶ The Panel did not address the issue of the theft-loss deduction.

On appeal, Kearns argues that the bankruptcy court correctly determined that offsets were permissible both for the deductible amounts of Kearns' restitution payments and the theft-loss deductions and properly calculated the amounts of those offsets. The IRS repeats its contention that the bankruptcy court lacked subject matter jurisdiction to determine tax liability in any year other than the 1989 tax year, the year for which a proof of claim was filed. In the alternative, the IRS asserts the Kearns failed to submit a claim for refund within the statutory period.

II.

A. Subject Matter Jurisdiction

The United States is immune from suit except where Congress has waived that immunity. See United States v. Testan, 424 U.S. 392, 399, 96 S.Ct. 948, 47 L.Ed.2d 114 (1976). "[T]he terms of [the United States'] consent to be sued in any court defines that court's jurisdiction to entertain the suit ." United States v. Sherwood, 312 U.S. 584, 586-87, 61 S.Ct. 767, 85 L.Ed. 1058 (1941). Section 505 of the Bankruptcy Code addresses the authority of bankruptcy courts to determine tax liability. ⁷ Section 505(a)(1) confers on bankruptcy courts jurisdiction to determine "the amount or legality of any tax ... whether or not previously assessed ... paid, ... or ... contested before and adjudicated by a judicial or administrative tribunal of competent jurisdiction." 11 U.S.C. § 505(a) (1998). Excepted from this broad grant of jurisdiction is the authority to determine:

any right of the estate to a tax refund, before the earlier of--(i) 120 days after the trustee properly requests such refund from the governmental unit from which such refund is claimed; or (ii) a determination by such governmental unit of such request.

11 U.S.C. § 505(a)(2)(B) (1998).

The IRS notes that the language, "properly requests such refund," incorporates provisions from the Internal Revenue Code (I.R.C.) governing application for income tax refunds. ⁸ Specifically, a "proper" request is one that, first, meets the filing requirements of I.R.C. § 7422(a), which provides, in relevant part, that "[n]o suit or proceeding shall be maintained in any court" for a tax refund "until a claim for refund or credit has been duly filed with the Secretary, according to the provisions of law [and regulations] in that regard." Additionally, the I.R.C. establishes that a claim for an income tax refund must be filed within three years from the time the return was filed or two years from the time the tax was paid, whichever expires later. See I.R .C. § 6511(a).

The Panel observed that although there is no issue of subject matter jurisdiction with respect to the tax year stated in the proof of claim, the law is "less clear" where the debtor seeks determination of tax liability for years other than that stated in the proof of claim. See In re Kearns, 219 B.R. 823, 826 (8th Cir.BAP 1998); 11 U.S.C. § 106(b). Nonetheless, it ruled that absent the filing of a refund claim, there can be no subject matter jurisdiction over disputed, post-bankruptcy tax years. See id. at 828.

While this is a plausible resolution of the issue, we cannot share an interpretation of the Bankruptcy Code that precludes a debtor from having the benefit of carrying back deductions that are intimately related to the adjudged tax liability. In our view, the bankruptcy court correctly recognized the applicability in this case of a corollary to the rule that embezzled funds constitute income to the embezzler: "[T]o the extent that the victim recovers back the misappropriated funds, there is of course a reduction in the embezzler's income." James v. United States, 366 U.S. 213, 220, 81 S.Ct. 1052, 6 L.Ed.2d 246 (1961) (quotation omitted). We do not read § 505 to...