United States v. Beskrone (In re Affirmative Ins. Holdings Inc.)

• Decision Date: 27 July 2020
• Docket Number: Civ. No. 19-2034-RGA,Case No. 15-12136-CSS
• Citation: 620 B.R. 73
• Parties: IN RE: AFFIRMATIVE INSURANCE HOLDINGS INC., et al., Debtors. United States of America, Appellant, v. Don A. Beskrone, Chapter 7 Trustee, Appellee.
• Court: U.S. District Court — District of Delaware

620 B.R. 73

IN RE: AFFIRMATIVE INSURANCE HOLDINGS INC., et al., Debtors.United States of America, Appellant,

v.Don A. Beskrone, Chapter 7 Trustee, Appellee.

Case No. 15-12136-CSS

Civ. No. 19-2034-RGA

United States District Court, D. Delaware.

July 27, 2020

Richard E. Zuckerman, Esq., Principal Deputy Assistant Attorney General; Christopher J. Williamson, Esq., Ward W. Benson, Esq. (argued), Tax Division, U.S. Department of Justice, Washington, D.C., attorneys for appellant the United States.

Ricardo Palacio, Esq. (argued), Stacy L. Newman, Esq., Ashby & Geddes, P.A, Wilmington, Delaware, attorneys for appellee Don A. Beskrone, Chapter 7 Trustee.

MEMORANDUM OPINION

ANDREWS, UNITED STATES DISTRICT JUDGE

This appeal presents an issue of bankruptcy law that does not appear to have been decided by any appellate court. The issue is how to treat the "straddle year" for federal income tax under the current Bankruptcy Code. The Bankruptcy Court ruled that the straddle year should be bifurcated into pre- and post-petition periods; that income tax obligations must be allocated between those two periods; and that income taxes resulting from pre-petition events during the straddle year are accorded general unsecured treatment, while income taxes resulting from post-petition events in that same straddle year are granted administrative priority treatment.

The issue arises because the corporate debtors, Affirmative Insurance Holdings, Inc. and certain affiliates ("Debtors"), filed for bankruptcy in October 2015. Their tax year ended on December 31^st, and, in due course, based on the Debtors' tax filing for 2015, the IRS filed an administrative expense priority claim in the bankruptcy cases for approximately $850,000 of taxes, penalties, and interest. It appears that the tax events that gave rise to the tax obligations occurred pre-petition. Thus, the Bankruptcy Court's determination meant that the IRS's claim would be treated as a general unsecured claim, with a low probability of any significant distribution from the estate.

The United States, on behalf of the IRS, has appealed the Order (B.D.I. 811)¹ implementing the accompanying Opinion, In re Affirmative Insurance Holdings, Inc., 607 B.R. 175 (Bankr. D. Del. 2019). The United States challenges the Bankruptcy Court's conclusion that a claim for corporate income taxes for the straddle year is only entitled to administrative priority to the extent it is attributable to post-petition income. For the reasons set forth below, I agree with the United States, and I will reverse the Order.

I. BACKGROUND

Prior to filing for bankruptcy, the Debtors had sold or otherwise disposed of substantially all of their material assets. (A049). On October 14, 2015 ("Petition Date"), the Debtors each filed a voluntary petition for relief under Chapter 11. The Bankruptcy Court later entered an order converting the Debtors' cases to cases under Chapter 7 (B.D.I. 337), and, thereafter, Trustee was appointed (B.D.I. 338).

On September 14, 2016, Trustee filed the Debtors' consolidated federal tax return for the 2015 calendar year. (A023, A050). The Debtors' full year consolidated taxable income was realized principally from the pre-petition activities. (A023-24). Based on their taxable income, the consolidated Debtors had a full tax year obligation of $792,113, plus an estimated penalty of $14,341. (A024). The IRS filed a timely administrative expense claim for taxes for the tax year ending 2015. (A050). Subsequently, the IRS filed an amended administrative expense claim that amended and superseded the original claim. (A018). The IRS Claim is comprised of the following amounts: (i) $792,113.00 (tax due), (ii) $18,566 (interest due), and (iii) $46,025.52 (penalty due). (Id. ) Trustee filed the Claim Objection (B.D.I. 762) seeking entry of an order disallowing administrative expense priority for the IRS Claim and reclassifying the entirety of the IRS Claim as a general unsecured claim. (A001-30). The Bankruptcy Court held oral argument, and thereafter issued a comprehensive Opinion that sustained Trustee's objection in part.

The Bankruptcy Court's analysis speaks for itself, but I think it could fairly be summed up as: Pre-BAPCPA,² the Third Circuit held that such straddle tax years must be bifurcated into (at the time) priority and unsecured claims; nothing in the plain meaning of the statute or the legislative history of BAPCPA would justify departing from this approach; and administrative priority should be applied only to obligations resulting in or arising from a benefit received after the bankruptcy estate came into existence, "unless Congress gives specific instructions otherwise." Affirmative , 607 B.R. at 188. Applying the bifurcated approach to the issue, the Bankruptcy Court held "that pre-petition events that incur tax liability during ‘Straddle Tax Years’ are afforded general unsecured status whereas, post-petition events that incur tax liability during those same ‘Straddle Tax Years’ are afforded administrative priority ..." Id. The Order thus sustained the Claim Objection in part and granted the United States ninety days to amend its claim and specify whether any of the IRS Claim is allocable to post-petition events.

On October 28, 2019, the United States filed a notice of intent not to amend the IRS Claim, along with its notice of appeal. (B.D.I. 812, 813). The appeal is fully briefed. (D.I. 7, 9, 10, 12). I heard video oral argument on June 25, 2020. (D.I. 14).

II. JURISDICTION AND STANDARD OF REVIEW

The Court has jurisdiction as the appeal is from a final order. See 28 U.S.C. § 158(a)(1). In ruling on the Claim Objection, the Bankruptcy Court conclusively determined the legal question that is the subject of this appeal. It granted the United States ninety days to amend its claim. An order resolving a preliminary issue as to priority, but not deciding which portion of the claim is actually entitled to priority, is not a final order. See In re Natale , 295 F.3d 375 (3d Cir. 2002). The United States filed a notice of intent not to amend its claims. (B.D.I. 812). That notice rendered the Order final and appealable. See Frederico v. Home Depot , 507 F.3d 188, 192-93 (3d Cir. 2007).

The sole issue on appeal is a legal one. This Court's review is de novo.

III. PARTIES' CONTENTIONS

The United States contends on appeal that the Bankruptcy Court reached the wrong result because under applicable non-bankruptcy law – the Internal Revenue Code ("IRC") – a corporation's entire annual income tax accrues on the last day of the tax year. (D.I. 7 at 4). Because a corporation has only a single tax liability for a tax year, the entire tax is "incurred by the estate" on that day. (See id. at 4-5). The United States argues that the Bankruptcy Court erred in its failure to consider the language of the IRC in its determination of when federal income tax is incurred. (See id. at 6-10). The United States further argues that both the Bankruptcy Code and the IRC distinguish income taxes from the sort of transaction- or event-based taxes which were the subject of cases relied on by the Bankruptcy Court. (See id. at 10-15). The United States further argues that BAPCPA clarified that a tax year cannot be bifurcated. Finally, the United States argues that the legislative history of § 503 demonstrates that income taxes are incurred at the end of the tax year.

According to Trustee, the Bankruptcy Court reached the correct result in holding that income tax is incurred daily, based on each day's events and transactions, and that a single yearly tax liability must be apportioned between pre-petition and post-petition days, events, and transactions. Under this view, Trustee argues, any portion of the tax traceable to events or transactions prior to the Petition Date, when no estate yet existed, was not "incurred by the estate." Moreover, since the tax period did not end prior to the filing of the bankruptcy petition, the tax incurred in the pre-petition portion of the straddle year is not entitled to priority status either, but rather is only a general unsecured claim, notwithstanding the policy of giving preferential treatment to taxes the government has not had a reasonable time to assess or collect. Trustee argues that a proper analysis of the issue begins and ends with the plain meaning of the "operative statutes," which he contends are §§ 503(b)(1)(B)(i) and 507(a)(8)(A), without reference to the IRC. (D.I. 10 at 7). According to Trustee, the distinctions between income taxes and other types of taxes are irrelevant and the determination can be made based on the statutes' plain meaning. (Id. at 10-12). Such analysis, Trustee argues, is also consistent with the Third Circuit's decision in Grossman's – a decision not mentioned in the Opinion – which held that state labels (and, by extension here, federal labels) should not serve as the sole basis to determine when a claim in bankruptcy arises. (Id. at 16 (citing In re Grossman's, Inc., 607 F.3d 114, 120-21 (3d Cir. 2010) ). Trustee argues that Grossman's mandates that the IRS Claim (i.e. , the right to the payment of taxes on income earned pre-petition) accrued when the income was earned (i.e. , at the time of the taxable event such as the pre-petition sale of assets), and that any other holding would undermine Third Circuit law. (Id. )

IV. ANALYSIS

Whether the federal income taxes for the full straddle year were "incurred by the estate" is the central issue on appeal. The United States urges that the answer turns on whether the Bankruptcy Court was required to look to the underlying substantive tax law to determine when the tax accrued. Trustee urges that the answer turns entirely on when individual transactions or events occurred – pre-petition or post-petition – requiring the pre-BAPCPA bifurcated approach adopted by some courts. Based on the plain meaning of the statute, I agree with the United States.

A. Administrative Expense Priority

The Code sets out ten priorities of...