United States v. Mackenzie

• Decision Date: 30 March 2023
• Docket Number: CV-22-00461-PHX-DWL
• Parties: United States of America, Appellant, v. Robert A. Mackenzie, Appellee.
• Court: U.S. District Court — District of Arizona

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United States of America, Appellant, v. Robert A. Mackenzie, Appellee.

No. CV-22-00461-PHX-DWL

United States District Court, D. Arizona

March 30, 2023

ORDER

Dominic W, Lanza United Stares District Judge

Pending before the Court are the parties' cross-appeals from an order of the bankruptcy court. For the following reasons, the bankruptcy court's decision is affirmed.

RELEVANT BACKGROUND

In 2010, Michael A. Leite and Andrea C. Carvalho (“Debtors”) filed a late income tax return for fiscal year 2009 and reported no taxes. (Doc. 6-17.) The Internal Revenue Service (“IRS”) issued Debtors a refund but later reexamined Debtors' tax return and found that Debtors had significantly underreported their taxes owed. (Id.) The IRS assessed additional taxes penalties, and interest on both the taxes and penalties. (Id.) The IRS then secured a federal tax lien (the “Tax Lien”) against Debtors' house in Connecticut (the “Property”). (Id. See also Doc. 6-11 at 5 [notice of federal tax lien].)

In September 2019, Debtors filed a petition for Chapter 7 bankruptcy. (Doc. 6-4.) The IRS filed a proof of claim, which included a secured claim for the taxes (the “Taxes”), penalties (the “Penalties”), and interest on both.^[1] (Docs. 6-6, 6-7.) The Property was later sold, but after satisfying other costs and claims on the Property, the proceeds from the sale (the “Proceeds”) were not enough to pay the full amount of the IRS's claim. (Doc. 6-11 at 2 ¶ 10 [reporting net proceeds of $38,642.80 from the sale of the Property].) Meanwhile, in December 2019, Debtors filed a (late) tax return for fiscal year 2017 and claimed a refund of $10,244 (the “Overpayment”).^[2] (Doc. 6-11 at 9-10.)

In May 2020, the Trustee initiated an adversary proceeding to avoid the Tax Lien and preserve it for the benefit of the bankruptcy estate. (Doc. 6-8.)

On June 18, 2020, the Trustee moved for summary judgment. (Doc 6-10.) In relevant part, the Trustee argued that the Proceeds should be allocated on a pro rata basis between the Taxes (an unavoidable claim held by the IRS) and the Penalties (an avoided and preserved claim held by the Trustee). (Id. at 6-8.) The Trustee also argued that the Overpayment, which had not yet been processed at the time, should be applied to offset the Taxes (rather than the Penalties). (Id. at 7-8.)

After full briefing and oral argument, the bankruptcy court agreed with the Trustee as to the allocation issue but declined to decide the Overpayment issue. (Doc. 6-25.) On October 8, 2020, the bankruptcy court issued a final order, allocating specific dollar amounts to the Taxes and Penalties, avoiding and preserving the Tax Lien to the extent of the Penalties, and stating that the Overpayment issue would “await agreement of the parties or further order of the [bankruptcy court].” (Doc. 6-30 at 1-2.)

The government appealed. On September 27, 2021, after full briefing, the issuance of a tentative order, and oral argument, the Court issued a 24-page order in which it affirmed the bankruptcy court's order as to the allocation of the Proceeds in a pro rata fashion but reversed and remanded as to the Overpayment issue, finding that the bankruptcy court erred by allocating specific dollar amounts of Proceeds before determining whether the government could retroactively offset the balance owed on the Tax Lien. United States v. Mackenzie, 2021 WL 4427069, *7-14 (D. Ariz. 2021).

The government appealed the Court's order to the Ninth Circuit. However, on December 17, 2021, the Ninth Circuit issued an order stating that “[a] review of the record suggests that this court may lack jurisdiction over this appeal from the district court's judgment affirming in part and reversing in part, the bankruptcy court's order on the first amended motion for summary judgment. Within 21 days after the date of this order, appellant shall move for voluntary dismissal of this appeal or show cause why it should not be dismissed for lack of jurisdiction.” In re Leite, Ninth Cir. No. 21-16987, Dkt. No. 8. Afterward, the government filed an unopposed motion to dismiss for lack of jurisdiction. Id., Dkt. No. 11. This request was granted and the appeal was dismissed. In re Leite, 2022 WL 1671886 (9th Cir. 2022).

On remand to the bankruptcy court, the parties submitted briefs regarding the Overpayment issue. (Doc. 6-43 [government's brief]; Doc. 6-44 [trustee's brief]; Doc. 645 [government's reply].) On February 3, 2022, a few days after oral argument (Doc. 646), the bankruptcy court issued an amended order holding that the IRS was entitled to retroactively apply the Overpayment to offset the Penalties. (Doc. 6-48 [minute entry explaining decision].)

More specifically, the bankruptcy court began by noting that, “[a]s the IRS explains, set off is allowed under 26 U.S.C. § 6402(a) and is credited on the date payment is due, not on the date it was processed.” (Doc. 6-48 at 3, footnote omitted.) Next, because the parties agreed that § 553 of the Bankruptcy Code applied to the setoff, the bankruptcy court turned to the framework for applying § 553 provided by the Ninth Circuit in Newbery Corp. v. Fireman's Fund Ins. Co., 95 F.3d 1392 (9th Cir. 1996):

Under section 553(a), each debt or claim sought to be offset must have arisen prior to filing of the bankruptcy petition. A claim can be set off whether it is contingent or unliquidated, as long as the claim qualifies as ‘mutual' under applicable nonbankruptcy law . . . . Additionally, the debts must be mutual and in order to be mutual they must be in the same right and between the same parties, standing in the same capacity. The mutuality requirement is strictly construed. . . . The right of set off is permissive, not mandatory; its application rests in the discretion of the court, which exercises such discretion under the general principles of equity.

(Doc. 6-48 at 4-5, internal citations omitted.)

With this framework in mind, the bankruptcy court addressed the Trustee's § 553 arguments, which focused on “mutuality and equity.” (Id. at 5.) First, the bankruptcy court concluded “the debt is mutual for purposes of set off.” (Id. at 5.) The bankruptcy court dismissed the cases provided by the Trustee, which “discuss[ed] the difficulty in set off when it is as against a contingent claim that has not yet become due,” as distinguishable. (Id. at 5 [“The Trustee does not explain how the overpayment, which is not a claim or a debt, fits into this analysis, or why the overpayment fails this test or why it was not ‘absolutely owing' simply because it had yet to be discovered as of the petition date.”].) The court then analogized to In re Gould, 401 B.R. 415 (B.A.P. 9th Cir. 2009), aff'd, 603 F.3d 1100 (9th Cir. 2010), where “there was no question regarding mutuality under similar facts.” (Id.) More specifically, the bankruptcy court reasoned that, like in Gould (in which the IRS “sought to offset as against a prepetition tax debt, an overpayment that was discovered based on overdue prepetition tax returns filed post-petition”), the Overpayment here was “contingent and unliquidated on the petition date, but only because the parties were not aware of it until the debtors filed their tax returns.” (Id. [“Despite the date of its ‘discovery' or ‘determination,' the overpayment itself occurred well before the petition date.”].)

As for equitable considerations, the bankruptcy court rejected the Trustee's contention that “the IRS acted in an inequitable manner in not processing the return quicker so that it could offset before this Court reached its decision as to avoidance of the lien.” (Id. at 6 [“The IRS kept the Court and the Trustee fully informed where things stood regarding the return.”].) Accordingly, the bankruptcy court concluded “the IRS undoubtedly possesses a right of set off.” (Id. at 6.)

Next, the bankruptcy court turned to the “narrower question” on remand-whether the IRS “retains a specific right to offset its debt to reduce a lien, after the Court ruled avoiding the lien under § 724(a).” (Id.) On that issue, the bankruptcy court rejected most of the government's arguments. For example, the court found the IRS's reliance on Gould unpersuasive, stating that Gould is distinguishable because it turned on “whether the IRS could offset an overpayment against prepetition tax debts in light of the debtor's claimed exemption in any refund under § 522.” (Id. at 6-7. See also id. at 7-8 [finding that In re Silver Eagle Co., 262 B.R. 534, 535 (Bankr. D. Or. 2001), was distinguishable because “the Silver Eagle court was not faced with a tax lien claim against real property and certainly not a tax lien that had been avoided by the chapter 7 trustee following an adversary proceeding”].) Because the court did not agree with the government's “premise”-i.e., that the government's setoff right “trump[ed] all other provisions, including the avoidance provisions of § 724(a)”-the court declined to address the Trustee's responsive arguments, which relied on In re Glass, 60 F.3d 565 (9th Cir. 1999), “other than to say that [the court] did not find the case, or similar cases, on point or helpful in resolving the issue at hand.” (Doc. 6-48 at 8.)

The bankruptcy court also disagreed with the government's argument that the portion of the tax code “mandating the application date of the overpayment as April 15, 2018, provides [the IRS] with the right to set off against an avoided lien.” (Id. at 8 [“As the [court] sees it, adopting the IRS's position would lead to all sorts of problems[] if a lien is avoided and the funds distributed prior to the IRS determining an overpayment.”].)

Nevertheless the bankruptcy court explained that, although it intended the October 8, 2020 order to be final at the time of issuance, it came to realize (after...