United States v. Warfield (In re Tillman)
| Citation | 53 F.4th 1160 |
| Decision Date | 18 November 2022 |
| Docket Number | 21-16034 |
| Parties | IN RE: Sandra J. TILLMAN, Debtor, United States of America, Appellant, v. Lawrence J. Warfield, Trustee; Sandra J. Tillman, Appellees. |
| Court | United States Courts of Appeals. United States Court of Appeals (9th Circuit) |
Matthew S. Johnshoy (argued), Francesca Ugolini, and Ellen Page DelSole, Attorneys; David A. Hubbert, Deputy Assistant Attorney General; United States Department of Justice, Tax Division; Washington, D.C.; for Appellant.
Terry A. Dake (argued), Terry A, Dake Ltd, Phoenix, Arizona, for Appellee Lawrence J. Warfield.
Thomas H. Allen, Allen Barnes & Jones PLC, Phoenix, Arizona, for Appellee Sandra J. Tillman.
Before: CLIFTON and BUMATAY, Circuit Judges, and CHEN,* District Judge.
Opinion by Judge Chen ;
Sandra J. Tillman (the "Debtor") purchased a house in Prescott, Arizona (the "Prescott Property"). The Internal Revenue Service ("IRS" or "the government") held a secured claim on the Prescott Property arising from a tax penalty lien. Thereafter, Debtor filed a petition for Chapter 7 bankruptcy and claimed a $150,000 homestead exemption in the house under Arizona law. Appellee Trustee Lawrence J. Warfield (the "Trustee") instituted an adversary proceeding to avoid the IRS's tax lien on the exempt property and to preserve the value of the lien for the benefit of the bankruptcy estate. The Bankruptcy Court granted summary judgment to the Trustee and the District Court affirmed. The government appealed.
We are presented with a matter of first impression: may a trustee use 11 U.S.C. §§ 724(a) and 551 to avoid and preserve a tax penalty lien on a debtor's exempt property for the benefit of the bankruptcy estate? We hold that a trustee may not. Therefore, we reverse the decision of the District Court affirming the Bankruptcy Court.
At the outset, we briefly summarize the terminology and statutory provisions of the Bankruptcy Code relevant to this dispute.
First, after a bankruptcy petition is filed, a bankruptcy estate is formed consisting of specified property interests of the debtor. 11 U.S.C. § 541(a).
Second, in some circumstances, a debtor may exempt property from the bankruptcy estate, thereby removing it from the bankruptcy estate. Mwangi v. Wells Fargo Bank, N.A. (In re Mwangi) , 764 F.3d 1168, 1175–76 & n.4 (9th Cir. 2014). In such circumstances, the debtor generally retains the exempt property, and the exempt property cannot be used by the bankruptcy estate to satisfy the claims of unsecured creditors. Owen v. Owen , 500 U.S. 305, 308, 111 S.Ct. 1833, 114 L.Ed.2d 350 (1991). Section 522 of the Bankruptcy Code enumerates exemptions available to an individual debtor in bankruptcy, but § 522(b)(1) also authorizes state legislatures to "opt out" of the § 522 exemption scheme and provide their own exemption schemes. "If a State opts out, then its debtors are limited to the exemptions provided by state law." Owen , 500 U.S. at 308, 111 S.Ct. 1833.
As relevant here, Arizona has opted out of the § 522 exemptions and provides its own set of exemptions to Arizona residents. Arizona Revised Statutes ("A.R.S.") § 33-1133(B). Among other things, Arizona provides a homestead exemption that permits a resident to exempt her "interest in real property ... in which [she] resides," up to $150,000 "in value." Id. § 33-1101(A)(1) (). Arizona, however, provides that consensual loans, such as mortgages, are not "subject to or affected by" the homestead exemption. A.R.S. § 33-1104(D). Thus, depending on the value of the property, a mortgage can diminish the amount of the homestead exemption available to the homeowners. Notably, the Arizona homestead exemption does not provide for any reduction in the exemption amount for tax liens.
Third, the Bankruptcy Code limits a debtor's ability to shield exempted property from liability for certain pre-petition debts. Section § 522(c) provides:
11 U.S.C. § 522(c) (emphasis added). In short, § 522(c) provides that a debtor remains liable for certain debts secured by liens, such as tax liens, even if the debtor has otherwise exempted property from the reach of unsecured creditors. Of note, an IRS tax lien lies "upon all property and rights to property, whether real or personal, belonging to such person." 26 U.S.C. § 6321.
Fourth, under § 724(a) of the Bankruptcy Code, a trustee may "avoid" a "lien that secures a claim of a kind specified in section 726(a)(4)" for the estate. Section 726 deals generally with distribution of property of the estate, and § 726(a)(4), as relevant here, addresses claims for non-compensatory penalties. 11 U.S.C. § 726(a)(4) ().
Fifth, if a trustee avoids a lien using § 724(a), the lien's priority position is automatically "preserved for the benefit of the estate but only with respect to property of the estate." 11 U.S.C. § 551. Thus, generally, once the trustee avoids a lien against property of the estate, he steps into the shoes of the lienholder and can recover that property interest for the estate, thereby increasing the property of the estate available to satisfy claims of unsecured creditors. Retail Clerks Welfare Trust v. McCarty (In re Van de Kamp's Dutch Bakeries) , 908 F.2d 517, 519 (9th Cir. 1990).
Having described the relevant statutory provisions, we now turn to the facts of this case.
In 2015, Debtor purchased a residence in Prescott, Arizona and granted a mortgage to Bank of America. The Prescott Property became the Debtor's homestead under Arizona law. See A.R.S. § 33-1101 (). The Debtor owed income tax for 2015 but failed to timely file a return or pay her 2015 taxes. The IRS assessed Debtor's 2015 income tax liability and related penalties and interest. Debtor eventually fully paid the original tax liability but did not fully pay the penalties and interest, which initially totaled over $18,000. On December 24, 2018, the IRS recorded a notice of a federal tax lien (the "IRS Tax Lien") securing the penalties against the Prescott Property.
On January 30, 2019, Debtor filed a Chapter 7 bankruptcy petition in the U.S. Bankruptcy Court for the District of Arizona. The IRS filed a claim for Debtor's 2015 tax liabilities and indicated its claim was secured by the IRS Tax Lien it had filed. Debtor claimed a homestead exemption of up to $150,000 on the Prescott Property under A.R.S. § 33-101, which the Bankruptcy Court permitted. that time, the Debtor's mortgage was for $364,381 and the IRS's secured tax lien was for $24,686.26.
Thereafter, the Trustee filed the adversary proceeding currently at issue and sought a summary judgment order: (1) avoiding the federal tax lien on the Prescott Property pursuant to 11 U.S.C. § 724(a), and (2) preserving the value of the avoided federal tax lien on the Prescott Property for the benefit of the bankruptcy estate pursuant to 11 U.S.C. § 551. The government responded that lien avoidance under § 724(a) and preservation under § 551 did not apply to liens encumbering exempt property, such as the Prescott Property, which was subject to Arizona's homestead exemption. The Debtor also intervened and asserted her right to an increased exemption under § 522(g).
The Bankruptcy Court granted the Trustee's summary judgment motion, holding that the Trustee could avoid the portion of the federal tax lien securing the tax penalties and interest under § 724(a) and that the value of the lien was preserved for the estate's benefit under § 551.
The Bankruptcy Court rejected the government's argument that lien avoidance under § 724(a) and preservation under § 551 for the benefit of the bankruptcy estate did not apply to the Debtor's exempted homestead property. Specifically, the Bankruptcy Court found that the IRS held a secured claim for a tax penalty, which is of the kind specified in § 726(a)(4), and was, thus, subject to avoidance by the Trustee under § 724(a). It observed that the IRS Tax Lien was held against the Prescott Property, which the Debtor claimed exempt under Arizona's homestead exemption—and which the Bankruptcy Court had previously granted—but that the grant of this exemption did not preclude the Trustee from avoiding the lien and preserving it for the benefit of the estate.
The Bankruptcy Court quoted Heintz v. Carey (In re Heintz ) for the proposition that " § 551 does not exclude exempt property from preservation" and that "[a]n avoided interest or lien encumbering exempt property is automatically preserved for the benefit of the estate under § 551." 198 B.R. 581, 586 (B.A.P. 9th Cir. 1996). Relying on Heintz , the Bankruptcy Court concluded that the Debtor's homestead was property of the bankruptcy estate at the commencement of the case and remained property of the estate for purposes of § 551 even after the Debtor's homestead exemption was allowed.
The Bankruptcy Court further reasoned that, under Arizona law, the Debtor's exemption was limited to an "interest" in her homestead, up to $150,000, equal...
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