Waters v. United States (In re Waters)

• Decision Date: 31 March 2021
• Docket Number: Civil No. 3:15-cv-1506 (AWT)
• Court: U.S. District Court — District of Connecticut
• Parties: In re: EDWARD J. WATERS, Debtor. EDWARD J. WATERS, Plaintiff, v. UNITED STATES OF AMERICA, Defendant.

In re: EDWARD J. WATERS, Debtor.EDWARD J. WATERS, Plaintiff, v. UNITED STATES OF AMERICA, Defendant.

Civil No. 3:15-cv-1506 (AWT)

UNITED STATES DISTRICT COURT DISTRICT OF CONNECTICUT

March 31, 2021

(Withdrawn Proceedings Bankruptcy Ct. Case No. 99-31833 and Bankruptcy Ct. Adv. No. 05-3054)

(Related case: 3:15-cv-1791 (AWT))

RULING ON MOTIONS FOR SUMMARY JUDGMENT

The United States of America (the "United States"), on behalf of the Internal Revenue Service (the "IRS"), has filed two motions for summary judgment: the United States' Motion for Summary Judgment on 1998 Tax Issues ("Motion Re 1998 Tax Determination"), ECF No. 25, and the United States' Motion for Summary Judgment on Issues Remaining in Withdrawn Adversary Proceeding ("Motion Re Adversary Issues"), ECF No. 26. In the former, the United States seeks a determination that the debtor, Edward J. Waters ("Waters"), is liable for individual income tax and accrued interest for the 1998 tax year. In the latter, the United States seeks a determination that the IRS did not violate the automatic stay provisions of the Bankruptcy Code by withholding overpayments claimed by Waters with respect to certain tax years. For the reasons set forth below, both motions are being granted.

I. FACTUAL BACKGROUND AND PROCEDURAL HISTORY

Waters has not set forth facts he contends are in dispute in response to the United States' motions for summary judgment and, as a result, is not in compliance with Local Rule of Civil Procedure 56(a)(2).¹ Nor has he presented evidence to controvert the assertions in the United States' motions.² Thus, all facts set forth in the United States' Rule 56(a)(1) statements are deemed admitted by Waters. See Dusanenko v. Maloney, 726 F.2d 82 (2d Cir.1984) (facts set forth in the movants' statement of undisputed facts were properly deemed admitted given opposing party's failure to present evidence to controvert any assertions in the movants' papers and failure to file a local rule statement of disputed facts). The material facts are set forth below.

On December 19, 1997, Waters filed a petition under Chapter 13 of the Bankruptcy Code, which was transferred between divisions of the United States Bankruptcy Court in 1999. Waters listed the IRS and the State of Connecticut Department of Revenue Services (the "CDRS") as his only personal creditors in the schedules to his Chapter 13 petition. The IRS filed an initial proof of claim on February 4, 1998 in the amount of $924, 682.59 for the 1986 through 1996 prepetition tax years.

In 2000, Waters filed a separate Chapter 11 case. Subsequently, Waters, the IRS and the CDRS entered into a stipulation (the "Stipulation"), see In re Waters, No. 99-31833, ECF No. 180, dated July 16, 2001, that was entered as an order of the Bankruptcy Court and required Waters to dismiss his Chapter 11 case, convert his Chapter 13 case to a Chapter 11 case, sell one of his residences, and put in escrow a portion of the proceeds from the sale of that property (the "Escrowed Funds"). Id. at 5-7. The Stipulation also required Waters to have a tax attorney of his choosing prepare his late 1993 through 2000 personal taxreturns, plus any quarterly personal income tax return due for 2001, and to use the Escrowed Funds to pay the tax liabilities for 1993 through 2000 and any estimated income tax due for 2001. Id. at 8. The Stipulation provided further that any administrative tax expense of the bankruptcy estate was to be paid from the Escrowed Funds, including prepetition and post-petition taxes incurred by Waters' bankruptcy estate.³ Pursuant to the Stipulation, the Chapter 13 case was converted to a Chapter 11 case, the residence was sold, and a portion of the sale proceeds -- $1,287,206 -- was placed into escrow with Waters' bankruptcy attorney.

In late 2001 and early 2002, Waters, through his tax counsel, filed his 1993 through 2000 federal and state tax returns. The taxes initially reported as due on these returns were paid from the Escrowed Funds pursuant to an agreed order of the Bankruptcy Court (the "Tax Payment Order"), dated April 25, 2002. The Tax Payment Order provided, in relevant part:

[C]ounsel for the Debtor is hereby authorized to make a distribution to the [IRS] of $529,520.62 . . . for the payment by [Waters] of the federal taxes, penalties and interest owed for his tax years 1993 through 2000, and the payment of his estimated taxes for 2001; provided however, that the Court notes that the [IRS] represented . . . that it has calculated these amounts based onreturns filed by [Waters] which have not yet been reviewed or assessed by the [IRS] and reserves its right to complete its assessment process which may change the amount due; and it is further . . .

ORDERED that the IRS agrees that the payment by [Waters] of his taxes, penalties and interest shall not constitute a waiver by him of the right to file a claim for a refund of any such penalties and to contest the assessment, validity or appropriateness of such penalties[.]

Tax Payment Order at 1-2, In re Waters, No. 99-31833, ECF No. 247. The Tax Payment Order also provided for a distribution of $130,277.99 to the CDRS for taxes, penalties, and interest, and in addition, a distribution of $128,000 to Waters individually. Id. It reserved the remaining Escrowed Funds -- approximately $360,000 -- pending further developments and continued litigation.

Not long after the tax returns were filed and taxes paid from the Escrowed Funds, Waters filed amended tax returns that claimed refunds for most of the taxes that were paid pursuant to the Tax Payment Order. The IRS examiner who was initially assigned to review the amended returns, who was unaware of the Tax Payment Order, agreed with many of the adjustments that Waters claimed on the amended returns and scheduled overpayments on the tax accounts maintained on the IRS's computer systems for tax years 1993, 1994, 1996, 1997, 1999 and 2000, and reduced the amount of tax still owed by Waters for tax year 1995. Before any refund was made, however, the IRS froze the refunds and audited the returns. Duringits consideration of the amended returns, the IRS refused to refund the claimed overpayments in order to preserve a right to setoff the claimed overpayments against other tax liabilities that were in dispute, including Waters' 1991 and 1995 taxes and his bankruptcy estate's 1998 and 2001 taxes.

It is undisputed that, under the Stipulation, the Escrowed Funds were being treated as Waters' personal post-petition earnings and were therefore not property of the bankruptcy estate. See United States' Local Rule 56(a)1 Statement for Mot. Re Adversary Issues ("Statement of Facts Re Adversary Issues") at 3, ECF No. 26-1. Thus, it is also undisputed that the claimed overpayments were paid with funds traceable to Waters' post-petition earnings -- specifically proceeds from the sale of a residence that was secured, in part, by a mortgage obtained through Waters' post-petition income -- and were understood by both parties to constitute post-petition obligations. See Mem. in Support of Mot. Re Adversary Issues ("Mem. Re Adversary Issues") at 10 and 11, ECF No. 26-2 (referring to the claimed overpayment as a "postpetition overpayment" and a "postpetition obligation"); Reply Re 1998 Tax Liability Determination and Adversary Proceeding ("Combined Reply") at 15, ECF No. 31 (describing the "alleged tax refund obligations here" as "postpetition"); Adv. Compl. at ¶ 10,Waters v. United States, Adv. No. 05-3054, ECF No. 1 ("Any tax refunds due the Debtor are post-petition tax refunds[.]").

In December 2003 Waters filed a contested matter motion with the Bankruptcy Court seeking a distribution to himself from the remaining Escrowed Funds because of the IRS's "refus[al] to pay the[] income tax, penalties, and interest refunds . . . due to [Waters]," and its "assert[ion of] a right to 'setoff' these funds" against other taxes that were disputed to be owed by Waters and the estate. Debtor's Mot. for Further Distribution to Him of Proceeds of Sale of His Residence, In re Waters, No. 99-31833, ECF No. 381. On December 22, 2003, the United States responded, stating that the IRS "ha[d] not made a final determination as to the federal tax refund figure, if any, which it will allow," and that therefore Waters' motion was "premature." U.S.'s Obj. to Debtor's Mot. at 4, In re Waters, No. 99-31833, ECF No. 385. This motion was held in stasis for several years by the Bankruptcy Court until this court withdrew the reference. See Order Re Mot. to Withdraw Bankr. Reference, No. 3:10-mc-14, ECF No. 5.

After completing its audit of the amended returns for 1993 through 2000, the IRS maintained its freeze on overpayments that it believed would be sufficient to satisfy Waters' 1991 and 1995 tax liabilities. At that time, the 1991 and 1995 tax liabilitieswere the only ones the IRS believed were owed by Waters personally⁴. It is undisputed that the IRS did not seek prior approval from the Bankruptcy Court to put in place or maintain the freeze with respect to a refund of Waters' claimed overpayments.

On October 4, 2004, Waters filed a Motion Under 11 U.S.C. § 362 and § 105: Requesting Court to Find IRS in Willful Violation of Stay by Withholding Post-Petition Tax Refunds Due Debtor, In re Waters, No. 99-31833, ECF No. 437, seeking, inter alia, to have the IRS release and pay his claimed post-petition refunds. The United States took the position that the relief sought required the filing of an adversary complaint under Bankruptcy Rule 7001 and Waters agreed to withdraw the motion without prejudice.

Meanwhile, on March 10, 2004, the Chapter 11 case was converted to a Chapter 7 case and a trustee (the "Chapter 7 Trustee") was appointed. On October 12, 2004, the IRS erroneously refunded the excess of the alleged overpayments (i.e., the refund amounts in excess of the 1991 and 1995 tax liabilities) to the Chapter 7 Trustee, based on an incorrect understanding that the source of the...