IN RE TEAL

Full title: In re TEAL

Court: United States District Court, W.D. Texas

Date published: Dec 23, 1992

No. A-91-CA-863 (W.D. Tex. Dec. 23, 1992)

Opinion

No. A-91-CA-863.

December 23, 1992.

Opinion

NOWLIN, District Judge

Before the Court is an appeal from an Order of the Bankruptcy Court brought pursuant to 28 U.S.C. § 158(a). Having considered the briefs of the parties, the Order appealed from, and the entire record on appeal, the Court is of the view that the decision of the Bankruptcy Judge should be affirmed in part and reversed and remanded in part.

Pursuant to 28 U.S.C. § 157(c), this Court has conducted a de novo review of the legal conclusions of the Bankruptcy Court. See also Matter of Hammons, 614 F.2d 399, 403 (5th Cir. 1980). The parties only contest one conclusion of the Bankruptcy Court on appeal. The parties dispute the Bankruptcy Court's legal conclusion that it lacked jurisdiction to consider the tax penalties, and interest thereon, imposed upon the petitioner for the 1979 tax year. This Court must apply a de novo standard of review to such a legal conclusion.

BACKGROUND

The appellant has paid his taxes due for the 1979 year. The appellant only contests his obligation for the penalties, and interest thereon, assessed against him for that tax year.

This is not a situation where the taxpayer did not contest disputed facts. Instead, this is a case where the law was clarified after the taxpayer agreed to pay penalties to the IRS for the 1979 tax year. This clarification of the law resulted in the penalties imposed by the IRS in such situations as being improper and void.

In Heasley v. Commissioner of Internal Revenue, 902 F.2d 380 (5th Cir. 1990), the Fifth Circuit addressed a controversy involving taxpayers in an essentially identical situation to the taxpayer in the present action. Indeed, Heasley involved the penalties imposed on taxpayers for their making and reporting of investments in the exact same leasing corporation, the O.E.C. Leasing Corporation, in which Teal had invested.See id. at 381.

The Fifth Circuit held that the I.R.S. and the Tax Court both erred as a matter of law in assessing and upholding, respectively, the valuation overstatement penalty, under 26 U.S.C. § 6659, against the taxpayers in that action. Id. at 383. The court ruled that the taxpayers' valuations overstatement did not attribute to the underpayment because the taxpayers' understatement is attributable to their claiming an improper deduction or credit. Id. In such a situation, the Fifth Circuit held that the valuation overstatement penalty did not apply. Id. The court further held that the additional interest penalty, imposed against the taxpayers under 26 U.S.C. § 6621(c), also did not apply for the same reasons. Id. at 385. The Heasley decision resolved the exact same penalties that are disputed in the present action.

In Heasley, the Tax Court expressly declared its reasons for upholding the I.R.S. assessment of the penalty. Id. at 382. Apparently, the Tax Court in Heasley did not enter a stipulated judgment as did the Tax Court in Teal's case. However, the taxpayers in Heasley did appeal from the adverse ruling of the Tax Court. Teal did not.

In the present situation, the Bankruptcy Court based its decision upon the language of 11 U.S.C. § 505(a)(2), which prohibits the bankruptcy court from determining:

(A) the amount or legality of a tax, fine, penalty, or addition to tax if such amount or legality was contested before and adjudicated by a judicial or administrative tribunal of competent jurisdiction before the commencement of the case under this title; . . . .

11 U.S.C. § 505(a)(2)(A). This rule is clear that the bankruptcy court may not redetermine or determine either the amount or legality of a tax penalty if that amount or legality has previously been contested before and decided by the Tax Court, which is a judicial tribunal of competent jurisdiction. To give proper effect to the language of this statutory provision, the determinations of the amount of a penalty and the legality of a penalty must be treated as separate and distinct decisions. It appears that the taxpayer Teal did agree to the amount of the penalties, but the stipulated judgment does not show an express agreement that Teal agreed to the legality of the penalties. Also, the Tax Court decision does not show that the Tax Court rendered a decision on the merits regarding the legality of the penalties imposed.

Although the amount of the penalties appears to have been determined by the Tax Court, the legality does not appear to have been determined by the Tax Court. Instead, the amount of the penalties was assessed based upon the agreed stipulation that the tax was legal. Although the stipulated judgment of the Tax Court is res judicata with respect to the amount of the penalties imposed, that decision is not res judicata with respect to the legality of the penalties imposed.

A stipulated or consent judgment "can be vacated according to basically contractual principles of fraud, ignorance, mistake, or mutual breach." See Wright, Miller Cooper, 18 Federal Practice and Procedure, § 4443, at 383 (1981) (footnote omitted). In this action, both parties clearly made a mistake as to the legality of the penalties imposed. Presumably, the I.R.S. would not try to impose a penalty that has been declared invalid.

With respect to the agreed stipulated judgment that was entered in a tax court, the Supreme Court has held that such judgments are res judicata for the tax claims for the years covered by the agreed judgments, "whether or not the basis of the agreements on which they rest reached the merits." See United States v. International Building Co., 345 U.S. 502, 506, 73 S.Ct. 807, 809 (1953). However, unless the agreed judgment clearly shows that a determination of the facts and law was made by the court entering the agreed judgment, then the agreed judgment cannot be used as a means of collateral estoppel. See id. The Supreme Court stated that the decisions entered by the Tax Court based upon the stipulations of the parties "were only a pro forma acceptance by the Tax Court of an agreement between the parties to settle their controversy for reasons undisclosed." Id., 345 U.S. at 505, 73 S.Ct. at 809.

Therefore, the Tax Court cannot be viewed as reaching the merits of the legality of the penalties involved in the stipulated judgment. In the present action, there is no showing that the Tax Court actually reached the merits of the legality of the penalty assessments for the 1979 tax year. The parties merely stipulated to the amount of the taxes owed and penalties due for the 1979 tax year.

In Grogan v. Garner, ___ U.S. ___, 111 S.Ct. 654 (1991), the Supreme Court stated that a bankruptcy court can properly apply the doctrine of collateral estoppel "to those elements of the claim that are identical to the elements required for discharge and which were actually litigated and determined in the prior action." Id., ___ U.S. at ___, 111 S.Ct. at 658 (emphasis added) (citing Restatement (Second) of Judgments, § 27 (1982))¹. The Supreme Court stated that a creditor who had successfully proved a claim in a prior proceeding by a higher evidentiary standard than required in bankruptcy proceedings could prevail by collateral estoppel. Id. However, creditors who had failed to previously prove a claim by at least the evidentiary standard required in bankruptcy proceedings would not be assured of prevailing merely by means of collateral estoppel. Id., ___ U.S. at ___, 111 S.Ct. at 659. Likewise, although the Government did litigate the claim concerning the validity of the penalties, the Tax Court never actually decided the legality of the penalties.

1 In Grogan v. Garner, the Supreme Court held that nondischargeability of debts must only be proved by a preponderance-of-the-evidence standard. Grogan, ___ U.S. at ___, 111 S.Ct. at 661.

"As a general rule, changes in law do not prevent the application of res judicata." See Wilson v. Lynaugh, 878 F.2d 846, 850 (5th Cir. 1989),cert. denied, 493 U.S. 969, 110 S.Ct. 417 (1989); see also Nilsen v. City of Moss Point, 701 F.2d 556, 564 (5th Cir. 1983) (en banc). Although not warranting the exception to res judicata principles applied in cases involving civil rights, this case does warrant an exception on distinct grounds because of a mistake as to the legality of the penalty. See Wilson v. Lynaugh, 878 F.2d at 850-851. The present situation does not involve a change in the law. Although such a distinction is technical, the legality of the penalties in this type of situation had never been addressed. Consequently, where no determination of the law had been made, there can be no change in the law. Instead, the law was merely uncertain until ultimately declared by the Fifth Circuit in Heasley that the penalties were invalid in this situation.

Teal relies heavily on the Fifth Circuit's decision in Logan Lumber Co. v. Commissioner of Internal Revenue, 365 F.2d 846 (5th Cir. 1966). InLogan Lumber, the Fifth Circuit explained:

Where a stipulation is entered into under a mistake of law induced by the then existing state of the case law, a taxpayer is entitled to be relieved of the effect of that stipulation if no prejudice results. See George S. Colton Elastic Web Co. v. White, 23 F. Supp. 761 (D.Mass. 1938). This Circuit has held that a party may be relieved of a stipulation "to prevent manifest injustice" so long as "suitable protective terms or conditions are imposed to prevent substantial and real harm to the adversary."

Logan Lumber, 365 F.2d at 855 (citations omitted). Most of the cases referred to in the Logan Lumber decision involved appeals from Tax Court decisions where there was an intervening change in the law after the case was on appeal and after the stipulation had been made in the Tax Court.

In Logan Lumber, the Fifth Circuit relied heavily upon the Fourth Circuit decision of Brast v. Winding Gulf Colliery Co., 94 F.2d 179 (4th Cir. 1938). See Logan Lumber, 365 F.2d at 855. In Brast, the taxpayer entered into stipulations before the tax court conceding the payment of certain taxes, and no appeal was taken from the tax court's decision that was based upon the stipulations. Logan Lumber, 365 F.2d at 855. In an unrelated decision entered subsequently to the tax court's decision, the Fourth Circuit decided the see legal issue against the Commissioner. Id. The taxpayer then instituted a refund suit, in which the Fourth Circuit affirmed the district court's setting aside the taxpayer's previous stipulation and refunding the erroneously paid taxes. Id. The Fifth Circuit recited the following language from the Brast decision:

The plaintiff by the stipulation merely agreed to pay what it was not, under the law as finally determined, required to pay, and when it discovered its mistake, had the unquestioned right to ask that it be relieved. . .

. . .

The trial court in the exercise of what we hold to be a sound discretion, and in furtherance of justice, relieved the plaintiff from the stipulation. By this action the government suffered no prejudice. It was only required to refund the sum it had collected, which it had no right to collect.

Logan Lumber, 365 F.2d at 855 (quoting from Brast, 94 F.2d at 181-182).

Unlike Brast, the taxpayer has not already paid the disputed penalties in this action. Further, the taxpayer is contesting only the penalties due for the 1979 tax year, not the actual taxes due for that year. Also, unlike Brast, the taxpayer in this case is challenging the validity of the penalties in a bankruptcy action and not in a refund action.

The Logan Lumber and the Brast decisions are controlling in this situation. This Court will follow those decisions.

In the present action, it appears from the record that Teal was unrepresented in his action before the Tax Court. The Tax Court did not address the legality of the penalties imposed for the 1979 tax year. This Court finds it difficult to permit parties to overturn stipulations only on direct appeal or in a refund action, but not let parties overturn stipulations in a later collateral challenge where such stipulations would be overturned in the other two types of actions.

Although the appellee Commissioner argues that the taxpayer should not be allowed to have the benefits of such a collateral attack when the taxpayers do not bear the burdens of such collateral attacks by the Commissioner, the two parties involved do not generally compete on a level playing field. Because I.R.S. is large and powerful compared to the individual taxpaying citizen, the I.R.S. is and should be expected to bear more burdens and responsibilities than individual taxpaying citizens against whom the I.R.S. has unleashed its virtually limitless resources. The prejudice to the I.R.S. of not permitting the I.R.S. to collect an unlawfully assessed penalty is insignificant compared to the injustice that would be wreaked by forcing an individual taxpayer to pay an unlawful penalty. The credibility and integrity of the Government and the I.R.S. would be strained unnecessarily to permit the I.R.S. to collect or impose an unlawful penalty. Indeed, this Court is somewhat amazed that the I.R.S. is even seeking to collect an unlawful penalty. Such conduct can only serve to erode the already weakened confidence of the public in the Government. In the interest of justice and fairness, this Court will not contribute to the further erosion of such confidence.

Because the Tax Court did not address the legality of the penalties, the Bankruptcy Court is not precluded from addressing that issue. The Tax Court did not state that the penalties were proper or valid. The Tax Court merely referenced the statutory authority for the penalties. The Tax Court's stipulated decision clearly did determine the amount of the tax and penalties due for 1979, but the decision did not address the legality of the penalties therein imposed.

The appellee Government has stated, by means of a rhetorical question:

If the 5th Circuit Court of Appeals had fully sustained the penalties which the government conceded in the Tax Court settlement, would Teal allow the government to have the Bankruptcy Court increase his tax liability? No, a deal is a deal.

See Appellee's Brief at 8. Although a fine distinction, the issue before this Court is the legality of the tax penalty, not the amount of the tax penalty. An increase or decrease in the amount of the penalty would not be possible, but a determination of whether or not the penalty should be assessed at all is.

Although sympathetic with Appellant Teal in his guest for fairness, this Court is concerned with the effects of permitting an exception to the doctrine of res judicata in this action. For example, suppose in an opposite situation the I.R.S. had entered into a stipulated judgment wherein it stated that no penalty was owed for a particular action of a taxpayer. Then, assume that the courts or Congress changed the law. If the taxpayer sought a determination of his prior tax liabilities in bankruptcy court, presumably res judicata principles would preclude the I.R.S. from seeking to impose a penalty on the conduct for which the previously entered stipulated judgment stated that no penalty was due.

Appellant Teal had the full and fair opportunity to contest the assessed penalties in the Tax Court litigation. Apparently, instead of incurring the monetary and time expenses to fully contest the disputed claims, Teal agreed to a compromise through the stipulated judgment. However, the courts must be more protective of the rights and liabilities of individual, unrepresented taxpayers, than of the Internal Revenue Service.

However, it is undoubtedly true, the I.R.S. is much more adept and experienced at protecting its interests and issues for appeal than the average taxpayer. The same concerns for fairness and justice do weigh much less in protecting the I.R.S. from entering into judgments based upon a mistake in the law than in protecting average taxpayers. Also, the prejudice and harm would be far more onerous to the individual taxpayer in such a situation than to the I.R.S. in the reverse situation. The I.R.S. will not be prejudiced or harmed by this decision.

Unrebutted by the Government, appellant Teal argues that the Government failed to inform him of the federal criminal investigation into the O.E.C. Leasing scheme. Such conduct by the Government further supports this Court's finding that the previously agreed penalties and interest thereon should be voided.

Finally, the appellee contends that a determination by the bankruptcy court is the improper procedural vehicle for the appellant Teal to contest the penalties. Because the legality of the penalties was not expressly decided by the Tax Court, the Bankruptcy Court can hear and decide that issue. To make the taxpayer pay the penalties and then institute a refund action would waste the litigants' and the judiciary's time and expense.

This case does present a very unique situation, and this Court's decision is limited to the facts and circumstances of this action.

ACCORDINGLY, IT IS ORDERED, ADJUDGED, AND DECREED that the decision of the Bankruptcy Court is AFFIRMED except with respect to the penalties, and interest thereon, imposed for the 1979 tax year. For the penalties imposed for the 1979 tax year, the decision of the Bankruptcy Court is REVERSED and RENDERED in favor of the taxpayer Teal. Teal does not owe nor does he have to pay the disputed penalties, and the associated interest thereon, for the 1979 tax year.