Civil Action Number 3:01CV808
February 10, 2003
This is an appeal by the United States of the bankruptcy court's denial of a motion for relief from the automatic stay of Title 11, United States Code, Section 362(a). This Court has jurisdiction over the appeal pursuant to Title 28, United States Code, Section 158(a). The case involves issues related to the Internal Revenue Service's purported right of setoff under Title 26, United States Code, Section 6402(a) and Title 11, United States Code, Section 553 and whether the bankruptcy court erred in denying appellant's motion for relief from stay.
For the reasons stated below, the Court affirms the bankruptcy judge's denial of the motion for relief from automatic stay. However, the Court remands this matter to the bankruptcy court for further proceedings consistent with this opinion.
I. FACTS AND PROCEDURAL HISTORY
Appellee Heing-Meyers Company et al. ("Debtors") filed a voluntary petition under Chapter 11 on August 16, 2000. Prior to that date, the Debtors financed a portion of their working capital needs through certain agreements among several entities, collectively referred to as the "Pre-Petition Secured Lenders." Appellee Wachovia Bank, N.A. ("Wachovia") is the collateral agent for the Pre Petition Secured Lenders, who are creditors in the bankruptcy case. The liabilities under these agreements are secured by liens against and security interests in, among other things, certain personal property, including tax refunds. After the Debtors filed the bankruptcy petition, they also mailed an income tax return for the year ending February 28, 2000 in which they claimed a tax refund of $910,970.00. Appellant United States of America, Internal Revenue Service ("IRS" or government") is also a creditor in the bankruptcy case. On March 6, 2001, the IRS filed a proof of claim for $5,344,609.28 (the "IRS Claim"), which consisted of assessed withholding taxes of $80.89, assessed highway use taxes of $9,842.62, and unassessed deficiencies in income taxes of $5,334,685.70 (the "Unassessed Deficiencies"). These Unassessed Deficiencies relate to the Debtors' corporate income tax returns for 1994, 1995, 1996, 1997, and 1998. On April 19, 2001, the IRS sent a "30-day letter" to the Debtors proposing certain adjustments to the tax returns. On May 24, 2001, the Debtors filed an objection to the IRS Claim, contesting the Unassessed Deficiencies. On March 7, 2001, the IRS filed a motion for relief from stay but while the motion for relief from stay was pending, the IRS issued a check representing the tax refund. It was issued due to computer error but the parties agreed to hold the check until this appeal is resolved. The Debtors objected to the motion for relief from stay, and Wachovia moved to intervene in the contested motion for relief from stay proceedings. The bankruptcy court entered a consent order authorizing the intervention, and Wachovia then objected to the government's motion for relief from stay. On May 29, 2001, the bankruptcy court conducted a hearing on the motion for relief from stay, during which the parties presented certain stipulations and arguments. On October 22, 2001, the bankruptcy court entered an order denying the motion for relief from stay. This appeal followed.
II. LEGAL ANALYSIS
A. Issues on Appeal
The issues on appeal, as stated by the appellant, are whether the bankruptcy court committed clear errors of law in concluding that the pre-petition taxes cannot be collected until they are assessed; whether the bankruptcy court abused its discretion by basing its decision not to grant the government relief from the automatic stay on erroneous legal premises; and whether the government should be granted relief from the automatic stay in order to assert its statutory right of set off under Title 26, United States Code, Section 6402(a) and Title 11, United States Code, Section 553.
B. Standard of Review
The applicable standard of review of the bankruptcy court's findings of fact is whether such findings are clearly erroneous. Green v. Staples (In re Green), 934 F.2d 568, 570 (4th Cir. 1991); Bankruptcy Rule 8013. "A finding is "clearly erroneous' when although there is evidence to support it, the reviewing court on the entire evidence is left with the definite and firm conviction that a mistake has been committed." Anderson v. Bessemer City, 470 U.S. 564, 573 (1985). Conclusions of law and questions of statutory interpretation are reviewed de novo. Ford Motor Credit Co. v. Reynolds Reynolds Co. (In re JKJ Chevrolet, Inc.), 26 F.3d 481 (4th Cir. 1994). Review of a bankruptcy court's decision whether to lift the automatic stay is under an abuse of discretion standard. To find that a bankruptcy court abused its discretion, "the reviewing court will only overturn the decision of the lower court `when there is a definite and firm conviction that the court below committed a clear error of judgment in the conclusion it reached upon weighing all of the relevant factors.'"Frederick Co. National Bank v. Lazerow, 139 B.R. 802, 808 (D.Md. 1992), citing Stephens Industries, Inc. v. MeClung, 789 F.2d 386, 389 (6th Cir. 1986).
As noted above, the first issue is whether the bankruptcy court committed any clear errors of law. In the October 22, 2001 Order, the bankruptcy court stated:
[T]he court finds that relief from the automatic stay is not warranted. The matter is not ripe for adjudication. Even if the matter were ripe, setoff is not justified under the circumstances before this court.
The bankruptcy court's Order also stated;
The issue at hand is not ripe for adjudication because the Unassessed Deficiencies have not been assessed, are purely speculative, and are not collectable at the current time. Further, the alleged tax liability is not collectable and thus, the IRS has failed to justify the right of setoff under § 553 of the United States Bankruptcy Code. Finally, assessment is required prior to having a valid liability in chapter 11 cases; setoff is premature and cannot be made until there has been a valid assessment.
The government argues that Section 507(a)(8)(A)(iii) supports its position that an assessment of liability is not a necessary prerequisite to the judicial collection of taxes. This section states:
(8) Eighth, allowed unsecured claims of governmental units, only to the extent that such claims are for —
(A) a tax on or measured by income or gross receipts —
(iii) other than a tax of a kind specified in section 523(a)(1)(B) or 523(a)(1)(C) of this title, not assessed before, but assessable, under applicable law or by agreement, after, the commencement of the case;11 U.S.C. § 507(a)(8)(A)(iii). Section 507 specifies the kinds of claims that are entitled to priority in distribution, and the order of the priority. Section 507(a)(8)(A)(iii) specifically includes taxes that are not assessed, but are assessable, after the commencement of the bankruptcy. However it does not conclusively answer the issues on appeal.
An assessment "shall be made by recording the liability of the taxpayer in the office of the Secretary. . . ." 26 U.S.C. § 6203. Taxpayers are liable for taxes whether or not the IRS assesses them. See Ewing v. United States, 914 F.2d 499, 502-04 (4th Cir. 1990), cert. denied, 500 U.S. 905 (1991); In re Goldston, 104 F.3d 1198, 1199-1200 (10th Cir. 1997) ("[a]bundant precedent exists for the proposition in a variety of tax contexts that liability for federal taxes does not hinge on whether the IRS has made a valid assessment.").
There is a split of authority as to whether assessment is required prior to the collection of taxes. Compare In re Goldston, 104 F.3d at 1200-01 ("[w]hile the absence of an assessment prevents the IRS from administratively collecting the tax, it may still file a civil action, which is the functional equivalent to filing a proof of claim in a bankruptcy proceeding.") and United States v. Jersey Shore State Bank, 781 F.2d 974, 979 (3d Cir. 1986), aff'd, 479 U.S. 442 (1987) ("it was long settled that the Government's failure to assess its taxes did not preclude it from exercising its common law right to sue for the taxes.")with In re Fingers, 170 B.R. 419, 426 (S.D. Cal. 1994) ("[u]nder the Internal Revenue Code, a valid tax assessment is a prerequisite to tax collection.") (citing 26 U.S.C. § 6201(d), 6203, 6215(a) and 6303(a)) and In re Conston, Inc., 181 B.R. 769, 776 (D. Del. 1995) ("[o]nce a tax is properly assessed, the Secretary may collect it `by levy or by a proceeding in court.'") (citing 26 U.S.C. § 6502(a)).
The statutory language is likewise unclear. Section 6501(a) states in relevant part:
Except as otherwise provided in this section, the amount of any tax imposed by this title shall be assessed within 3 years after the return was filed . . ., and no proceeding in court without assessment for the collection of such tax shall be begun after the expiration of such period.26 U.S.C. § 6501(a). Discussing Section 6501(a), the Fourth Circuit stated "[t]his section simply mandates that the United States has no authority to collect a tax forcibly after the applicable period for assessment has expired." Ewing v. United States, 914 F.2d at 502-03. However, the statute does not answer the question of whether a proceeding in court for the collection of taxes can be begun during the relevant period, but without an assessment. Section 6502 also addresses the issue. Entitled "collection after assessment," it states in relevant part:
(a) Length of Period. Where the assessment of any tax imposed by this title has been made within the period of limitation properly applicable thereto, such tax may be collected by levy or by a proceeding in court, but only if the levy is made or the proceeding begun —
(1) within 10 years after the assessment of the tax, or
(A) there is an installment agreement between the taxpayer and the Secretary . . . or
(B) there is a release of levy under section 6343. . . .26 U.S.C. § 6502(a). While this section does not specifically state that a tax may be collected by a proceeding in court prior to an assessment, it does say that where an assessment has been made, the tax may be collected "by levy or by a proceeding in court," thus implying that where no assessment has been made, the tax may not be collected by levy or by a proceeding in court.
Section 6402 addresses the right of setoff under Title 26. Treasury Regulation Section 301.6402-1, entitled "authority to make credits or refunds" and referring to 26 U.S.C. § 6402, states that the "Commissioner . . . may credit any overpayment of tax . . . against any outstanding liability for any tax. . . . (emphasis added). A recent Chief Counsel Advice (CCA) that addresses Section 6402 and Treasury Regulation 301.6402-1 is also instructive.
Pursuant to Internal Revenue Code Section 6402(a) and the regulations thereunder, the Service may not offset an overpayment against unagreed, proposed deficiencies for which no statutory notice of deficiency has been issued. An "outstanding liability" within the meaning of Treas. Reg. 301.6402-1 against which an overpayment may be offset exists only when an assessment has been made or a statutory notice of deficiency has been issued. Filing a proof of claim in a bankruptcy case is not a substitute for an assessment or a statutory notice of deficiency, and thus does not render the liability an "outstanding liability" within the meaning of Treas. Reg. § 301.6402-1 against which an over payment may be offset under Section 6402(a).
IRS CCA 200217005, 2002 WL 735444 (IRS CCA). While Chief Counsel Advice reports have no precedential value, they are instructive as to the legal advice given to field personnel to promote correct and uniform application of tax law. In this case, no assessment has been made and no statutory notice of deficiency has been issued. Therefore, pursuant to internal IRS policy, the bankruptcy court did not err when it ruled that "setoff is premature and cannot be made until there has been a valid assessment."
Accordingly, based on the Court's review of the applicable statutes and case law, the Court concludes that the bankruptcy court did not err when it ruled that "setoff is premature and cannot be made until there has been a valid assessment."
In addition, given this conclusion and the four requirements that must be met in order to have a right of setoff under Section 553(a) of the Bankruptcy Code, this Court further concludes that the bankruptcy court did not err when it ruled that "the IRS has failed to justify the right of setoff under § 553 of the United States Bankruptcy Code." The bankruptcy court correctly ruled that the IRS failed to establish that it had a right of setoff under Section 553. The IRS was not able to establish the fourth of the four required elements, specifically that its claim was "valid and enforceable." The IRS might argue, as it states in the Chief Counsel Advice report, that it still has a common law right of setoff. However, the Court concludes that Section 6402(a), Treas. Reg. § 301.6402-1, and Section 553, as well as the applicable case law, preclude the IRS from actually setting off the debt.
Accordingly, given these conclusions, the bankruptcy court did not abuse its discretion by denying the government relief from the automatic stay, and the government should not be granted relief from the automatic stay.
Given the fact that a tax refund check was issued to the Debtors, the Court directs that the refund check be placed into escrow in the estate of the Debtors, where the funds shall be held but will earn interest until the underlying tax liability is determined.
For the reasons stated above, the Court affirms the bankruptcy judge's denial of the motion for relief from automatic stay. However, the Court remands this matter to the bankruptcy court for further proceedings consistent with this opinion.
An appropriate Order shall issue.