Opinion
Civil No. 01-3288 (JBS). [Case No. 96-14262]
January 23, 2002
Warren S. Wolf, Esquire, Cureton, Caplan, Hunt, Scaramella Clark, P.C., Delran, N.J., Attorney for Debtor-Appellant.
Gregory Hrebiniak, Esquire, U.S. Department of Justice, Washington, D.C., Attorney for the Internal Revenue Service.
Sat Below: Judge Gloria M. Burns
ON APPEAL FROM AN ORDER OF THE UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF NEW JERSEY.
OPINION
This matter is before the Court upon appeal from a Bankruptcy Court Order entered by the Honorable Gloria Burns, U.S. Bankruptcy Judge on June 15, 2001 in the Chapter 11 bankruptcy case of Robert Sage, No. 96-14262 (GMB). The debtor, Robert Sage, appeals from the Bankruptcy Court's Opinion of April 11, 2000, and Order of June 15, 2001, which determined that the IRS can collect additional individual income taxes from debtor for the year 1995 in the amount of $285,698, despite the confirmation of debtor's Chapter 11 Plan for Reorganization and despite the Bankruptcy Court's Order of January 19, 1999, fixing all pre-petition claims, neither of which included the 1995 tax liability. Presently before the Court is debtor's appeal, which was filed on July 12, 2001. The Court heard oral argument on January 18, 2002. For the reasons discussed below, the debtor's appeal will be denied and the Order appealed from will be affirmed.
The Order under appeal does not fix the actual amount of this tax, but it merely permits the IRS to go forward with the assessment and collection of the 1995 personal income taxes. Whether any tax is owed is in dispute in Tax Court between these parties, and the IRS may not levy or execute until the Tax Court adjudication becomes final.
BACKGROUND
The facts as found by the Bankruptcy Court in its opinion of April 11, 2001 will be incorporated herein. Debtor filed the petition under Chapter 11 of the United States Bankruptcy Code on June 7, 1996. Schedules were filed in July 1996 which listed the IRS as creditor. Before the debtor's Third Modified Plan of Reorganization was confirmed by Order dated November 2, 1998, the IRS filed proofs of claim dated August 19, 1996, October 15, 1997, and July 16, 1998. None of these proofs of claim indicated that the IRS sought any income taxes from the debtor for tax year 1995. On October 26, 1998, the debtor filed a motion to reduce various creditors' claims, including the claim filed by the IRS. The debtor and IRS successfully negotiated a reduced claim amount which was accurately reflected in its last amended claim dated January 19, 1999.
The Bankruptcy Court notes that the IRS submitted proofs of claim for various of debtor's tax liabilities for the 1992 through June 30, 1996 tax periods, and that the claim dated August 19, 1996 indicates that the IRS sought corporate income tax for 1995. Reference to corporate liability, however, was considered a mistake due to debtor's status as an individual.
Meanwhile, the IRS was conducting an audit of the debtor's 1995 taxes, which was known to the debtor but not to the government's bankruptcy attorney at the time of the confirmation of the Plan in November 1998. Five months after the debtor's Chapter 11 Plan for Reorganization had been confirmed, the IRS by letter dated April 5, 1999 sought an additional $285,698 in tax liability from debtor for the year 1995, based on the IRS audit.
On July 7, 1999, the debtor filed and served a proposed form of order under the five-day rule which fixed the amount of the IRS' proof of claim to the amount that the parties previously agreed upon in the November 2, 1998 confirmation. On July 13, 1999, the IRS filed an objection to this form of order, stating:
The Bankruptcy Court in its opinion of April 11, 2001 noted that "there is no record of the court receiving any objection to the proposed form of order." See Bankr. Ct. Op. 4/11/00, at 4 n. 2.
the IRS had inadvertently omitted a substantial obligation for the year 1995. While the government recognizes that the proof of claim cannot now be amended and the omitted amounts may never be collected if debtor successfully completes his Chapter 11 plan, nevertheless the IRS should be permitted to issue its statutory notice of deficiency to the debtor to assert the additional liability and protect itself should this case be dismissed or should the plan not be consummated. In that regard, the order entered in this matter which resolves the objection to the proof of claim should unambiguously state that the amended proof of claim is allowed for the purpose of this Chapter 11 proceeding and the ambiguous term "fixed" be omitted.
By order dated August 15, 1999, the Bankruptcy Court fixed all pre-petition claims at the amounts listed in the IRS proof of claim dated January 19, 1999. The order provided that "the prepetition claims of the Internal Revenue Service shall be fixed at those amounts listed on the amended Proof of Claim filed by the Internal Revenue Service and dated January 19, 1999." The case was subsequently closed on December 3, 1999.
On May 4, 2000, in response to the IRS's continued attempts to collect the 1995 tax liability, the debtor filed a Motion to Reopen Bankruptcy and Declare Rights Between Debtor and IRS Regarding Additional Pre-Petition Taxes in the Bankruptcy Court, seeking an order determining that the IRS could not collect the 1995 taxes. Judge Burns reopened the case and heard oral argument from the parties on July 31, 2000 and August 29, 2000. Judge Burns's Opinion dated April 11, 2001 and Order dated June 15, 2001 denied the debtor's motion. Debtor's appeal of Judge Burns's Opinion and Order was filed on July 12, 2001, and was reassigned to this Court by order dated September 20, 2001.
I. Whether the Taxes Are Non-Dischargeable
The IRS asserts that the proposed 1995 tax deficiency is a non-dischargeable tax under the U.S. Bankruptcy Code, stating that the tax at issue is a priority claim under § 507(a)(8)(A)(iii) and hence non-dischargeable pursuant to § 523(a)(1)(A). Title 11 U.S.C. § 1141 provides that the confirmation of a plan for reorganization:
discharges the debtor from any debt that arose before the date of such confirmation . . ., whether or not
(i) a proof of the claim based on such debt is filed . . .;
(ii) such claim is allowed under section 502 of this title; or
(iii) the holder of such claim has accepted the plan."
However, "[t]he confirmation of a plan does not discharge an individual debtor from any debt excepted from discharge under section 523 of this title." 11 U.S.C. § 1141(d)(2). Under 11 U.S.C. § 523(a)(1)(A), "[a] discharge under section . . . 1141 . . . does not discharge an individual debtor from any debt for a tax or a customs duty of the kind and for the periods specified in section 507(a)(2) or 507(a)(8) of this title, whether or not a claim for such tax was filed or allowed." 11 U.S.C. § 523(a)(1)(A). § 507(a)(8)(iii) provides that "a tax on or measured by income or gross receipts 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" is a priority tax, non-dischargeable under 11 U.S.C. § 523 and 1141.
The liability at issue is debtor's personal income tax for the tax year 1995. Debtor Sage does not dispute that the tax at issue is a non-dischargeable liability. Because § 507(a) applies to the 1995 federal income tax deficiency claimed by the IRS, the debtor's 1995 tax liability is non-dischargeable.
II. Whether Res Judicata Applies to Bar the IRS's Claim
The main issue here is whether res judicata principles apply to this non-dischargeable liability. The debtor asserts that, notwithstanding the non-dischargeability of the debt, the IRS's claim for the 1995 tax deficiency is barred by the doctrine of res judicata because all the pre-petition amounts owed by the debtor to the IRS were determined by the order fixing the IRS claim and incorporated into the confirmed plan of reorganization. Debtor argues that the Bankruptcy Court incorrectly distinguished between pre-petition "debt" and "claim" when it concluded that the IRS is bound by the plan as to the amount of the pre-petition claim but that the IRS is not bound by the plan as to the amount of the debtor's pre-petition debt for federal income taxes. The IRS argues in opposition that res judicata does not apply because the 1995 income tax liability was never litigated or even addressed by the parties in the bankruptcy proceeding. The claims asserted by the IRS in its proofs of claim did not include this 1995 tax, nor could the IRS have done so until its audit was complete. In addition, the IRS argues that even if the bankruptcy court made such a distinction, the bankruptcy code nevertheless allows the IRS to proceed and collect post-petition federal income taxes.
Although there is no Third Circuit case directly on point, the Tenth Circuit case DePaolo v. United States, 45 F.3d 373 (10th Cir. 1995), involves similar facts and is therefore persuasive in its holding that non-dischargeable liabilities may be sought by the IRS after a debtor's reorganization plan is confirmed. In DePaolo, debtors filed for Chapter 11 reorganization in February 1986, and the IRS filed a proof of claim for what it believed to be debtors' tax liability for tax years 1985 and 1986. In February 1988, debtors filed their second amended plan of reorganization, and the IRS and debtors thereafter executed a stipulation as to the amount to be paid to the IRS. In connection with the stipulation, the IRS submitted proofs of claim for what it believed to be debtors' tax liability for the years 1984, 1985, 1986, and 1987. The court subsequently confirmed the debtor's plan for reorganization in April 1988. The IRS in November 1989 then notified the debtors of its intent to audit their 1986 tax return, after which the IRS issued a notice of deficiency to debtors reflecting that they owed an additional $14,024. Similar to the instant matter, the debtors moved for a declaratory judgment, arguing that the bankruptcy proceedings fully and finally determined the amount of their tax liability for 1986 and that principles of res judicata barred payment to the IRS for any additional taxes. The bankruptcy court entered summary judgment for the IRS, concluding that the tax at issue was a new tax previously not treated under the debtors' confirmed Chapter 11 plan. The district court reversed the bankruptcy court, concluding that the bankruptcy proceeding had judicially determined the legality and amount of the tax claims, thereby barring the IRS from asserting additional tax liability under res judicata.
In re Becker's Motor Transport., Inc . , 632 F.2d 242 (3d Cir. 1980), cert . denied , 450 U.S. 916 (1981), involves the collection of pre-petition penalties and post-petition interest from debtors that had never been sought by the IRS in the bankruptcy proceedings. The court held that while the IRS could seek these debts after confirmation of the plan, the IRS could not seek the pre-petition interest that had previously been sought in the chapter 11 proceeding. This case holds limited guidance because the proceedings, begun in 1974, had been governed by the old Bankruptcy Act, and 11 U.S.C. § 507 and 523, which were enacted in 1978, had yet to take effect.
The Tenth Circuit reversed the district court, stating that "[a]lthough a confirmed plan generally binds any creditor regardless of whether the creditor's claim is impaired by the plan or whether the creditor accepted the plan, the same is not true of a creditor whose claim is nondischargeable." 45 F.3d at 375 (citation omitted). "Therefore, `the confirmation of a plan of reorganization does not fix tax liabilities made nondischargeable under 11 U.S.C. § 523.'" 45 F.3d at 376 (citingUnited States v. Gurwitch, 794 F.2d 584, 585 (11th Cir. 1986) (rejecting debtor's res judicata argument and affirming district court decision allowing IRS to assess and collect taxes beyond pre-petition claim)). The Tenth Circuit further noted that the express language of §§ 1141 and 523 "forbid" the application of res judicata to the facts of the case:
By expressly providing that the described taxes are not discharged `whether or not a claim for such taxes was filed or allowed,' 11 U.S.C. § 523(a)(1)(A), Congress has determined that the IRS may make a claim for taxes for a particular year in a bankruptcy proceeding, accept the judgment of the bankruptcy court, then audit and make additional claims for that same year, even though such conduct may seem inequitable or may impair the debtor's fresh start.DePaolo, 45 F.3d at 376. Debtor in this case, however, fails to address anywhere in his brief the policy aspects of the non-dischargeability of his liability.
The Fifth Circuit has also rejected the contention that payment in such a case would prejudice a debtor's reorganization and impair his fresh start:
The courts of appeals that have considered this issue have concluded that in the case of individual debtors, Congress consciously opted to place a higher priority on revenue collection than on debtor rehabilitation or ensuring a "fresh start."Fein v. United States, 22 F.3d 631, 633 (5th Cir. 1994) (affirming judgment that debtor's priority tax liabilities were not discharged by his confirmed chapter 11 plan where IRS was not scheduled creditor in pre-petition filings). See also Grynberg v. United States, 986 F.2d 367, 371 (10th Cir.) ("[I]t is apparent to us that Congress has made the choice between collection of revenue and rehabilitation of the debtor by making it extremely difficult for the debtor to avoid payment of taxes under the Bankruptcy Code") (quoting Gurwitch, 794 F.2d at 585-86)),cert. denied, 510 U.S. 812 (1993). The Tenth Circuit has noted that "[t]his is an express congressional policy judgment that we are bound to follow." Grynberg, 986 F.2d at 371.
The facts regarding debtor Sage are very similar to DePaolo. As inDePaolo, the IRS had been a scheduled creditor and filed pre-petition claims, but issued an additional claim on debtor's tax liability as the result of an audit completed after confirmation of debtor's chapter 11 plan. The debtor's liabilities at issue relate to his income for the tax year 1995, and are therefore nondischargeable under the Bankruptcy Code. Because the IRS may seek pre-petition non-dischargeable liabilities as indicated by the Bankruptcy Code, notwithstanding res judicata principles, the confirmation of debtor's plan did not serve to "fix" the debtor's liabilities to the amount in the court's previous order, especially in keeping with the congressional policy preference of recovering monies owed to the government over rehabilitating debtors. The IRS's claim would therefore not be barred under the rationale as applied by these circuit courts.
This Court notes that, although one court has taken a less restrictive view of the scope of § 1141(d)(2), its precedent is not very instructive here. In In re Mercado, the court favored the view that while the plan cannot discharge a non-dischargeable debt, "the claimant may otherwise subject the debt to the provisions of a confirmed plan." In re Mercado, 124 B.R. 799, 800 (Bankr.C.D.Cal. 1991). In Mercado, which notably involved not the IRS, but non-priority unsecured claims of a private creditor who timely filed nondischargeability complaints, the court construed § 1141(d)(2) to "preserve the right of a creditor holding a nondischargeable debt to full payment," id. at 801-02, however ordering that the creditors were to be stayed from proceeding to execute on any nondischargeable judgment unless debtor had defaulted on the chapter 11 plan and had not cured such default within 30 days. Due to the dissimilar facts and circumstances presented, this case does not persuade the Court to follow its holding.
However, the Court notes that whether this approach comports with the aim of the bankruptcy code to preserve the right of the creditor holding a nondischargeable debt to full payment, under § 1141(d)(2), is questionable. The Mercado court itself notes that "[o]nly a few cases have addressed the issue. Admittedly, the cases do not support the limited approach to § 1141(d)(2)." Mercado , 124 B.R. at 803 .
Debtor raises In re Matunas for the proposition that res judicata should prevent the IRS from collecting additional pre-petition taxes. 261 B.R. 129 (Bankr.D.N.J. 2001). In Matunas, after the debtors' plan was confirmed in July 1999, the parties then entered into negotiations upon the amount of taxes to be paid and a payment schedule, resulting in a stipulation agreement. The IRS had failed to include the tax liability for the year 1993 in its proof of claim, which formed the basis for the stipulation agreement. The court in Matunas rejected the argument that the IRS's claim was preserved on debts excepted from discharge under 11 U.S.C. § 523, stating that "the issue at hand . . . centers around the fact that both parties voluntarily entered into a stipulation agreement determining the amounts owed to the IRS." Id. at 134 (emphasis added). The Matunas court again distinguishes itself on the existence of the stipulation agreement when faced with the policy implications of the statutory framework in In re Becker's Motor Tranport., Inc., which states that "inasmuch as claims for pre-petition penalties and post-petition interest are nondischargeable . . . a reasonable debtor should expect that the IRS will seek to enforce such claims." 632 F.2d 242, 249 (3d Cir. 1980) (holding that although claims for pre-petition penalties on a tax debt are not allowable against a bankruptcy estate, debtors may be held personally liable for such penalties following the confirmation of a chapter 11 plan under the old Bankruptcy Act). Because there are no stipulation agreements in the instant matter as to the amount of the 1995 individual income tax liability, and because the debtor knew that this liability was itself under audit before the Plan was confirmed, this Court is unwilling to adhere to the Matunas court's analysis.
Debtor raises additional cases which base their decisions to bind the IRS to the confirmed plan on "the broad authority of the Bankruptcy Court to modify creditor-debtor relationships" and the IRS's "full opportunity to participate in the plan process." See In re Martin, 150 B.R. 43, 46, 47 (Bankr.S.D.Cal. 1993); see also Snyder v. United States, 213 B.R. 321, 323 (Bankr.E.D.Mich. 1997) (denying IRS's proof of claim after confirmation under res judicata, without addressing policy concerns). In re Martin counters the congressional policy addressed by the courts above in stating that "the Court has jurisdiction to enjoin the IRS from the assessment and collection of taxes despite the anti-injunction statute if such activity interferes with the orderly administration of the estate." 150 B.R. at 47 (quoting In re Major Dynamics, Inc., 14 B.R. 969, 970 (Bankr.S.D.Cal. 1981) (enjoining IRS investigations of third party creditors)). In re Martin's reliance on Major Dynamics, a case addressing the IRS's interactions with third party creditors, which undoubtedly interfere with the administration of a debtor's estate, does not provide sufficient guidance in this case, where the debtor's direct liability to the IRS is at issue.
Thus, under the reasoning applied by the Tenth and Fifth Circuits, because the IRS seeks debtor's tax liability for the year 1995, which is a non-dischargeable claim, the principles of res judicata do not apply to bar the IRS's claim. In keeping with the congressional policy expressed in 11 U.S.C. § 1141 and § 523, the IRS should be allowed to recover debtor's 1995 tax liability even after confirmation of debtor's chapter 11 plan has taken place. Accordingly, the Bankruptcy Court's Order will be affirmed on this ground.
III. Whether Equitable Estoppel Applies to Bar the IRS's Claim
Debtor asserts that the IRS should be precluded from seeking further tax liability from debtor under equitable estoppel principles. In order to succeed on a traditional estoppel defense, the litigant must prove (1) a misrepresentation by another party, (2) which he reasonably relied upon, (3) to his detriment. United States v. Asmar, 827 F.2d 907, 912 (3d Cir. 1987). "Traditionally, an equitable estoppel has been imposed when one party has relied to its detriment on the conduct of the other party, and such reliance was justified." In re Becker's Motor Transport., Inc., 632 F.2d 242, 248 (3d Cir. 1980), cert. denied, 450 U.S. 916 (1981). In addition, in order to impose equitable estoppel against the government, a party must also show that the government committed an affirmative misconduct. See Asmar, 827 F.2d at 912 (citing Yang v. INS, 574 F.2d 171, 175 (3d Cir. 1978); United States v. Board of Educ., 697 F. Supp. 167, 178 (D.N.J. 1988) (citing Lovell Mfg. v. Export-Import Bank of United States, 777 F.2d 894, 899 (3d Cir. 1985)); FDIC v. Hulsey, 22 F.3d 1472, 1489 (10th Cir. 1994).
Debtor fails to support his contention that the IRS participated in affirmative misconduct, a required element in order for equitable estoppel to apply. There is no indication in the record that the IRS intentionally withheld from the debtor the fact that it would eventually audit debtor's 1995 tax return and subsequently seek additional payment. As discussed in the Bankruptcy Court's opinion, counsel for IRS had conceded that it had "inadvertently omitted a substantial obligation for the year 1995" in its submission of July 13, 1999, objecting to debtor's motion to reduce the amount of claim. However, as counsel for the IRS indicated in oral argument, whereas the IRS knew that it was conducting an audit, it was counsel's mistaken belief that omission of the tax liability would result in elimination of the possibility of ever recovering such taxes, as is the case with chapter 13 bankruptcies.
The IRS states that "[t]he audit was ongoing during the bankruptcy proceedings, and there is no doubt that debtor knew about the audit." IRS App. Br. at 5.
The Bankruptcy Court concluded that "the debtor has not demonstrated that the IRS committed any act of affirmative misconduct which would warrant the application of estoppel." Bankr. Ct. Op. 4/11/01 at 20. A district court's review of a bankruptcy court's findings of fact are not to be set aside unless they are clearly erroneous, while questions of law are to be reviewed de novo. F.R.Bankr.P. 8013; In re Miloszar, 238 B.R. 266, 268 (D.N.J. 1999) (citing In re Indian Palms Assoc., Ltd., 61 F.3d 197, 203 (3d Cir. 1995)). Here, debtor argues that the IRS committed misconduct by waiting 6 to 7 months to notify debtor of the tax deficiency. Additionally, debtor argues that if the IRS had given notice that it was going to seek additional taxes after the plan was confirmed, debtor would have formulated a different plan; otherwise, debtor's chapter 11 plan becomes meaningless. Debtor fails to provide evidence, however, of any affirmative misconduct on the IRS's part that would warrant a finding that the Bankruptcy Court had committed clear error. In addition, although counsel for debtor could not pinpoint the time debtor knew of the audit, there is agreement that the debtor knew of its existence and could therefore anticipate further proceedings. Because debtor has demonstrated neither a showing of affirmative misconduct nor that he could have reasonably relied upon a misrepresentation as to the status of his 1995 tax liability then under audit, the debtor fails to satisfy his burden of proof. Therefore, this Court will not equitably estop the IRS from seeking the additional taxes.
Debtor's argument that the bankruptcy court estopped the IRS in In re Burford, 231 B.R. 913, 915 (Bankr.N.D.Tex. 1999), is unpersuasive. InBurford, the plan and order of confirmation specifically provided that the payments to the IRS were to "retire the debt." Because the court found misconduct when the IRS waited six years after confirmation to seek collection of post-petition interest outside the plan, the court estopped the IRS from claiming any more liabilities owed to the debtor subsequent to the confirmation. In our case, the IRS waited five months after confirmation to seek additional tax liabilities for the year 1995. This length of time does not indicate the prolonged delay which constitutes affirmative misconduct, as the Burford court found.
Furthermore, case law indicates that courts estop the government only in rare cases. Although the Third Circuit notes that it "is one of the majority of circuits which recognize the validity of an estoppel defense against governmental parties," see United States v. Asmar, 827 F.2d 907, 912 (3d Cir. 1987) (finding IRS not precluded by equitable estoppel from seeking income tax deficiencies), the Seventh Circuit has noted that the doctrine of estoppel must be applied with great caution. See In re Larson, 862 F.2d 112, 115 (7th Cir. 1988); cf. In re American Bicycle Ass'n, 895 F.2d 1277, 1281 (9th Cir. 1990) (holding Anti-Injunction Act to prohibit bankruptcy court from entering order estopping the collection efforts of the IRS against third parties). While the Third Circuit finds equitable estoppel to be a viable defense, other circuits "generally disfavor the application of the estoppel doctrine against the government and invoke it only when it does not frustrate the purpose of the statutes expressing the will of Congress or unduly undermine the enforcement of the public laws." DePaolo, 45 F.3d at 376 (citing FDIC v. Hurley, 22 F.3d 1472, 1489 (10th Cir. 1994)).
In keeping with the Third Circuit's construction that equitable estoppel is a viable defense against the government, affirmative misconduct must be demonstrated. The debtor in the instant case, however, is unable to demonstrate that the IRS committed affirmative misconduct in issuing its claim to debtor. Accordingly, equitable estoppel will not be applied to debtor's claim, and the Bankruptcy Court's Order will be affirmed on this ground.
CONCLUSION
For the reasons discussed above, neither res judicata nor equitable estoppel principles preclude the IRS from seeking additional tax liabilities from debtor for the tax year 1995. The debtor's appeal will be denied and the Order of the Bankruptcy Court dated June 15, 2001 will be affirmed. The accompanying order is entered.
O R D E R
THIS MATTER having come before the Court upon debtor Robert Sage's appeal from the order entered by the Bankruptcy Court on June 15, 2001, and the Court having considered the parties' submissions, and the Court having heard oral argument in this case on January 18, 2002, and for the reasons discussed in the Opinion of today's date;
IT IS this day of January, 2002, hereby
ORDERED that the Order of the Bankruptcy Court dated June 15, 2001 be, and hereby is, AFFIRMED .