Twenty-five years ago, the Supreme Court held that a Bankruptcy Court had the authority to order the IRS to allocate payments made "voluntarily" by a Debtor when necessary to effectuate a successful reorganization. United States v. Energy Resources Co., 495 U.S. 545 (1990). Left to its own devices, the IRS will generally allocate payments to the oldest taxes first, or, in the case of payroll taxes, to non-trust funds taxes first. If the Debtor can require the IRS to allocate payments differently, it can greatly impact the overall amount the Debtor will be required to pay. A recent decision out of Fort Worth illustrates how Energy Resources continues to provide a valuable tool for Debtors with tax obligations. In re Fielding, 522 B.R. 888 (Bankr. N.D. Tex. 2014).
Fielding was a chapter 13 case where the Debtors owed $539,885.26 to the IRS. The debt was secured by a lien against all of the Debtors' real and personal property. The Debtors filed a motion to sell their homestead. After paying superior obligations, there was approximately $128,000 available to pay on the IRS claim. The Debtors sought to apply the payment to the base tax amounts but not to interest or penalty. The IRS, on the other hand, wanted to apply the payments to the oldest taxes first, including penalties and interest. This could have resulted in paying priority and unsecured claims prior to secured claims.
The IRS argued that it could not be compelled to allocate the proceeds and that payments from a bankruptcy sale were not "voluntary" payments which could be designated by the taxpayer. The Court held that Energy Resources could be applied in a chapter 13 case. In doing so, it noted that other courts and commentators had been hesitant to limit the case to its facts. (One of the authorities it cited was a law review article that I wrote).
However, having found that the designation doctrine could be applied to a chapter 13 case, the Court raised the issue of whether it could be done in the absence of a confirmed plan. The Court noted that:
(J)ust as a debtor in a chapter 11 case must make payments in accordance with its chapter 11 plan upon confirmation, a chapter 13 debtor must make payments in accordance with its proposed plan even prior to confirmation.
Opinion at *15. Based on this distinction between chapter 11 and chapter 13, the court found that payments could be designated in chapter 13 even prior to confirmation.
Next, the court found that the designation was necessary to effectuate the reorganization. The Court stated:
Opinion, at *18.In the case at bar, to achieve success through the reorganization, Debtors must be capable of complying with Amended Plan provisions. To do so, Debtors rely on the sale of assets to reduce the debt owed to the IRS. If the IRS is permitted to apply the Proceeds to unsecured or priority portions of the debt as requested, then the lien held by the IRS for the secured claim would continue to attach to Debtors' property. thus, any reduction in the IRS secured claim would not sufficiently correspond with the assets being sold. Debtors would also continue to incur the interest and penalties on the unpaid, secured portion of the debt, further decreasing the plan's feasibility.
Finally, the Court rejected the IRS's argument that payments made in bankruptcy proceedings could never be considered to be voluntary. It noted that the Supreme Court rejected this position in Energy Resources and there was no basis for limiting the case to its facts. The Court found that chapter 13 itself was a voluntary process and that the case involved the voluntary sale of exempt property. As a result, the Court found that the payment was voluntary and could be designated by the Debtors.
The Court's 28-page opinion is very thorough which makes at times for difficult reading. It has a lot of good discussion of bankruptcy policy in general and chapter 13 in particular. The main lessons that I picked up are that: 1) it is possible to use chapter 13 creatively and 2) it pays to dust off old precedents you haven't thought about in a while.