Tax Lien on Pension Plan Survives Bankruptcy Due to Ambiguity in Debtor's Petition.
(Parker Tax Publishing March 13, 2014)

A taxpayer who used ambiguous language in a bankruptcy petition was found to have listed his account in an ERISA-qualified pension plan as excluded (rather than exempt) property, which resulted in an IRS tax lien against the account surviving the bankruptcy. Gross v. Comm'r, 2014 PTC 94 (9th Cir. 2/14/14).

A debtor may exempt from his bankruptcy estate certain property, including retirement funds, to ensure that the debtor has at least some property with which to make a fresh start. Property that is exempt from the bankruptcy estate (exempt property) is not available to satisfy prepetition debts during or after the bankruptcy, except for debts secured by liens that are not avoided in the bankruptcy and federal tax liens for which the IRS filed a notice of federal tax lien before the debtor filed his bankruptcy petition. In contrast, liens on prepetition assets that are excluded from the bankruptcy estate (excluded property) are not affected by the bankruptcy proceeding that is, they generally survive the bankruptcy, even absent a prepetition notice of federal tax lien.

In Gross v. Comm'r, 2014 PTC 94 (9th Cir. 2/14/14), a taxpayer learned a hard lesson about the cost of being ambiguous in listing an interest in an ERISA-qualified pension plan as exempt or excluded property in a bankruptcy petition. Because the taxpayer's bankruptcy petition indicated that his interest in the plan was excluded from the bankruptcy estate, the Ninth Circuit held that the IRS maintained a valid lien on that interest after the taxpayer's bankruptcy case closed.

OBSERVATION: This case is a cautionary tale of what can happen when vague or confusing language is used in a bankruptcy petition. Because there is no formal procedure within the bankruptcy process to clarify what property is excluded, and confusion has resulted from this lack of clarity, it's important for practitioners to ensure that a bankruptcy petition is very clear as to the property that is exempt, rather than excluded, from the bankruptcy estate. As the Ninth Circuit noted, any ambiguity in a bankruptcy schedule is construed against the debtor.

Facts

On October 16, 2005, Stuart Gross filed a bankruptcy petition under chapter 7 of the U.S. Bankruptcy Code. On the date he filed his bankruptcy petition, Stuart owned an interest in an ERISA-qualified pension plan from the Director's Guild of America (the DGA plan) valued at $300,000. Stuart listed his interest in the DGA plan on Schedule B, Personal Property, attached to the bankruptcy petition. On Schedule C, Property Claimed as Exempt, which he also attached to the bankruptcy petition, Stuart listed as exempt the full value of his interest in the DGA plan. He included the following description on Schedules B and C:

This is an ERISA Qualified Pension Plan which is not property of the estate but in an abundance of caution has been listed herein and exempted.

No objections to the exemptions Stuart claimed on his Schedule C were filed. In June 2006, the bankruptcy court entered an order of discharge, and on August 7, 2006, the bankruptcy court entered an order closing Stuart's bankruptcy case. On the same day Stuart's bankruptcy case was ordered closed, the IRS sent Stuart a levy notice. The levy notice indicated that Stuart owed federal income taxes for 1998, 1999, 2000, and 2001 totaling $270,041. The IRS had not filed a notice of federal tax lien (NFTL) with respect to any of the federal income tax liabilities that were the subject of the levy notice by the time Stuart had filed his bankruptcy petition.

Stuart timely requested a Collection Due Process (CDP) hearing to dispute the IRS's intent to levy on his future entitlement to an annuity from the DGA plan. On October 29, 2007, the IRS issued a Notice of Determination Concerning Collection Action(s) Under Section 6320 and/or 6330. In that notice, the IRS sustained the proposed levy because Stuart's interest in the DGA plan was excluded from Stuart's bankruptcy estate, and the IRS was not precluded from attaching (or levying) assets excluded from the bankruptcy estate.

The Parties' Arguments

In the Tax Court, Stuart argued that the exclusion of an interest in an ERISA-qualified pension plan is permissive rather than mandatory, and that he properly included the DGA plan account in his chapter 7 bankruptcy estate and claimed it as exempt without objection. Thus, according to Stuart, the IRS cannot levy on the DGA plan account because the IRS did not file a valid NFTL as required under Bankruptcy Code Section 522(c)(2)(B).

The IRS argued that the exclusion of an ERISA-qualified pension plan account is mandatory and cannot be included in the bankruptcy estate, even for the sole purpose of listing it as exempt. The IRS further argued that even if a debtor may include an ERISA-qualified pension plan account in the bankruptcy estate and claim it as exempt, Stuart did not do so; instead, he excluded the DGA plan account by describing it on his bankruptcy schedules as an "ERISA Qualified Pension Plan which is not property of the estate." Either way, in the IRS's view, the DGA plan account was excluded. Thus, the IRS concluded that the statutory lien survived the bankruptcy, and the IRS may collect from the DGA plan.

OBSERVATION: In an amicus brief filed in the Tax Court proceeding, the Center for the Fair Administration of Taxes took the position that, as a matter of law, all bankruptcy debtors are entitled to the benefit of Bankruptcy Code Section 522(c)(2)(B) with respect to their interests in ERISA qualified pension plans, regardless of whether they claim that their interests in such plans as exempt.

Excluded vs. Exempt Property

The filing of a petition in bankruptcy automatically creates a bankruptcy estate consisting of all legal or equitable interests of the debtor in property as of the beginning of the case. The bankruptcy estate includes all of the debtor's prepetition property and rights to property, except property excluded from the estate under Bankruptcy Code Section 541. Bankruptcy Code Section 541(c)(2), as interpreted by the Supreme Court in Patterson v. Shumate, 504 U.S. 753 (1992), allows a debtor to exclude an interest in an ERISA-qualified pension plan from his bankruptcy estate.

In addition, Bankruptcy Code Section 522 allows a debtor to exempt from his bankruptcy estate certain property, including retirement funds. Property that is exempt from the bankruptcy estate under Bankruptcy Code Section 522 is not available to satisfy prepetition debts during or after the bankruptcy, except debts secured by liens that are not avoided in the bankruptcy and Code Sec. 6321 liens for which a valid NFTL has been filed.

Unlike exempt property, excluded property never becomes part of the bankruptcy estate and is therefore never subject to the bankruptcy estate trustee's or the debtor's power to avoid the Code Sec. 6321 lien. Thus if a Code Sec. 6321 lien on excluded property has not expired or become unenforceable under Code Sec. 6322, it survives the bankruptcy.

Tax Court's Analysis

The Tax Court noted that there is no formal procedure within the bankruptcy process to clarify what property is excluded, and confusion has resulted from this lack of clarity. According to the court, simply listing an ERISA-qualified pension plan account, an excludable asset, on Schedule C is not necessarily sufficient to claim an exemption if all the facts including any statements made on the bankruptcy schedules indicate that the debtor excluded the ERISA-qualified pension plan account from his bankruptcy estate.

The court observed that on Schedule C of his bankruptcy petition, Stuart stated that the DGA plan account was not property of the estate, but in an abundance of caution was listed on the bankruptcy schedules and claimed as exempt. The court concluded that Stuart's pension plan account was properly excludable from his bankruptcy estate under Bankruptcy Code Section 541(c)(2) and Patterson v. Shumate, and that Stuart had in fact excluded the pension plan account from his bankruptcy estate. As a result, the Code Sec. 6321 lien that attached to the pension plan account before bankruptcy continued to attach to Stuart's interest in his pension even after his personal liability for his tax liabilities was discharged in bankruptcy.

OBSERVATION: Because the court found that Stuart excluded his DGA plan account from his bankruptcy estate, there was no need for the court to decide whether the exclusion of an ERISA-qualified pension plan account from a bankruptcy estate is mandatory or permissive.

Ninth Circuit Affirms Tax Court's Decision

The Ninth Circuit affirmed the Tax Court's decision, holding that the IRS maintained a valid lien on Stuart's interest in the DGA plan. According to the court, in Patterson v. Shumate, the Supreme Court held that an ERISA plan is properly excluded from a bankruptcy estate, and here, Stuart's Chapter 7 schedules explicitly stated that the DGA plan was not part of the estate. Although the schedules went on to suggest that his interest in the ERISA plan might be "exempted," any ambiguity in a bankruptcy schedule is construed against the debtor. Because his interest in the DGA plan was not part of Stuart's Chapter 7 estate, the bankruptcy proceedings did not affect the IRS's Code Sec. 6321 lien. Thus, the Ninth Circuit concluded that the Tax Court had properly determined that the Code Sec. 6321 lien remained attached to Stuart's interest in the plan, and the IRS may levy that asset. (Staff Editor Parker Tax Publishing)

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