Tax Court Can Interpret Bankruptcy Discharge Order

In Washington, 120 TC No. 8 (2003), the Tax Court unanimously ruled that it has jurisdiction under Sec. 6330(d)(1) to decide whether a bankruptcy court has discharged taxpayers from their unpaid Federal tax liability. It does not have jurisdiction to decide this issue in a Sec. 6213 deficiency proceeding. Secs. 6330 and 6320 were enacted by Congress in 1998 to provide due-process protections for IRS lien and levy actions.

Sec. 6213(a) gives the Tax Court jurisdiction over petitions to redetermine income, estate and gift tax deficiencies issued under Secs. 6211(a) and 6212(a). Sec. 6321 imposes a lien on all of a taxpayers property and rights to property if the Service has demanded payment and the taxpayer did not pay the taxes due. Under Sec. 6322, the lien arises when the IRS makes the assessment. For the lien to be valid against other parties, the Service must file a notice of lien, as specified in Sec. 6323.

According to Sec. 6320(a), the Service has to provide the taxpayer with written notice of the lien filing within five business days of the filing. The notice must also include the taxpayers right to request, within 30 days, a hearing conducted by the Office of Appeals (Appeals). Sec. 6320(c) specifies that the hearing be conducted and judicial review be allowed, applying the procedures in Sec. 6330(c), (d) and (e).

Sec. 6330(a) and (b) provide for notice and right to a hearing before levy. Under Sec. 6330(c)(2)(A), the taxpayer may raise any relevant collection issues at the Appeals hearing, including the propriety of the IRSs intended collection action, spousal defenses and possible alternatives (including asset substitution, an installment agreement or an offer in compromise). However, under Sec. 6330(c)(2)(B), the taxpayer may only challenge the underlying tax liability if he or she did not receive a deficiency notice or otherwise have an opportunity to dispute the liability. Thus, the hearings intent is not to provide the taxpayer with a second chance to dispute the liability. Under Sec. 6330(d)(1), the taxpayer has 30 days to appeal the determination to the Tax Court or a district court, as appropriate. Sec. 6330 does not otherwise specify any details about the Tax Courts scope or standard of review.

Bankruptcy Code Section 523(a) specifies exceptions to discharge in bankruptcy. Under Section 523(a)(1)(B)(ii), a debtor is not discharged from a tax liability when the return was either not filed, or filed late (including extensions) and within two years before the bankruptcy petition filing.

In Washington, Howard and Everlina Washington jointly filed their 1994 and 1995 Federal returns in December 1996. They did not pay the combined liability of over $15,000 owed on these returns. In February 1997, the IRS assessed tax, penalties and interest for 1994 and 1995. In May 1998, the couple filed a bankruptcy petition. In September 1998, the bankruptcy court entered a discharge order releasing the Washingtons from all dischargeable debts and from debts dischargeable under Section 523(a). In January 2001, the Service filed a notice of Federal tax lien and, within five days, mailed a filing notice and appeal rights. The couple filed a timely request for a Collection Due Process Hearing under Sec. 6320(a)(3)(B).

In its notice of determination following the hearing, the IRS stated that the 1994 and 1995 tax liabilities were not discharged by the bankruptcy court, because the two-year rule specified in Section 523(a)(1)(B)(ii) is an exception to discharge. The couple appealed.

The Tax Court first ruled that when it has jurisdiction over an underlying tax liability, it has jurisdiction under Sec. 6330(d)(1) to review a determination by Appeals to proceed by lien with any such unpaid tax liability. However, citing Swanson, 65 TC 1180 (1976), the court noted that it does not have jurisdiction to decide whether a bankruptcy court has discharged the taxpayers from their unpaid Federal tax liability in a Sec. 6213 deficiency proceeding. It reasoned in Swanson that the redetermination of a deficiency has nothing to do with collection of the tax, which is the issue in a bankruptcy discharge.

The Tax Court then ruled that it does have jurisdiction under Sec. 6330(d)(1) to decide whether a bankruptcy court has discharged the taxpayers from their unpaid Federal tax liability, because a lien proceeding under Sec. 6330(d)(1) is closely related to the collection of the taxpayers unpaid tax liability. The Tax Court has to determine if the bankruptcy courts discharge order prevents the IRS from proceeding with the collection action.

The court ruled that the bankruptcy court did not discharge the Washingtons from their unpaid Federal tax liabilities for 1994 and 1995, because the couple filed these tax returns late and within two years before filing their bankruptcy petition. Thus, the Service can proceed with its collection action. The Tax Court did not specify the standard of review (de novo or abuse of discretion) it used to review the determination made as to the bankruptcy discharge issue by Appeals. Four concurring opinions addressed the standard of review and jurisdiction issues.

Washington clarifies that the Tax Courts jurisdiction under Sec. 6330(d)(1) extends to interpreting bankruptcy discharge orders. Presumably, it would also apply if an Appeals hearing concerned a levy under Sec. 6330(a), rather than a lien under Sec. 6320(a).

From Peter C. Barton, MBA, CPA, J.D., Professor of Accounting, University of WisconsinWhitewater, Whitewater, WI