The McMillan Law Firm, APC - Bankruptcy Adversary Litigation

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The McMillan Law Firm Bankruptcy Adversary Litigation Blog

Bankruptcy adversary litigation is the procedure used to resolve disputes against a defendant who has filed for bankruptcy and whose bankruptcy case is pending. The adversary litigation process is often used to set aside fraudulent transfers that the bankrupt defendant may have engaged in prior to filing for bankruptcy.

Tuesday, January 01, 2008

Objection to Franchise Tax Board's claim for unpaid taxes is overruled.

Patricia Vignola filed for Chapter 13 bankruptcy, and the California Franchise Tax Board (“FTB”) filed a claim for $51,770.99 for tax years 1991 and 1993. Vignola objected to the claim, but the Chapter 13 petition was dismissed before resolution of the claim objection.

Vignola later filed a second Chapter 13 petition, and the FTB filed a second claim in the full amount originally owed to it, even though Vignola had in the interim paid some of the taxes due. This time, Vignola did not object to the FTB claim, and did not object when the Trustee paid the tax claim in full. After discharge, Vignola’s motion to reopen the case was granted and she objected to the FTB claim. The Court ordered the return of the overpayment that represented collection of more than was due (and more than FTB agreed to accept in a post-collection agreement).

The remaining question was, when does interest on unpaid state income taxes begin to accrue? Interest is paid on any amount of unpaid tax. Vignola argued that tax liability did not accrue until she received notice of the deficiency assessment. The Court rejected this argument and found that interest began to accrue from the due date of the tax, April 15, 1992, whether or not the tax was a deficiency assessment.

Interest on tax deficiencies at the federal level is treated similarly as that under California law. It is paid from the last date the tax is due. Cal. Rev. & Tax. Code §19101(a). The last date for tax payment is determined by Cal. Rev. & Tax Code §19101(b) and was due April 15, 1992. Interest accrued from that date.

Vignola argued accrual of interest does not occur until the deficiency is created. If the tax is not paid, interest is assessed to compensate the government for its loss, no matter what the reason is for the late payment. See Suffness v. United States, 974 F.2d 608, 610 (5th Cir.1993).

Taxes assessed 240-days pre-bankruptcy petition have priority status. 11 U.S.C. §507(a)(8)(A). In this case, the tax was assessed within that 240-day pre-petition period when the notice of deficiency became final. Interest on the FTB’s claim accrued from nearly four years before the deficiency notice became final. Vignola argued that FTB could not have priority status from the date the deficiency notice became final and calculate interest from the 1992 due date. Under that argument, if the notice of deficiency had been timely filed, the entire FTB claim would be too old for priority status.

The Court disagreed. FTB’s claim maintained priority status. The Court agreed with Vignola that it is unfair to give priority status to both the claim, which has the effect of stating the claim is only 240 days old, and charge interest for the prior four years. But the Court determined that interest is a mandatory component of the tax owed, not an independent liability. Additionally, there is no statutory authority for abatement of mandatory interest.

The objection to the FTB claim was overruled.

Gallery Items

In re Vignola

Tuesday, January 01, 2008

Company Director liable for unpaid taxes.

Gary Hartman (“Debtor”) was the sole officer and director of Pleasant Hills Construction Company (“PHCC”). Mary Ann Hartman’s (“Wife”) involvement in PHCC was limited to her position as signatory on an indemnity agreement with an insurance company (“GAIC”) which acted as surety on several bonds for PHCC. When PHCC experienced financial difficulty, GAIC assumed control of the completion of PHCC’s pending construction jobs.

Debtor and Wife eventually filed for individual Chapter 11 protection. State and federal taxing authorities filed claims based on nonpayment of withholding taxes by PHCC. Debtor and Wife objected to both of the tax claims. The Pennsylvania Department of Revenue (“DOR”) and the Internal Revenue Service (“IRS”) moved for summary judgment. Hartman alleged that GAIC was to have paid the taxes when it assumed control of PHCC’s jobs. Because Debtor was the officer in control of the corporation at the time the taxes were due, the issue was whether Debtor had a defense for nonpayment of the taxes.

All taxes deducted and withheld from employees constitute a trust fund for the Commonwealth of Pennsylvania and are enforceable against the employer. 72 Purdon’s Statutes §7320. There is no case precedent regarding whether §7320 requires proof of a specific mental state. Debtor’s argument that he was no longer in control and therefore not responsible for the trust fund taxes owed to the state was found to be without merit where Debtor remained in control of the corporation. He referred to himself as president and signed checks at the relevant time.

A different standard applies to the IRS claim. Any person required to collect, account and pay any tax imposed by the title who willfully fails to collect such tax or willfully attempts to evade payment of the tax shall be liable for payment of the tax and a penalty equal to the amount of unpaid tax. 26 U.S.C. §6672. Willfulness is defined as a voluntary, conscious and intentional decision to prefer other creditors over the Government with reckless disregard as to whether taxes have been paid. Evil motive is not required.

Debtor asserted he was unaware that taxes were owed because GAIC had assumed control of PHCC’s jobs. However, Debtor remained in control of PHCC. He was the only officer and director. He had actual knowledge that the taxes were not paid when he notified GAIC that PHCC needed assistance completing its jobs. As authorized signatory on the corporation’s checking account, Debtor signed the majority of checks for creditors, and had control for purposes of 26 U.S.C. §6672.

Hartman was PHCC’s responsible officer during the time taxes were due, and paid other creditors. When GAIC assumed responsibility for PHCC’s jobs, PHCC had already incurred the liability for unpaid taxes. Debtor was not relieved of tax liability simply because GAIC completed PHCC’s jobs.

Debtors’ objections to the tax claims were overruled. Motions for summary judgment were granted in favor of Pennsylvania DOR and the IRS.