A district judge in Indiana held that a bankruptcy court does not automatically have jurisdiction to determine the amount of a tax claim, even though Section 505(a) provides that the bankruptcy court “may determine the amount or legality of any tax, any fine or penalty relating to a tax.”
Evidently, the holding only applies when the amount of tax debt will not affect the distribution to unsecured creditors. The ruling also may only apply where courts follow the Seventh Circuit’s more limited definition of “related to” jurisdiction.
The debtor had agreed with the government that he owed a nondischargeable tax debt of about $100,000. He filed a chapter 13 petition to halt a pending tax court proceeding to decide whether he also owed either a 75% fraud penalty or a 20% penalty for negligence.
After converting to chapter 7 and receiving a general discharge, the debtor filed a Section 505 motion asking the bankruptcy court to rule that he was not liable for a fraud penalty. According to District Judge William T. Lawrence of Indianapolis, the discharge lifted the automatic stay and allowed the tax court proceeding to resume.
The government then filed a motion to dismiss the Section 505 proceeding for lack of subject matter jurisdiction. After the bankruptcy court denied the motion, Judge Lawrence granted permission for an interlocutory appeal.
On an issue that divides the courts, Judge Lawrence first held in his Aug. 12 opinion that Section 505 is not an independent grant of jurisdiction. As he saw it, the question was whether the bankruptcy court had jurisdiction under Section 1334(b) to decide the Section 505 motion.
“Clearly,” he said, there was no “arising in” jurisdiction.
The debtor contended there was “arising under” jurisdiction because Section 505 permits a bankruptcy court to determine the amount of tax debt. The debtor cited a 2006 decision in the reorganization of UAL Corp. for the proposition that a Section 505 proceeding “arises under” title 11 and is therefore a core proceeding. See In re UAL Corp., 336 B.R. 370 (Bankr. N.D. Ill. 2006).
Judge Lawrence disagreed with the UAL decision, written by now-retired Bankruptcy Judge Eugene R. Wedoff, although he admitted that other courts have reached the same conclusion as Judge Wedoff.
In disagreeing with UAL, Judge Lawrence reasoned that Section 505 only grants a procedural right, not a substantive right. He therefore held that the Section 505 motion did not “arise under” title 11.
There was similarly no “related to” jurisdiction, Judge Lawrence said, because the Seventh Circuit has a more narrow view and finds “related to” jurisdiction only if the outcome will affect the amount of property for distribution or the allocation among creditors.
Regardless of the outcome of the tax dispute, Judge Lawrence looked at the trustee’s report and said there would be no distribution for unsecured creditors because the tax claim, excluding penalties, would consume the entire estate. Because the amount of the tax penalties would be “irrelevant to the administration of the estate,” the bankruptcy court also lacked “related to” jurisdiction.
Judge Lawrence therefore reversed the bankruptcy court, holding that the Section 505 motion should have been denied for lack of subject matter jurisdiction.
In an emailed message to ABI, Judge Wedoff said he believes “that the district court’s decision is incorrect, and that the bankruptcy court did have jurisdiction.”
Judge Wedoff reasoned that the “district court’s opinion fails to recognize that the issue in dispute arose in the context of a complaint to determine the dischargeability of a debt, and that most courts have held that there is jurisdiction to enter a money judgment in the amount of a debt found to be nondischargeable. These courts include the Seventh Circuit, whose holding is binding on the district court. Morrison v. W. Builders of Amarillo Inc. (In re Morrison), 555 F.3d 473 (5th Cir. 2009); Cowen v. Kennedy (In re Kennedy), 108 F.3d 1015 (9th Cir. 1997); Longo v. McLaren (In re McLaren), 3 F.3d 958 (6th Cir. 1993); N.I.S. Corp. v. Hallahan (In re Hallahan), 936 F.2d 1496 (7th Cir. 1991).”
Under Hallahan, Judge Wedoff therefore believes that the bankruptcy court had jurisdiction to “determine the amount of the nondischargeable debt owed the IRS.”