National Consumer Bankruptcy Rights Center

Protecting The Rights Of Consumer Debtors In Bankruptcy

Subchapter II – Collection, liquidation, and distribution of the estate (Sections 721 to 728)

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The 6th Circuit To Determine Whether the Debtors’ Post-Petition Application of Their Tax Refund to Future Tax Liabilities is Per Se Intent to Hinder a Trustee Justifying a Denial of Discharge

The Sixth Circuit in Wylie v Miller is reviewing the decision of the District Court for the Eastern District of Michigan. The district court reversed the bankruptcy court’s decision, holding that the bankruptcy court erred in applying a per se rule that the debtors’ post-petition application of their tax overpayment to future tax liabilities constituted an intent to hinder the trustee.

Facts

Jason and Leah Wylie filed for Chapter 7 bankruptcy and were denied discharge under 11 U.S.C. § 727(a)(2)(B) by the bankruptcy court. The denial was based on the Wylies’ post-petition election to apply a $20,736 tax overpayment from their 2019 tax return to their 2020 tax liabilities, which the bankruptcy court interpreted as an intent to hinder the trustee.

Analysis

The court’s analysis centered on the bankruptcy court’s application of a per se rule regarding the debtors’ intent. The bankruptcy court found that the Wylies’ election to apply their 2019 tax overpayment to their 2020 tax liabilities was sufficient to establish an intent to hinder the trustee. This conclusion was drawn without direct evidence of the Wylies’ intent but rather inferred from the action itself, effectively applying a per se rule that such an action always constitutes intent to hinder.

The court found this application problematic because it did not consider the specific circumstances or the debtors’ actual intent. The court highlighted that intent to hinder, delay, or defraud must be supported by concrete evidence and not merely inferred from the action of applying tax overpayments. The Wylies had consistently made similar elections pre-petition, which the bankruptcy court had previously found were made without intent to hinder, delay, or defraud. The court emphasized that exceptions to discharge must be narrowly construed, and a broad per se rule undermines this principle by potentially denying a fresh start without sufficient evidence.

The court also noted that the bankruptcy court failed to account for the Wylies’ testimony, which consistently stated that their intent was to ensure payment of future tax liabilities, not to hinder the trustee. The bankruptcy court’s failure to distinguish between intent to prefer one creditor over another and intent to hinder the trustee further weakened its position. Therefore, the application of a per se rule was inappropriate, and the court reversed the decision, remanding for entry of a discharge.

NCBRC and NACBA filed an amicus brief in support of the Debtor/Appellee.

Wylie v Miller – Amici Brief

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“Sham” Carve-Out Agreement Rejected

Calling the agreement a “sham,” the district court affirmed the bankruptcy court’s denial of a carve-out agreement between the chapter 7 trustee and the state and federal tax creditors. The court found the agreement would adhere to no one’s benefit but their own. The court also upheld the bankruptcy court’s finding that the debtor’s homestead exemption applied to section 724(b). Summerlin v. Turnage (In re Turnage), No. 22-122 (W.D. N.C. March 14, 2023).

The 72-year-old widowed debtor living on Social Security income and help from her son, filed for chapter 7 bankruptcy. She claimed an exemption of $55,000 in her home which she valued at $124,510.00. Her secured debts at the time of her petition totaled $231,788.29, and consisted of a mortgage on her home and both federal and state tax debts.

The chapter 7 trustee valued the debtor’s home at between $175,000 and $180,000. He objected to her exemption as inapplicable to her tax liens under North Carolina law. He then entered into a carve-out agreement with the debtor’s tax creditors under which he would receive $30,000 for his expenses and “[t]he IRS and NCDOR each get 60% of their secured tax liens. The remaining 40% carved out of the tax liens (approximately $38,000 after payment of the Trustee’s expenses) would be used to pay priority unsecured claims in full and the remainder would be disbursed pro rata among the general unsecured creditors.” He moved the court for authority to sell the property so he could carry out this distribution plan.

The bankruptcy court denied the motion to sell and overruled the objection to the debtor’s exemption. The trustee appealed to the district court.

The court found the appeal turned on application of section 724(b). In addition to establishing the order of distribution where tax liens are involved, that section provides that after the first mortgage is paid off, claimants holding certain types of priority claims may substitute in for the tax lien to the extent of the tax lien. The court noted that the only priority claim that would be available to substitute in for the tax lien would be the trustee’s own compensation, related primarily to the sale of the debtor’s home.

Notably, section 724(b) makes no provision for exemptions. Because North Carolina opted out of the federal exemptions, the court turned to state law to determine how the debtor’s homestead exemption would fare under a section 724(b) distribution scheme. It found state law emphasizes a liberal construction of exemption laws, favoring their application.

The court was unpersuaded by the trustee’s argument that permitting the debtor to take her homestead exemption would impinge on the tax liens. The court differentiated between the homestead exemption’s applicability to proceeds from sale of the home and its applicability to the tax liens themselves. It found that “once the tax agencies agree to the carve-out they cannot direct the allocation of the value created by such carve-out.”

Finally, the court noted with distaste that the carve-out benefited only the trustee and the tax agencies. It stated: “for her ‘fresh start,’ the Debtor, a 72- year-old widow with no meaningful source of income, loses her home and gets no more than a check for about $2,000. The minimal benefit to the other general unsecured creditors does not obscure the reality of this agreement.”

The court affirmed the Bankruptcy Court’s decision that the Debtor’s homestead exemption applies to section 724(b) and its denial of the Motion to Sell.

Turnage WD NC March 2023