AUSTIN E. CARTER, United States Bankruptcy Judge.
This contested matter comes before the Court on the Debtors' objection to a claim filed by the Department of the Treasury—Internal Revenue Service (the "IRS"). The Debtors objected to the priority asserted by the IRS regarding a portion of its claim, to which objection the United States of America, on behalf of the IRS, responded. The Court held a hearing on this matter April 14, 2015; the aforementioned parties appeared at the hearing and argued for their respective positions.
Proceedings regarding the allowance or disallowance of claims are core proceedings under 28 U.S.C. § 157(b)(2)(B). The Court states its findings of fact and conclusions of law separately pursuant to Federal Rule of Civil Procedure 52, made applicable to this contested matter by Federal Rule of Bankruptcy Procedure ("Bankruptcy
The parties stipulated to the following facts, which the Court adopts as its findings. The IRS timely filed its proof of claim in this Chapter 13 case for unpaid income taxes and associated charges. The proof of claim, as amended, asserts priority status as to $36,385.00 owed pursuant to I.R.C. § 72(t)
Section 502 is the foundation for determining whether a claim is allowed in a bankruptcy case. According to § 502, "[a] claim . . ., proof of which is filed under section 501 . . ., is deemed allowed, unless a party in interest . . . objects," and "if such objection to a claim is made, the court. . . shall allow such claim in such amount, except to the extent that" one of the nine specific disallowance provisions in § 502(b) applies. 11 U.S.C. § 502(a), (b). Section 502(b)(1) provides for the disallowance of any claim to the extent that "such claim is unenforceable against the debtor and property of the debtor, under . . . applicable law. . ." Id. § 502(b)(1).
Once a party in interest raises an objection pursuant to § 502(b)(1), the burden of proof is determined by applicable law. In re Crutchfield, 492 B.R. 60, 69 (Bankr.M.D.Ga.2013) (citing Raleigh v. Ill. Dep't of Revenue, 530 U.S. 15, 21, 120 S.Ct. 1951, 147 L.Ed.2d 13 (2000)). Here, § 507, which governs priorities of claims in bankruptcy cases, is the applicable law;
In relevant part, § 507(a) states:
11 U.S.C. § 507(a). Priorities are narrowly construed to support the Bankruptcy Code's objective of equal distribution to similarly situated creditors: "Every claim granted priority status reduces the funds available to general unsecured creditors and may diminish the recovery of other claimants qualifying for equal or lesser priorities." Howard Delivery Serv., Inc. v. Zurich Am. Ins. Co., 547 U.S. 651, 667, 126 S.Ct. 2105, 165 L.Ed.2d 110 (2006).
The IRS argues that the Exaction is a "tax on or measured by income or gross receipts for a taxable year" under § 507(a)(8)(A); in the alternative, it claims that the Exaction is a penalty in compensation of actual pecuniary loss under § 507(a)(8)(G). Each of these theories supports the IRS's position that the Exaction is entitled to priority status. The parties agree that if the Exaction does not fit into a subcategory of § 507(a)(8), it is not entitled to priority treatment under the Debtors' Plan.
I.R.C. § 72(t)(1) includes in a taxpayer's annual income tax an amount equal to 10% of any taxable distribution from an IRA, unless a listed exception applies (such additional 10% tax hereinafter referred to as the "I.R.C. § 72(t) Exaction"). 26 U.S.C. § 72(t)(l). The most prominent exception in I.R.C. § 72(t) excepts distributions made on or after the taxpayer reaches 59 ½ years of age, id. § 72(t)(2)(A)(i); all other such distributions are often called "early" or "premature" distributions (or withdrawals).
Although the Tax Code labels the I.R.C. § 72(t) Exaction a "tax" which seemingly falls within the ambit of
Here, however, the parties' agreement ends. The Debtors urge the Court to follow In re Cassidy, in which the United States Court of Appeals for the Tenth Circuit rejected contentions that the I.R.C. § 72(t) Exaction was entitled to § 507(a)(8) priority either as an income tax or a penalty in compensation for actual pecuniary loss, holding instead that it was a non-pecuniary-loss penalty.
The IRS raises numerous concerns with Cassidy and its progeny, each of which the Court attempts to address hereinafter; but, in the Court's view, the ultimate question presented is whether an exaction imposed primarily for the purpose of discouraging lawful prepetition debtor conduct is an exaction imposed "for the purpose of supporting the Government," as that phrase is used in CF & I and its ancestors, and so a "tax" within the meaning of § 507(a)(8). See 518 U.S. at 224, 116 S.Ct. 2106. The Court seeks to answer this question by examining Cassidy and CF & I, and addressing the cases on which these cases relied.
Cassidy was decided four years before CF & I. In Cassidy, the Court rejected the IRS's argument that the Tax Code's labeling of the I.R.C. § 72(t) Exaction as a "tax" finally determined that the I.R.C. § 72(t) Exaction was a "tax" as that term is used in § 507(a)(8). 983 F.2d at 162. The court supported its ruling by examining salient Supreme Court precedent under section 64 of the 1898 Bankruptcy Act (determining priority under the Act) (hereinafter, "section 64")—United States v. New York, 315 U.S. 510, 62 S.Ct. 712, 86 L.Ed. 998 (1942) [hereinafter New York]; New York v. Feiring, 313 U.S. 283, 61 S.Ct. 1028, 85 L.Ed. 1333 (1941) [hereinafter Feiring]; and New Jersey v. Anderson, 203 U.S. 483, 27 S.Ct. 137, 51 L.Ed. 284 (1906)—and a case determined under section 17a of the Bankruptcy Act of 1898 (determining dischargeability under the Act) (hereinafter, "section 17a")—United States v. Sotelo, 436 U.S. 268, 98 S.Ct. 1795, 56 L.Ed.2d 275 (1978). In re Cassidy, 983 F.2d at 162-63.
After examining these cases, the Cassidy court cited a commonly used, four-factor "functional analysis" for defining a "tax." In re Cassidy, 983 F.2d at 163. This test was derived from Feiring by the United States Court of Appeals for the Ninth Circuit, and it was first applied by that court in the context of § 507 in County Sanitation District No. 2 of Los Angeles County v. Lorber Industries of California, Inc. (In re Lorber Industries of California, Inc.), 675 F.2d 1062 (9th Cir.1982) (such test hereinafter the "Lorber/Feiring test"). According to the Lorber/Feiring test, a tax is: "(1) an involuntary pecuniary burden, regardless of name, laid upon individuals or property; (2) imposed by, or under authority of the legislature; (3) for public purposes, including the purposes of defraying expenses of government or undertakings authorized by it; (4) under the police or
The Cassidy court next looked to the reasons non-pecuniary-loss government penalties are not entitled to priority under § 507(a)(8). Id. It determined that § 507(a)(8) embodies the principle that claims based on exactions designed to punish or deter debtor conduct should not be entitled to preferential treatment in a bankruptcy case. Id. (citing Simonson v. Granquist, 369 U.S. 38, 82 S.Ct. 537, 7 L.Ed.2d 557 (1962)). The Cassidy court, quoting the district court below, explained:
Id. Based on this policy, the Cassidy court added to the Lorber/Feiring test that an exaction imposed to deter a debtor's conduct is a "penalty" rather than a "tax" under § 507(a)(8). Because the I.R.C. § 72(t) Exaction had the purpose and function of dissuading taxpayers from withdrawing his or her retirement early, the court determined that it was not a tax entitled to priority. Id. at 164.
The Cassidy court also rejected the government's argument that the I.R.C. § 72(t) Exaction is a penalty that compensates the government for actual pecuniary loss by recouping lost interest on the taxes that, absent the tax benefits afforded by the IRA, would have been collectible from the taxpayer. Id. The court reasoned that because the I.R.C. § 72(t) Exaction—as a flat 10% amount of the taxable funds withdrawn—has no cognizable relationship to any lost government revenue, it was not intended to defray government loss, but rather to punish the taxpayer. Id. at 164-65.
The IRS argues that Cassidy and its progeny cannot be trusted because the
In CF & I, the Supreme Court was presented with the question of whether an exaction imposed on an employer under I.R.C. § 4971—the amount of which was equal to 10% of the amount which the employer had failed to fund an employee pension plan—(hereinafter, the "I.R.C. § 4971 Exaction"), was a tax entitled to priority under § 507. 518 U.S. at 218, 116 S.Ct. 2106. The IRS argued that because the I.R.C. § 4971 Exaction was framed as a "tax" in the Tax Code, it was a tax entitled to priority. Id. at 219, 116 S.Ct. 2106. In rejecting the IRS's plain language argument, the Supreme Court observed that the Bankruptcy Act of 1898—which, as amended, was in effect until the passage of the Bankruptcy Code in 1978—had also entitled "taxes" to priority and that the courts had employed a "functional analysis" in determining what was, and was not, a "tax" under the Bankruptcy Act's priority statute. Id. at 220-21, 116 S.Ct. 2106. Because the Court, after study, found no indication that Congress intended to change this "functional analysis" in enacting the 1978 Bankruptcy Code, it held that the functional analysis formerly applied under the Act was the proper analysis for defining a "tax" under § 507(a)(8).
The CF & I Court summarized the functional analysis from three leading pre-1978 section 64 cases (also cited by Cassidy)—New York, Feiring, and Anderson: "a tax is a pecuniary burden laid upon individuals or property for the purpose of supporting the Government." 518 U.S. at 224, 116 S.Ct. 2106. The Court then addressed what constitutes a penalty—the converse of a tax. The Court quoted an older case, defining "penalty" in the context of a punishment based on a violation of federal liquor law, for the proposition that "if the concept of a penalty means anything, it means a punishment for an unlawful act or omission." Id. at 222, 116 S.Ct. 2106 (quoting United States v. La Franca, 282 U.S. 568, 572, 51 S.Ct. 278, 75 L.Ed. 551 (1931)). The Court determined that the behavior that gives rise to an I.R.C. § 4971 Exaction is unlawful, as exemplified by the private right of action granted to those injured thereby. Id. at 224-25, 116 S.Ct. 2106. Next, the Court examined how the I.R.C. § 4971 Exaction fit into the structure of the Tax Code and found nothing that mitigated the I.R.C. § 4971 Exaction's punitive nature. Id. at 225, 116 S.Ct. 2106. Finally, the Court examined the legislative history to I.R.C. § 4971 and noted that Congress intended it to serve as a deterrent. Id. The Court concluded that I.R.C. § 4971 Exaction had a "patently punitive function" and, as a penalty, could not be a tax. Id. at 226, 116 S.Ct. 2106.
The IRS's first argument is that the final line of demarcation between a "tax" and "penalty" is whether the underlying
The IRS's second argument is that CF & I precludes the Court's decision from turning on a consideration of the policy embodied in § 507(a)(8), apparently because such a consideration would amount to an unwarranted addition to CF & I's definition of tax as "a pecuniary burden laid upon individuals or property for the purpose of supporting the Government."
The Court does not find either of these arguments compelling. CF & I did not use the lawful-unlawful distinction as a blanket rule, exclusive of any other test, for distinguishing penalties from taxes. As stated in Cespedes:
In re Cespedes, 393 B.R. at 408 (second emphasis added) (parallel citations omitted). Accordingly, even if the CF & I Court's analysis had consisted solely of determining that the conduct giving rise to the I.R.C. § 4971 Exaction was unlawful, that case provides no reason to think that a purpose of punishing unlawful conduct is the only purpose inconsistent with the purpose of government support (and thus no reason to limit the definition of "penalty" to exactions imposed on unlawful conduct). Furthermore, the CF & I Court did not cease its inquiry upon determining that the conduct giving rise to the I.R.C. § 4971 Exaction was unlawful; to the contrary, employing established rules of statutory interpretation, the Court went on to examine how the I.R.C. § 4971 Exaction fit into the scheme of the Tax Code and to examine the provision's legislative history. 518 U.S. at 225-26. Accordingly, the CF & I Court's reference to the lawful-unlawful distinction is likely best viewed as a nonexclusive factor (though determinative in CF & I as to the I.R.C. § 4971 Exaction) in deciding whether an exaction has the purpose of supporting the government. For these reasons, CF & I does not preclude an examination of the policies embodied in § 507(a)(8) in assessing whether an exaction imposed to discourage certain lawful conduct is for the "purpose of supporting the Government," and thus, a tax.
In sum, the Court in CF & I did not establish a new standard, but rather affirmed the application of an old standard—the functional analysis historically employed by the Supreme Court in distinguishing taxes from penalties under the Bankruptcy Act of 1898. As noted above, CF & I directly relied on Anderson, Feiring, and New York, each of which was decided under the Bankruptcy Act's priority statute (section 64). See CF & I, 518 U.S. at 220-21, 224, 116 S.Ct. 2106. The Court also relied by analogy on Sotelo, decided under the Act's discharge statute. See CF & I, 518 U.S. at 221, 222 n. 6, 116 S.Ct. 2106. It is accordingly helpful to examine these cases to understand this standard better, and the Court now does so.
In Anderson, the Supreme Court, interpreting the term "tax" in section 64, determined whether a franchise exaction, sometimes termed as a "license fee," was a tax entitled to priority—despite differing terminology used to describe the exaction in the operative state statute and by the courts of that state—or a debt owed to the state arising from a contractual relationship and accordingly not entitled to priority. 203 U.S. at 490-94, 27 S.Ct. 137.
Importantly, the Court in Anderson expressly stated that it was interpreting the priority statute in the context of the Bankruptcy Act and with the purpose of determining Congress's intent behind the term "tax" in that statute. See, e.g., id. at 489, 27 S.Ct. 137 (noting that previous priority statute was "doubtless in the view of Congress when the present law was drafted"), at 491 ("[T]he bankruptcy act is a Federal statute, the ultimate interpretation of which is in the Federal Courts." (emphasis added)), at 492 ("[W]hether [the state exaction as construed by the state courts] creates a tax within the meaning of a Federal statute, giving a preference to taxes, is a Federal question, of ultimate decision in this court." (emphasis added)), at 494 (addressing the "intention of Congress").
In Feiring, the Supreme Court, in the context of a New York sales tax, was once more called on to distinguish between a tax and a contractual debt. 313 U.S. at 284, 61 S.Ct. 1028. The parties' arguments centered on the fact that the sales tax at issue was a tax on the purchaser (as most sales taxes are), though the seller had the responsibility to collect and remit the tax. Id. at 286-88, 61 S.Ct. 1028. The Supreme Court rejected the debtor's argument—that because the exaction was a tax on the purchaser, it could not also be a tax on the seller—stating:
313 U.S. at 287, 61 S.Ct. 1028 (emphasis added). As in Anderson, the Court was clear that the goal of its analysis was to determine "the meaning of § 64 of the Bankruptcy Act," id. looking to "the terms and purposes of the Bankruptcy Act as establishing the criteria upon the basis of which the priority is to be allowed," id. at 285, 61 S.Ct. 1028 (emphasis added).
New York is of particular importance because it is the first in this line of cases
However, this was not the end of the Court's analysis. The State of New York argued that a portion of the exaction was a penalty. (At that time, a penalty would have been disallowed as a claim in a bankruptcy case. Id. at 513 n. 4, 516, 62 S.Ct. 712.) The State's argument was based on a credit allowed by the federal government on the federal unemployment insurance exaction; by that credit, the employer's federal tax liability would be reduced dollar-for-dollar (up to 90% of the obligation) by the amount that the employer contributed to a qualifying state unemployment fund. Id. at 516, 62 S.Ct. 712. New York argued that because the 90% credit was available to offset the federal liability, only 10% of the tax was a true tax and the balance was a penalty (not in compensation for any actual pecuniary loss to the government) for failing to contribute to the state fund. Id.
The Court rejected this argument, reasoning that the unemployment burden borne by the federal and state governments was static and that, under the pertinent federal law, any unemployment not addressed by the state would necessarily fall on the federal government. Id. at 517, 62 S.Ct. 712. Thus, regardless of to whom the exaction was paid, it ultimately supported the same burden; accordingly, 100% of the exaction was for the purpose of supporting the government. Id. New York established that a tax, in contrast to a penalty, must be an "effort by the United States to obtain . . . revenue;" in other words, monies collected for the purpose of supporting the government. See id.
In Sotelo, the Court addressed whether an officer's liability as a "responsible party" for his company's failure to remit taxes withheld by his company on behalf of an employee should be interpreted as a "tax" excepted from discharge under section 17a of the Bankruptcy Act of 1898.
Anderson, Feiring, and New York directly support the proposition that this Court should examine the purpose of the priority statute in determining the definition of "tax." These cases set forth a functional analysis which examines the characteristics of the exactions in question to determine if they function as taxes, and as particularly relevant here, whether they function to support the government.
This examination of these statutes' underlying purposes is not surprising. It is a core duty of the judiciary to determine Congress's intended meaning. United States v. Am. Trucking Ass'ns, 310 U.S. 534, 542, 60 S.Ct. 1059, 84 L.Ed. 1345 (1940) ("In the interpretation of statutes, the function of the courts is. . . . to construe the language so as to give effect to the intent of Congress."). When Congress's meaning is unclear from the face of a provision in the Bankruptcy Code, the Court must determine Congress's intent using the common tools of statutory construction, which include: looking at the rest of the subject statute, the provision's function within the Bankruptcy Code, the provision's history, and the provision's purpose and supporting policies.
Accordingly, the Court rejects the IRS's argument that CF & I limits penalties to those exactions imposed on unlawful acts and rejects the IRS's argument that the courts in Cassidy and its progeny are out of line with CF & I by considering the policies underlying § 507(a)(8) in reaching their decisions. In so holding, this Court respectfully disagrees with Juvenile Shoe, and instead agrees with the grounds for dissent entered in that case. 99 F.3d at 903-04 (Beam, J., dissenting).
Next, the IRS argues that the Supreme Court, in its landmark ruling in National Federation of Independent Business v. Sebelius, ___ U.S. ___, 132 S.Ct. 2566, 183 L.Ed.2d 450 (2012), "revisited" CF & I and created a universal definition of "tax," as distinct from penalty, that applies in all contexts, including § 507(a)(8). According to the IRS, in National Federation, the Supreme Court determined (or affirmed) that a "penalty," in contrast to a "tax," is limited to an exaction imposed on unlawful conduct. This Court disagrees with this reading of National Federation.
In National Federation, the Supreme Court was called upon to determine, among other things, whether the controversial "individual mandate"
The teeth of the individual mandate is the so-called "shared responsibility payment,"
Id. at 2593-94 (citations omitted).
As National Federation reaffirmed, under its taxing power, Congress has broad power to regulate conduct, so long as the regulation: (1) produces at least some revenue for the government; and (2) does not have certain characteristics of criminal punishment. Id. at 2594-95 (noting that "the essential feature of any tax[] [is that] it produces at least some revenue for the Government," and citing Bailey v. Drexel Furniture Co., 259 U.S. 20, 38-42, 42 S.Ct. 449, 66 L.Ed. 817 (1922), which held that regulation labeled "tax" by Congress and produced at least some revenue to government, was criminal penalty, not constitutional tax, because of criminal characteristics). The Court noted:
Id. at 2594 (citations omitted). Thus, the Court was examining whether it could reasonably construe the characteristics of the individual mandate as sustainable under Congress's taxing power. The question before the Court was whether it was "fairly possible" to interpret the mandate as merely a trigger for a tax payment (which would be sustainable under Congress's taxing power), rather than as an absolute command subject to criminal sanctions (which would render it unsupportable under the taxing power).
Because the Court had already held that Congress intended the payment as a penalty for the purpose of the Anti-Injunction Act, id. at 2582-84; see also 26 U.S.C. § 7421(a), the Court's first task was to show that Congress could intend for a term to have differing meanings under two different statutes, Nat'l Fed'n, 132 S.Ct. at 2593-95. For this reason, the Court cited a pair of cases, one of which held that Congress intended a regulation to be a "tax" under the Anti-Injunction Act, even though the other case held that Congress intended that same regulation to have
The Court's next step was to cite cases in which it had previously upheld under Congress's taxing power exactions that Congress had labeled something other than a "tax." Id. at 2595 (citing United States v. Vassar (License Tax Cases), 72 U.S. (5 Wall.) 462, 18 L.Ed. 497 (1866)). The dissent responded by noting that it knew of no case in which the Court had upheld under Congress's taxing power an exaction that was denominated a "penalty" by statute. Id. at 2651 (Scalia, Kennedy, Thomas, & Alito, JJ., dissenting). The majority countered by citing Sotelo to show that the Court had construed an exaction denominated as a "penalty" under one provision of the U.S.Code, as a "tax" under another provision of the U.S.Code. See Nat'l Fed., 132 S.Ct. at 2595 & n. 7 (majority). The dissent took issue with the citation of this case because, "[w]hether the `penalty' was a `tax' within the meaning of the Bankruptcy Code had absolutely no bearing on whether it escaped the constitutional limitations on penalties." Id. at 2651 n. 5 (Scalia, Kennedy, Thomas, & Alito, JJ., dissenting). The majority did not consider this an insurmountable distinction because in National Federation, as in Sotelo, the Court was interpreting something Congress called a "penalty" to mean something other than its plain language. Id. at 2595 n. 7 (majority). To the majority, all that mattered was that the Court often "[d]isregard[ed] the designation of the exaction, [in view of] its substance and application," which is what it did in National Federation. Id. (citations omitted).
Once the majority determined that it was appropriate to treat what Congress called a "penalty" as a "tax" under the Congress's taxing power, it proceeded to distinguish two cases where the Court had redefined a labeled "tax" as a "penalty," first under the Constitution—Drexel Furniture—and second under another statute—CF & I. See id. at 2595-98. Both cases were cited because they were helpful in determining the characteristics of penalties as distinct from taxes.
For example, Drexel Furniture presents different characteristics than CF & I. The majority distinguished Drexel Furniture on three grounds: (1) correlation between the burden and the infraction; (2) no requirement of scienter; and (3) enforcement by the IRS. Nat'l Fed'n, 132 S.Ct. at 2595. The majority distinguished CF & I because in that case the underlying conduct was unlawful (because of the private right of action for the underlying infraction), whereas ACA does not make failure to purchase healthcare insurance unlawful (because the ACA neither prescribes a private right of action nor dictates any legal consequences beyond liability for the shared responsibility payment). Id. at 2595-97.
The IRS highlights that the National Federation Court cited CF & I for the proposition that "if the concept of penalty means anything, it means punishment for an unlawful act or omission." See id. at 2596 (quoting CF & I, 518 U.S. at 224, 116 S.Ct. 2106). However, even if it is true that an exaction on an unlawful act can never be a tax under the Constitution, that does not necessarily mean that every exaction imposed upon lawful acts must be a tax rather than a penalty, particularly in the context of § 507 of the Bankruptcy Code.
To the contrary, National Federation affirms what the Court held in CF & I—Congress can mean two different things by the use of the same term in the U.S.Code. For this reason, the characteristics of an exaction Congress termed a "penalty" in the ACA are not necessarily the exact converse of those characteristics Congress intended by using the term "tax" in § 507(a)(8) of the Bankruptcy Code.
As noted above, the IRS argues that CF & I was extended from its humble origins in the Bankruptcy Code to now (coincidentally) apply directly to the definition of "tax" under the Constitution. But there is yet another reason, evident from the face of National Federation, which makes this interpretation impossible—the majority's examination did not consist solely of whether (pursuant to CF & I) the failure to comply with the individual mandate was unlawful. To the contrary, even though the majority determined that, on its face, failure to comply with the mandate was lawful if the shared responsibility payment was made, it examined the factors in Drexel Furniture—how the exaction was collected, the mechanics and amount of the
Finally, if the Supreme Court wanted to reshape the definition of "tax" for the purpose of § 507(a)(8), it likely would not do so in such an obtuse manner. For these reasons, National Federation cannot be viewed as the Supreme Court merely "revisiting" and applying CF & I to the ACA, such that National Federation now governs the definition of "tax" in § 507(a)(8) of the Bankruptcy Code.
CF & I and National Federation do not preclude an examination of the policy underlying § 507(a)(8) in determining whether an exaction with the primary purpose of discouraging taxpayer behavior should be considered "a pecuniary burden laid upon individuals or property for the purpose of supporting the Government." To the contrary, CF & I affirms the vitality of Anderson, Feiring, New York, and Sotelo, which encourage an examination of the purposes of bankruptcy priority statutes, and National Federation did not alter this mandate.
Cassidy explains that the purpose for the differentiation between punitive penalties and taxes is two-fold: (1) punitive exactions are not vital to the support of the government and accordingly should not be given preference over ordinary creditors, and (2) giving preference to punitive exactions puts the "sting" of the deterrent on the creditors, such that the deterrent's impact is lost. See In re Cassidy, 983 F.2d at 164. These policies flow from the Bankruptcy Code's overall objective in providing equal and fair distribution among creditors. See Howard Delivery Serv., 547 U.S. at 657, 126 S.Ct. 2105. Further, disallowing priority to exactions with the primary purpose of discouraging debtor conduct is in harmony with § 507(a)(8)(G), which entitles to priority only penalties in compensation of actual pecuniary loss to the government. See In re Suburban Motor Freight, Inc., 998 F.2d 338, 341 (6th Cir.1993) ("Had the Congress intended [the Government `to prevail consistently against private creditors with arguably equal claims'], it would not have entitled only specifically described unsecured governmental claims to priority, but all government claims.").
Accordingly, in examining whether the Exaction is a tax rather than a penalty, this Court must determine whether the primary (or dominant) purpose of the I.R.C. § 72(t) Exaction is to support the government rather than to punish or discourage certain conduct, whether it be unlawful or lawful.
Although Cassidy was decided without the benefit of CF & I,
In the Court's view, where an exaction arguably serves more than one purpose, it is necessary to address the primary (or overriding) purpose of the exaction. See Mahon v. IRS (In re Unified Control Sys., Inc.), 586 F.2d 1036, 1036 (5th Cir.1978) (examining "sole substantial purpose" of exaction).
The Court also disagrees with the IRS's contention that the revenue purpose of the I.R.C. § 72(t) Exaction is dominant. In addressing this contention, the Court looks first to the legislative history of I.R.C. § 72(t) and then examines several relevant Supreme Court cases. According to Cassidy, the legislative history of I.R.C. § 72(t) indicates several purposes—"to prevent retirement plans from being treated as savings accounts, to recapture a measure of tax benefits that have been provided prior to the withdrawal, and to deter the use of retirement funds for non-retirement purposes." In re Cassidy, 983 F.2d at 164. While all of these purposes are present in some degree or another, the Court believes that they are not all equally so; in the Court's opinion, Cassidy's summary underemphasizes the I.R.C. § 72(t) Exaction's overriding deterrent purpose.
The legislative history cited (but not quoted) by the court in Cassidy states in relevant part:
S.Rep. No. 99-313, at 612-13 (1978).
This history shows that the I.R.C. § 72(t) Exaction was designed to put IRAs on the same plane as other retirement plan structures by creating comparable "sanctions." Congress's primary goal in creating the 10% exaction on all tax-preferred retirement mechanisms was to discourage spending of tax-preferred retirement funds, regardless of type, in a way it did not deem appropriate. See, e.g., id. ("[T]he committee also believes that tax incentives for retirement savings are inappropriate unless the savings generally are not diverted to nonretirement uses." (emphasis added)), ("[T]he additional income tax appears in many instances to be an insufficient deterrent to the use of retirement funds for nonretirement purposes. . . ." (emphasis added)).
Although there is one phrase in this legislative history indicating a recognition that the exaction might allow the "recapture" of some lost tax revenue, that single reference pales in comparison to the lengthy and detailed discussion concerning the anticipated deterrent impact of the law. This slight indication that Congress contemplated some revenue benefit from the exaction on these "inappropriate" tax benefits is not a sufficient basis to hold that the provision has the root purpose of supporting the government.
It is worth noting that the only people subject to the I.R.C. § 72(t) Exaction are those who withdraw their retirement funds for a purpose deemed inappropriate by Congress. As noted above, there are so-called "hardship" exceptions to the early withdrawal rule—exceptions for distributions made after a taxpayer's death or disability, to pay for a taxpayer's medical expenses, to help pay for a taxpayer's first home, and to satisfy a state order of domestic support or property settlement, among others. Those that have a reason for their early withdrawal deemed appropriate by Congress are not subject to the exaction. This seems incongruous with
Further, the legislative history indicates that the percentage of the exaction is attuned to a level, not to obtain maximum revenues, but to discourage early withdrawal. Judging by the legislative history, the revenue effect of raising the percentage of the exaction was not even a consideration. In short, Congress's mere cognition that the I.R.C. § 72(t) Exaction might generate some revenue is not sufficient to hold that the primary purpose of the I.R.C. § 72(t) Exaction is unclear; its primary purpose is clear—the deterrence of inappropriate uses of retirement savings. Even if, as suggested in Cassidy, Congress had several purposes in enacting the I.R.C. § 72(t) Exaction, the deterrent purpose is noticeably dominant.
Second, the Supreme Court, in addressing IRAs in other contexts, has expressly called the I.R.C. § 72(t) Exaction a penalty, and has relied on the I.R.C. § 72(t) Exaction's strong deterrent function to make significant determinations under the Bankruptcy Code. For example, in Rousey v. Jacoway, the Supreme Court held that IRA funds were exemptible under § 522(d)(10)(E), as "a payment under a. . . plan or contract on account of illness, disability, death, age, or length of service, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor." 544 U.S. 320, 322-24, 125 S.Ct. 1561, 161 L.Ed.2d 563 (2005) (quoting 11 U.S.C. § 522(d)(10)(E)). The Court rejected the trustee's argument that the IRA funds could not constitute payments "on account of" the conditions specified in § 522(d)(10)(E) because the funds could be withdrawn freely, though subject to the 10% I.R.C. § 72(t) Exaction. Id. at 327, 125 S.Ct. 1561. The Court reasoned:
Id. at 327-29, 125 S.Ct. 1561 (internal citations omitted) (emphasis added); see also id. at 327, 125 S.Ct. 1561 n. 1 (citing statistics as to effectiveness of I.R.C. § 72(t) Exaction).
In addition, in Clark v. Rameker—where the Supreme Court recently held that inherited "retirement funds" exempted from the debtor's estate under § 522(b)(3)(C)—the Court stated:
___ U.S. ___, 134 S.Ct. 2242, 2246-47, 189 L.Ed.2d 157 (2014) (internal citations omitted) (emphasis added). The absence of the deterrent created by the I.R.C. § 72(t) Exaction, among other things, persuaded the Court that inherited IRAs should not be considered "retirement funds." Id. at 2247-48.
These cases, though not decided in the context of § 507, evidence the common, and common-sense, understanding of I.R.C. § 72(t): it is designed to, and in fact does, function as a penalty to deter the inappropriate (early) use of retirement savings. According to these cases, this penalty is quite effective; accordingly, it provides very little revenue to the government.
The IRS's alternative argument—that Congress is not discouraging the waste of retirement savings, but rather encouraging saving—self-destructs upon serious examination. This appears to be a distinction without a difference. It is hard to see how a deterrent on spending past-saved amounts encourages future saving. Moreover, even if Congress's purpose is to encourage saving, that is still not the purpose mandated by CF & I in its definition of "tax"—government support.
As an additional argument, the IRS asserts that the I.R.C. § 72(t) Exaction is imposed on conduct that diminishes government tax revenues, and accordingly is not imposed on "revenue-neutral" conduct, like the I.R.C. § 4971 Exaction addressed in CF & I.
The IRS argues that traditional IRAs shield ordinary income from taxes in the short-term, which is revenue-negative to the government, at least in the years of those contributions. The Court rejects this argument for several reasons.
First, the IRS seems to be looking at the wrong conduct in comparing revenue-effect; the I.R.C. § 72(t) Exaction is not imposed on making IRA contributions, but
Second, even assuming that the contribution to the IRA is the correct conduct to examine in comparing revenue effect, the I.R.C. § 72(t) Exaction does apply to revenue-neutral conduct, contrary to the IRS's contention. As for traditional IRAs, although the government does have an immediate negative revenue effect in forgoing the taxation of the contributed amounts, this effect seems to be offset by the greater taxes that the government will (presumably) later collect upon the distribution of the fund's growth.
99 F.3d at 901 (citations omitted). In other words, absent any additional regulation (such as the Self-Reversion Exaction), an employer could defer tax by depositing funds into such a pension fund and later withdrawing them subject to the exact same tax that it would have incurred had the tax not been deferred. While such an employer would thereby be deprived of the interest on the funds for its regular obligations, the interest accrued in the pension fund would still presumably benefit the
Roth IRAs are even more troublesome under the IRS's argument. Roth IRAs, as noted by the counsel for the IRS, are funded with a taxpayer's post-tax dollars. 26 U.S.C. § 408A(c)(1). Accordingly, Roth IRA contributions do not diminish government revenue in the year in which they are made.
In conclusion, construing § 507 narrowly (as directed by the Supreme Court) to effectuate its purpose in providing equal distribution to similarly situated creditors, the Court concludes that the primary purpose and function of the I.R.C. § 72(t) Exaction is not to support the government, but rather to deter an "inappropriate" use of tax-preferred retirement accounts. Accordingly, the I.R.C. § 72(t) Exaction is not a "tax" within the meaning of § 507(a)(8)(A)—(F).
In the alternative, the IRS argues that the Exaction, if a penalty, is one entitled to priority as compensation of the government's actual pecuniary loss. The IRS's arguments here overlap with those discussed above. First, it is argued that the exaction recoups a loss to the government incurred through the taxpayer's deferment of income recognition by contributing the income to a traditional IRA. And, second, it is argued that the exaction recoups the greater amount of taxes that the government would have collected had the IRA fund been allowed to grow until the taxpayer reached retirement age.
In addressing these arguments above in the regard to the definition of "tax," the Court has already shown that the government
Importantly, § 507(a)(8)(G) entitles to priority only penalties that are in compensation of actual pecuniary loss to the government. The Court is not convinced that the I.R.C. § 72(t) Exaction was designed to, or in fact does, compensate the government for any comparable, demonstrable actual pecuniary loss. For these reasons, construing § 507(a)(8)(G) narrowly as directed by the Supreme Court, this Court joins the other courts that have addressed this question and determined that the I.R.C. § 72(t) Exaction is not a penalty in compensation for actual pecuniary loss under § 507(a)(8)(G). See In re Cassidy, 983 F.2d 164-65; In re Cespedes, 393 B.R. at 409; see also Mounier, 232 B.R. at 194.
Therefore, because the Exaction is neither a tax nor a penalty in compensation for actual pecuniary loss under § 507(a)(8), it is not entitled to priority in the Debtors' case, and the Court sustains the Debtors' objection to the IRS's claim. An order consistent with this Opinion will be entered on even date herewith.
26 U.S.C. § 5000A(a).
26 U.S.C. § 5000A(b).
Nat'l Fed'n, 132 S.Ct. at 2594-95 (citations omitted).
This is not an idle fear. The Fourth Circuit. . . picked up the "public purpose" theme and ran with it in Williams v. Motley, 925 F.2d 741 (4th Cir.1991). In that case, Virginia charged motorists who were attempting to register a car, but who had not purchased private auto insurance, an "uninsured motor vehicle assessment" fee. The court held the fee to be a "tax" for bankruptcy purposes since the fee "creates a fund that benefits the general public by reducing the overall cost of . . . insurance." Id. at 744. We believe that Williams amply illustrates the danger that overemphasis on the "public purpose" element will eliminate all distinction between "taxes" and "fees" or other money owed the Government, enabling the Government to prevail consistently against private creditors with arguably equal claims. This would turn on its head the traditionally egalitarian manner in which the Bankruptcy Code has dealt with competing creditors, who by definition fight over very limited assets. Had the Congress intended such a result, it would not have entitled only specifically described unsecured governmental claims to priority, but all government claims.
In re Suburban Motor Freight, Inc., 998 F.2d at 341. See also In re Freymiller Trucking, Inc., 194 B.R. 914, 916 (Bankr.W.D.Okla. 1996) ("Under the [the Lorber/Feiring] definition most, if not all, judgments obtained by governmental units would meet the definition of a `tax'. . . . No one, however, would reasonably conclude that ordinary judgments obtained by governmental units are `taxes' and, as such, entitled to bankruptcy priority."). Notably, the Supreme Court in CF & I chose not to use the broad "public purposes" language found in Lorber, even though that was the language used by the Tenth Circuit in the opinion below. United States v. Reorganized CF & I Fabricators of Utah, Inc. (In re CF & I Fabricators of Utah, Inc.), 53 F.3d 1155, 1158 (10th Cir.1995) vacated sub nom. 518 U.S. 213, 116 S.Ct. 2106, 135 L.Ed.2d 506 (1996).
Additionally, whereas Cassidy analyzed the policy and purpose of § 507(a)(8) separately from the concept of government support (the "public purposes" factor under Lorber/Feiring), this Court considers the policy and purpose of § 507(a)(8) as helpful in understanding that the degree to which exactions are imposed to deter conduct, they are (to the same degree) not imposed to support the government.
Finally, as noted herein below, the Court disagrees with the conclusion of the Cassidy court that the legislative history of I.R.C. § 72(t) does not reveal a dominant purpose for the enactment of that statute.
