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In re Daley

United States District Court, D. Massachusetts

August 2, 2018

In re Thomas E Daley and Nicole Daley, Debtors,
v.
Thomas E Daley & Nicole Daley, Appellees. United States of America, IRS, Appellant,

          MEMORANDUM & ORDER

          Nathaniel M. Gorton United States District Judge.

         This bankruptcy appeal arises from a dispute regarding the priority of a creditor's claim in a bankruptcy proceeding. The Internal Revenue Service (“IRS” or “appellant”) and joint debtor-appellees Thomas E. Daley and Nicole E. Daley (collectively, “the Daleys” or “appellees”) disagree as to whether the liability imposed by an early withdrawal from a qualified retirement plan is 1) a tax, 2) compensation for actual pecuniary loss or 3) compensation for non-pecuniary loss. Appellees made early withdrawals from a qualified retirement plan in 2012 and 2013. Pursuant to 26 U.S.C. § 72(t), they incurred charges of $6, 693 in 2012 and $10, 351 in 2013 (collectively, “the 10% exaction”). Those charges were equal to approximately 10% of the amounts withdrawn by appellees from a qualified retirement plan in 2012 and 2013.

         Pending before the Court is the appeal of the IRS from a United States Bankruptcy Court (“Bankruptcy Court”) opinion holding that the 10% exaction is compensation for non-pecuniary loss and thus subject to a general unsecured claim.

         I. Background and Procedural History

         In July, 2015, appellees filed for bankruptcy protection under Chapter 13 of the Bankruptcy Code. In March, 2016, the IRS filed its fifth amended proof of claim No. 1 (“POC”) in the amount of $44, 149, of which $28, 431 was categorized as “Unsecured Priority Claims”. The amount of the Unsecured Priority Claim attributable to § 72(t) is $6, 693 for the tax year 2012 and $10, 351 for the tax year 2013.

         In May, 2017, the Bankruptcy Court allowed the Daleys' motion for summary judgment and denied the IRS's cross-motion for summary judgment. The Bankruptcy Court held that the charges against the Daleys attributable to § 72(t) are penalties that do not compensate the IRS for a pecuniary loss and thus its claims are characterized as unsecured general claims. On May 22, 2017, appellant filed an appeal in this Court.

         II. Analysis

         United States district courts have jurisdiction to hear “appeals from final judgments, orders, and decrees . . . of bankruptcy judges.” 28 U.S.C. § 158(a)(1). In reviewing an appeal from an order of a bankruptcy court, a district court reviews de novo conclusions of law but must accept the bankruptcy judge's findings of fact unless they are clearly erroneous. TI Fed. Credit Union v. DelBonis, 72 F.3d 921, 928 (1st Cir. 1995).

         An individual who makes an early withdrawal from certain qualified retirement accounts must include the withdrawn money in gross income for that year. 26 U.S.C. § 408(d)(1). Taxpayers must contribute an additional exaction “equal to 10 percent of the portion of such amount which is includible in gross income.” 26 U.S.C. § 72(t)(1).

         The IRS avers that the 10% exaction is either a tax or a penalty for actual pecuniary loss and as such should be properly characterized as an unsecured priority claim. The Daleys deny that characterization and maintain that the decision of the Bankruptcy Court characterizing the 10% exaction as an unsecured general claim should be affirmed. They contend that because the 10% exaction is not intended as recompense for an actual pecuniary loss, it is not entitled to priority status as an unsecured priority claim.

         A. The Liability Imposed by § 72(t) Is Not a Tax for Bankruptcy Purposes

         The IRS claims that the 10% exaction should be classified as a priority claim because it is a “tax on or measured by income or gross receipts.” 11 U.S.C. § 507(a)(8)(A). It is purportedly a tax on income because it surcharges an additional 10% of the amount included in the taxpayer's gross income that has been withdrawn from a qualified retirement account.

         Relying on Nat'l Fed'n of Indep. Bus. v. Sebelius, 132 S.Ct. 2566, 2596 (2012), the IRS also contends that the standard for determining whether an exaction is a tax or penalty for purposes of determining priority of claim in a bankruptcy proceeding is not whether the exaction deters certain conduct but rather whether it is a “punishment for an unlawful act or omission.” The Daleys deny those characterizations and maintain that the standard for determining whether an exaction is a tax or penalty is whether the purpose of the exaction is to deter taxpayers from taking certain actions or to compensate the government for lost revenue.

         When determining whether an exaction is a tax or penalty for purposes of establishing priority of claim in a bankruptcy proceeding, the United States Supreme Court has held that courts interpreting the Internal Revenue Code should place no weight on the “tax” label in the statute but rather make determinations based “directly on the operation of the provision using the term in question.” United States v. Reorganized CF & I Fabricators of Utah, Inc.,518 U.S. 213, 220 (1996) (“CF & I”). As a result, the characterization of the ...


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