That issue was addressed in In re Fielding, 522 B.R. 888 (Bankr. N.D.TX 2014). In Fielding, a taxpayer filed Chapter 13 bankruptcy owing the IRS approximately $539,000 for multiple tax years. The taxpayer sold his residence after filing bankruptcy to generate cash to reduce the secured debt owed to the IRS and to make the Chapter 13 plan more affordable.
The issue before the Fielding court was whether the taxpayer may apply, at the taxpayer’s own discretion, proceeds from the sale of an exempt asset to tax debt owed to the IRS. The taxpayer argued that the taxpayer has the right to allocate sale proceeds to whatever tax years the taxpayer desires. The IRS maintained that the IRS has the right to apply payments to portions of debt according to the IRS’ existing policies and procedures, including applying payments to the oldest tax liability, including the penalties and interest associated with that liability.
The Fielding court began its analysis by citing the 1990 U.S. Supreme Court decision, United States v. Energy Res. Co., Inc., 495 U.S. 545 (1990), which held that a bankruptcy court has the authority to order the IRS to apply tax payments made as designated by the taxpayer when the designation is necessary to ensure a successful reorganization. The Fielding court then analyzed the facts of the case and determined that the taxpayer’s allocation was indeed necessary to ensure a successful reorganization.
Granting the taxpayer relief on an alternative theory, the Fielding court found that the taxpayer’s payment of the sale proceeds constituted a “voluntary payment” which allowed the taxpayer to allocate payments to any tax year of the taxpayer’s choosing. The court rejected the IRS’ position that the payment was “involuntary” because it was part of a bankruptcy proceeding. The court pointed to the voluntary nature of a Chapter 13 case versus an involuntary Chapter 7 case. Plus, the court noted that the sale proceeds were exempt under Texas law and that the application of the payments to the IRS would not violate the “best interest of the creditors” text of 11 U.S.C. §1325(a)(4) because the unsecured creditors were not entitled to the exempt funds.
Practice Pointers: The taxpayer should have attempted to sell the homestead prior to filing bankruptcy so that there would be no question that the sale proceeds were “voluntary payments” to the IRS.
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