Hutchinson v. Internal Revenue Service, No. 19-60065 (9th Cir. 2021)
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The IRS recorded liens for unpaid taxes, interest, and penalties against the debtors’ residence. After debtors filed for bankruptcy, the IRS filed a proof of claim. The portion of the claim that was secured by liens on the residence and attributable only to penalties was $162,000. The debtors filed an adversary proceeding, asserting that the IRS’s claim for penalties was subject to avoidance by the trustee and that because the trustee had not attempted to avoid this claim, debtors could do so under 11 U.S.C. 522(h). The trustee cross-claimed to avoid the liens and alleged their value should be recovered for the benefit of the bankruptcy estate.
The bankruptcy court dismissed the adversary complaint. The trustee and the IRS agreed that the penalty portions of the liens were avoided under 11 U.S.C. 724(a). The Bankruptcy Appellate Panel and Ninth Circuit affirmed. Section 522(h) did not authorize the debtors to avoid the liens that secured the penalties claim to the extent of their $100,000 California law homestead exemption. Section 522(c)(2)(B), denies debtors the right to remove tax liens from their otherwise exempt property. Under 11 U.S.C. 551, a transfer that is avoided by the trustee under 724(a) is preserved for the benefit of the estate; this aspect of 551 is not overridden by 522(i)(2), which provides that property may be preserved for the benefit of the debtor to the extent of a homestead exemption.
Court Description: Bankruptcy. The panel affirmed the Bankruptcy Appellate Panel’s decision affirming the bankruptcy court’s dismissal of Chapter 7 debtors’ adversary complaint concerning tax liens asserted by the Internal Revenue Service. The IRS recorded liens for unpaid taxes, interest, and penalties against debtors’ residence. After debtors filed for bankruptcy, the IRS filed a proof of claim for both the secured and unsecured portions of its then-existing claim for unpaid taxes, interest, and penalties. The portion of the claim that was secured by liens on debtors’ residence and attributable only to penalties was over $162,000. Debtors had filed an adversary proceeding against the United States and the Chapter 7 trustee, asserting that the IRS’s claim for penalties was subject to avoidance by the trustee, and that because the trustee had not attempted to avoid this claim, debtors were empowered to do so under 11 U.S.C. § 522(h). Debtors sought to avoid the liens and to preserve the liens for debtors’ benefit. The trustee cross-claimed against the United States, asserting the right, as trustee, to avoid the IN RE HUTCHINSON 3 liens and alleging that, to the extent the liens were avoided, their value should be recovered for the benefit of the bankruptcy estate. The bankruptcy court dismissed the adversary complaint for failure to state a claim, and it entered a stipulated judgment in which the trustee and the United States agreed that the penalty portions of the IRS’s liens were avoided pursuant to 11 U.S.C. § 724(a). The BAP affirmed the dismissal. Affirming the dismissal of debtors’ first cause of action, the panel held that § 522(h) did not authorize debtors to avoid the liens that secured the IRS’s penalties claim. Under § 522(h) a transfer (including a lien) can be avoided by a debtor if (1) the transfer is avoidable by the trustee under § 724(a); (2) the trustee does not attempt to avoid the transfer; and (3) the debtor could have exempted the property under § 522(g)(1) if the trustee had avoided the transfer. One of the components of the third of these requirements is that “the debtor could have exempted such property” under § 522(b) “if such property had not been transferred.” Debtors contended that they met this component because § 522(b) allowed them to exempt their interest in their principal residence up to the extent of their $100,000 homestead exemption under California law. The panel held that this contention was foreclosed by DeMarah v. United States (In re DeMarah), 62 F.3d 1248 (9th Cir. 1995), which held that, because, under § 522(c)(2)(B), Congress has denied debtors the right to remove tax liens from their otherwise exempt property, they may not avoid a lien for tax penalties under § 522(h). The panel held that debtors’ first cause of action also failed because the trustee did attempt to avoid the tax lien to the extent that it secured the penalties claim. 4 IN RE HUTCHINSON Debtors further contended that, even if the trustee acted to avoid the liens, the property should have been preserved for debtors’ benefit, rather than for the benefit of the estate. Therefore, either their second cause of action should not have been dismissed or they should have been allowed to intervene in the trustee’s cross-claim against the United States. The panel held that debtors could not preserve for their own benefit the portions of the tax liens that were avoided by the trustee, and their complaint was therefore properly dismissed in its entirety with prejudice. The panel held that, under the plain language of 11 U.S.C. § 551, a transfer that is avoided by the trustee under § 724(a) is preserved for the benefit of the estate. The panel held that this aspect of § 551 is not overridden by § 522(i)(2), which provides that property may be preserved for the benefit of the debtor to the extent of a homestead exemption, because, under DeMarah, § 522(i)(2) is subordinate to § 522(c)(2)(B)’s bright-line rule that debtors lack the right to remove tax liens from their otherwise exempt property.
The court issued a subsequent related opinion or order on December 23, 2021.
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