IN RE: SANDRA TILLMAN, ET AL V. LAWRENCE WARFIELD, ET AL, No. 21-16034 (9th Cir. 2022)
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The IRS held a secured claim on the debtor’s real property arising from a tax penalty lien. The debtor claimed a $150,000 homestead exemption in the property under Arizona law. The trustee sought to avoid the tax penalty lien on the debtor’s exempt property and preserve it for the benefit of the estate pursuant to 11 U.S.C. Sections 724(a) and 551.
The Ninth Circuit reversed the district court’s decision affirming the bankruptcy court’s summary judgment in favor of a Chapter 7 trustee who brought an adversary proceeding seeking to avoid an Internal Revenue Service tax lien on property subject to a homestead exemption and to preserve the value of the lien for the benefit of the bankruptcy estate.
The panel held that Section 724(a) concerns the trustee’s avoidance of qualifying liens attached to the property of the estate at the time of distribution. When a debtor exempts a property interest under 11 U.S.C. Section 522, the exemption withdraws that property interest from the bankruptcy estate and, thus, from the reach of the trustee for distribution to creditors. Accordingly, because exempt property is not “property of the estate” which may be “distributed,” a trustee may not avoid a lien under Section 724(a) attached to exempt property which is no longer part of the estate. The panel held that it follows that a trustee is not permitted to preserve the tax lien for the benefit of the estate under Section 551, which provides for automatic preservation of certain avoided liens, including liens avoided under Section 724(a).
Court Description: Bankruptcy. The panel reversed the district court’s decision affirming the bankruptcy court’s summary judgment in favor of a Chapter 7 trustee who brought an adversary proceeding seeking to avoid an Internal Revenue Service tax lien on property subject to a homestead exemption and to preserve the value of the lien for the benefit of the bankruptcy estate. The IRS held a secured claim on the debtor’s real property arising from a tax penalty lien. The debtor claimed a $150,000 homestead exemption in the property under Arizona law. The trustee sought to avoid the tax penalty lien on the debtor’s exempt property and preserve it for the benefit of the estate pursuant to 11 U.S.C. §§ 724(a) and 551. The panel held that § 724(a) concerns the trustee’s avoidance of qualifying liens attached to the property of the estate at the time of distribution. When a debtor exempts a property interest under 11 U.S.C. § 522, the exemption withdraws that property interest from the bankruptcy estate and, thus, from the reach of the trustee for distribution to creditors. Accordingly, because exempt property is not “property of the estate” which may be “distributed,” a trustee may not avoid a lien under § 724(a) attached to exempt property which is no longer part of the estate. The panel held that because a trustee may not avoid a tax lien attached to exempt property through § 724(a), it follows that a trustee is not permitted to preserve the tax lien for the benefit of the estate under § 551, which provides for automatic preservation of certain avoided liens, including liens avoided under § 724(a). The panel concluded that its holding was consistent with Hutchinson v. IRS (In re Hutchinson), 15 F.4th 1229 (9th Cir. 2021), in which the court was not called upon to resolve any dispute as to the applicability of § 724(a) to the property at issue. The panel reversed and remanded to the district court with instructions for further proceedings. Dissenting, Judge Bumatay wrote that the panel should have affirmed the trustee’s avoidance of the IRS tax penalty lien because the Bankruptcy Code creates no exception to the trustee’s avoidance power for liens on exempt property. Judge Bumatay wrote that under the plain text of §§ 724(a) and 726(a)(4), a trustee has the authority to avoid a federal tax penalty lien, and estate property does not evolve over the course of a bankruptcy proceeding. Rather, exempt property is protected from prepetition debts, but it is not wholly removed from the bankruptcy estate.
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