In Re. Daley

United States District Court

District of Massachusetts

________________________________

)

In re Thomas E Daley and Nicole )

Daley, )

Debtors, )

________________________________ ) Civil Case No.

17-10962-NMG

United States of America, IRS, )

Appellant, )

)

v. )

)

Thomas E Daley & Nicole Daley, )

Appellees. )

________________________________ )

MEMORANDUM & ORDER

GORTON, J.

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

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(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approximately 10% of the amounts withdrawn by appellees from a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.

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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

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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

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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 10% exaction as an “additional tax”

in § 72(t) is not determinative of its status for priority in

this bankruptcy proceeding.

The standard for determining whether the 10% exaction is a

tax or a penalty for purposes of establishing priority of claim

in a bankruptcy proceeding is complicated. Under the so-called

“Feiring-Anderson” standard, taxes are defined as

pecuniary burdens laid upon individuals or their property,

regardless of their consent, for the purpose of defraying

the expenses of government or of undertakings authorized by

it.

CF & I, 518 U.S. at 222 n.6.

To apply that standard, courts look beyond the statutory

label of an exaction and evaluate its actual effects to

determine “whether it functions as either a tax or else as some

different kind of obligation, like a debt, fee, or penalty.”

Boston Reg’l Med. Ctr., Inc. v. Massachusetts Div. of Health

Care Fin. & Policy, 365 F.3d 51, 58 (1st Cir. 2004) (citing CF &

I, 518 U.S. at 221, 224-25) (additional citation omitted). For

certain complex exactions, the First Circuit Court of Appeals

has endorsed the use of a multi-factor test known as the

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Lorber/Suburban II analysis. See id. (observing that courts have

adopted additional criteria when “applying Feiring-Anderson’s

general definition of a tax to the unusual state exactions

sometimes encountered in a bankruptcy contest”). Because the

question before the Court in this case is not remarkably

complex, the Feiring-Anderson test will suffice. See id. at 59

(suggesting that the Lorber/Suburban II approach “remains an

available tool of analysis, although, of course, subject at all

times to the overarching authority of Feiring and Anderson)

(citations omitted).

The IRS’s contention that NFIB replaced the Feiring-

Anderson framework is unavailing.

The Supreme Court acknowledged in NFIB that the same

exaction can be construed as a tax for some purposes and a

penalty for others. See NFIB, 132 S. Ct. at 2594-5 (holding that

the individual mandate is a penalty in the context of the Anti-

Injunction Act and a tax in the context of the Constitution).

It is true that the NFIB Court found that

if the concept of penalty means anything, it means

punishment for an unlawful act or omission.

Id. at 2596 (quoting CF&I 518 U.S. at 220).

But that remark appears in the Court’s discussion of

whether the disputed Affordable Care Act exaction constituted a

tax for constitutional purposes. See id. at 2594 (“[W]hile that

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label [as a penalty] is fatal to the application of the Anti–

Injunction Act, it does not determine whether the payment may be

viewed as an exercise of Congress's taxing power.”). The case

is silent on the standard for determining whether an exaction is

a tax for bankruptcy purposes. There is no reason to believe it

upset Feiring-Anderson.

The IRS cites no caselaw in which a court has adopted its

interpretation of that provision. In contrast, multiple

bankruptcy courts have held that § 72(t) exactions are penalties

for purposes of the Bankruptcy Code. See, e.g., In re Cespedes,

393 B.R. 403, 409 (Bankr. E.D.N.C. 2008) (concluding that

nothing in CF&I requires § 72(t) exactions to be construed as

taxes and therefore § 72(t) exactions are a non-priority

penalty); In re Bradford, 534 B.R. 839 (Bankr. M.D. Ga. 2015).

Similarly, the only United States Circuit Court of Appeals

to address the question determined that the 10% exaction is a

penalty in the context of the Bankruptcy Code. In re Cassidy,

983 F.2d 161, 164 (10th Cir. 1992). The Tenth Circuit reasoned

that, because the purpose of the 10% exaction in bankruptcy

proceedings is, inter alia, to deter debtors from discharging

their obligations at the expense of innocent creditors, the

exaction is a penalty for determining priority in bankruptcy.

See id. This Court agrees with that conclusion. Although the

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exaction may generate some revenue, the presence of “hardship”

exceptions to the early withdrawal rule indicates that the

purpose of the statutory provision is to deter unwanted conduct.

Therefore, the exaction functions as a penalty and not a tax.

The judgement of the Bankruptcy Court that the Daleys’

charges attributable to § 72(t) are penalties will be affirmed.

B. The Liability Imposed by § 72(t) Is Not a Penalty for

Actual Pecuniary Loss

Alternatively, the IRS claims that the 10% exaction should

be classified as a penalty compensating the government for

actual pecuniary loss because it compensates the government for

the cost incurred in deferring tax revenue. Appellant asserts

that because the 10% exaction is a penalty for actual pecuniary

loss, it is entitled to priority status as an unsecured priority

claim under 11 U.S.C. § 507(a)(8)(G). The Daleys deny that

characterization and maintain that because the primary purpose

of the 10% exaction is to deter taxpayers from taking early

withdrawals from their retirement accounts, it is not a penalty

for pecuniary loss and thus should be characterized as an

unsecured general claim.

This Court agrees with appellees that the primary purpose

of § 72(t) in the context of the Bankruptcy Code is to deter

taxpayers from making early withdrawals from qualified

retirement plans and not to compensate the government for lost

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revenue. The Cassidy court concluded that the § 72(t) penalty

is not for actual pecuniary loss because it is a flat rate

penalty “bearing no relationship to the direct financial loss of

the government.” 983 F.2d at 164. This Court agrees. The

exaction is also imposed on Roth IRAs, from which the government

generally expects no tax revenue, and the rate does not change

relative to the taxpayer’s age. There is no indication that the

government suffered any actual pecuniary loss for which it seeks

compensation.

Accordingly, the judgment of the Bankruptcy Court that

appellees’ charges attributable to § 72(t) are penalties not for

actual pecuniary loss will be affirmed.

ORDER

For the foregoing reasons, the order of the Bankruptcy

Court is AFFIRMED and the bankruptcy appeal (Docket No. 1) is

DISMISSED.

So ordered.

/s/ Nathaniel M. Gorton_____

Nathaniel M. Gorton

United States District Judge

Dated August 2, 2018

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