Opinion
Case No. 98-10100-MVB
April 2, 1998
MEMORANDUM OPINION AND ORDER
A hearing was held in open court on March 31, 1998, on the objection of the United States of America on behalf of the Internal Revenue Service ("IRS") to confirmation of the debtors' proposed chapter 13 plan dated January 29, 1998. The debtors were present in person and represented themselves. The United States was present by counsel. The chapter 13 trustee was also present but took no position.
The debtors having filed a modified plan on March 12, 1998, the court would ordinarily simply have denied confirmation of the January 29, 1998, plan. Because, however, the objections raised by the United States were possibly dispositive with respect to the modified plan as well, and because the debtors had filed a pleading joining issue with respect to the various grounds of objection raised by the IRS, the court took the matter under advisement. For the reasons stated in this memorandum opinion and order, the court concludes that confirmation of both plans must be denied, with leave to file a modified plan within ten days.
Facts
German Pomajambo and Martha Pomajambo, who are husband and wife, filed a joint voluntary petition under chapter 13 of the Bankruptcy Code in this court on January 7, 1998. Each of them had previously filed a chapter 7 case four years earlier. On their schedules they listed as an asset their residence at 8310 Carrleigh Parkway, Springfield, Virginia, which they valued at $198,000. The property was shown as being subject to first and second deeds of trust on which there was owed a total of $185,220.73, a Federal tax lien in the amount of $24,207.73, and a Virginia tax lien in the amount of $1,387.25. Their schedules listed the Internal Revenue Service as an unsecured priority creditor in the amount of $24,207.73 for 1993, 1994, and 1995 Federal income taxes. In addition to the taxes, they listed $6,440.36 in unsecured debts. The schedules reflect that Ms. Pomajambo is not employed and that Mr. Pomajambo works as an independent contractor for his wholly-owed real estate brokerage firm, Don German Real Estate, Inc. Their schedules showed net monthly income in the amount of $2,880 and monthly expenses in the amount of $2,770.
The debtors filed their petition pro se. An attorney subsequently entered an appearance and prepared the original plan. The debtors discharged the attorney after the meeting of creditors and are again representing themselves.
Mr. Pomajambo's chapter 7 petition was filed on January 25, 1994, Case No. 94-10252-DOT, and he received a discharge on May 20, 1994. Ms. Pomajambo's chapter 7 petition was filed on June 28, 1994, Case No. 94-12550-MVB, and she received a discharge on October 14, 1994.
On January 29, 1998, the debtors filed a proposed chapter 13 plan. The plan required the debtors to pay the chapter 13 trustee $425.00 per month for 60 months and provided for the trustee to make payments of $150 per month for 60 months on an Internal Revenue Service priority claim described as "uncertain amt./est." but shown as $9,000. The holders of the two deeds of trust against their residence would be paid $1,745.14 per month directly by the debtors, while the trustee would pay $177.22 for 60 months to cure a total of $10,460.98 in prepetition mortgage arrearages. General unsecured creditors would receive a dividend of 20 cents on the dollar.
On March 6, 1998, the United States filed an objection to confirmation of the January 29th plan. In the interim, it had filed a proof of claim in the total amount of $26,336.88, of which $18,325.05 was shown as secured, $5,663.64 as priority unsecured, and $2,347.29 as general unsecured. The secured claims arose from unpaid Federal income tax liabilities for 1992 and 1993, and for which a notice of Federal tax lien had been filed in Fairfax County, Virginia, in November 1994. The unsecured priority claim arose from unpaid Federal income taxes for 1995. The general unsecured claim consists primarily of unpaid Federal withholding and social security taxes (Form 941) and Federal unemployment taxes (Form 940) as well as penalties.
The objection to confirmation complained that the plan failed to provide for the IRS's $18,325.05 secured claim; that the debtors had failed to file Form 941 returns for two quarters (2nd quarter 1992 and 2nd quarter 1993); and that the plan was unfeasible. The debtors then filed on March 12, 1998, a modified plan. The modified plan provided for a modest increase in the amount of the payments to the trustee (from $425 per month to $450 per month), but made no change in the treatment of the Internal Revenue Service claim. The debtors also filed on March 17, 1998, a pleading with 45 pages of exhibits entitled "Debtor's Answer to Complaint to Determine Dischargeability and Objection to Confirmation of the Plan and Debtor's Motion Requesting the Approval of the Plan." In substance, the debtors asserted that the Internal Revenue Service did not have a secured claim because there was no equity in their house to which the lien could attach; that the bulk of the IRS's claim could properly be compromised in chapter 13; and that their income was sufficient to make the required plan payments.
There has been no complaint filed to determine dischargeability, and the court treats the pleading as a response to the Internal Revenue Service's objection, a motion to value collateral, and an objection to the Internal Revenue Service's claim.
Discussion
Although the IRS's objection is specifically addressed to the January 29th plan, the March 12th modified plan makes no change to the treatment of the IRS claim, nor does it otherwise moot any of the IRS's objections. Accordingly, the court concludes that it is proper to treat the filed objection as an objection also to the modified plan.
A.
The major bone of contention is that the plan fails to provide for the IRS's secured claim as set forth in its filed proof of claim. The debtors' response, as noted above, is that the IRS does not have a secured claim, because there is no equity in their residence to which the filed Federal tax lien may attach. In support of that assertion, they have submitted to the court a written "Market Value Analysis" prepared by William A. Brooks, a real estate agent, stating an "Estimate [sic] Market Value" for the debtors' house of $183,000.00 based on a "Distress sale." The report notes that the property is assessed for real estate tax purposes at $197,915, essentially identical to the $198,000 fair market value which the debtors show on their original schedules. The analysis also reflects that the two comparables which were sold as a "normal Sale" rather than a "Distress sale" sold between 4 to 7% above the real estate tax assessment.
The debtors have since filed a "Petition to Amend Schedules" in which they assert a "Current Market Value" for the property of $183,000.
The proofs of claim filed by the first and second deed of trust holders reflect balances due, as of the filing date of the debtors' petition, of $188,292.86. Both deeds of trust appear to have been recorded prior to the notice of Federal tax lien, and thus have priority over it. The debtors' schedules also reflect that they own unencumbered personal property in the amount of $5,991.00.
Under 26 U.S.C. § 6321, the failure, after demand, to pay any tax due the United States creates a lien in favor of the United States for the amount of the unpaid tax "upon all property and rights to property, whether real or personal, belonging to [the taxpayer]." Nevertheless, under § 506(a), Bankruptcy Code, a claim in bankruptcy is secured only to the extent of the value of the debtor's interest in the property securing the claim, and the balance of the claim is unsecured. The value of the property is "determined in light of the purpose of the valuation and of the proposed disposition or use of such property, and in conjunction with any hearing . . . on a plan affecting such creditor's interest." Id. The Supreme Court has recently held that where a debtor proposes to retain collateral under a chapter 13 plan, the collateral must be valued for § 506(a) purposes at replacement cost to the debtor. Assocs. Comm'l Corp. v. Rash, — U.S. —, 117 S.Ct. 1879, 138 L.Ed.2d 148 (1997). In this case, the debtors are proposing to retain their house. Accordingly, the use of a "distress sale" valuation for § 506(a) purposes is inappropriate. The market analysis offered by the debtors supports a replacement value — that is, what the debtors would have to pay to buy a comparable house — of at least the value shown on their original schedules, that is, $198,000. Given the two deeds of trust with a total balance due of $188,292.86, there is $9,707.14 in equity to which the filed Federal tax lien attaches. Additionally, the lien extends also to the $5,991 in unencumbered personal property shown on the debtors' schedules. Thus, the IRS is entitled to have its claim for 1992 and 1993 income taxes treated as secured to the amount of $15,698.14. Under § 1325(a)(5), Bankruptcy Code, unless a secured creditor accepts some other treatment, a chapter 13 plan must either surrender the property securing the claim, or must provide for the holder of the claim to retain the lien securing the claim and to receive payments having a value, as of the effective date of the plan, of not less than the allowed amount of the secured claim. Since the modified plan, like the original plan, does not provide for such treatment, it cannot be confirmed.
Based on the tax years involved, and the date of assessment as shown on the proof of claim, the remaining $2,627.91 shown on the proof of claim as secured would appear not to be entitled to priority and would therefore be a general unsecured claim. See § 507(a)(8)(A), Bankruptcy Code. Because, however, the court has no information as to whether the debtors requested and were granted extensions for the two years in question, the court makes no ruling on that issue.
This rather convoluted formulation means, in essence, that a secured creditor who is being paid over time must be paid interest on its claim. United Carolina Bank v. Hall, 993 F.2d 1126, 1130 (4th Cir. 1993); see In re Milspec, Inc., 82 B.R. 811, 820-21 (Bankr. E.D. Va. 1988) (Bostetter, C.J.) (rate of interest to be paid on secured Federal tax claim must be determined based on market rate/case-by-case approach).
In part, the debtors' argument is that $9,000.00 is a reasonable compromise of the Government's tax claims and falls well within the range of offers in compromise that are typically approved by the IRS. They point out that they have made substantial payments to the IRS over the past three years, but that because of penalties and constantly running interest, they have been unable to make a dent in the underlying liability. The court is not unsympathetic to their plight and would certainly encourage the Government to give careful consideration to any reasonable offer that the debtors may propose. However, the Bankruptcy Code is very clear that unless the Government consents to less favorable treatment, priority and secured taxes must be paid in full under a chapter 13 plan. Put another way, while this court can fix reasonable terms of payment, this court cannot force a taxing authority to accept less than the full amount of its priority and secured tax claims.
B.
Since the plan, because of its failure to provide for the IRS's secured claim, cannot be confirmed, it is not necessary to reach the remaining grounds of objection. Nevertheless, since the court can reasonably anticipate that the debtors may seek to further modify their plan, some discussion is appropriate.
First, the IRS complains that because the debtors have not filed Form 941 withholding tax returns for two quarters (one in 1992 and one in 1993), the Service has had to estimate the tax liability for those two quarters. The amount involved — $1,250 — is less than 5% of the total claim. The debtors have furnished copies of several Employer's Quarterly Tax Returns (Form 941) for the years in question, but none of them is for the two specific quarters shown on the IRS proof of claim. While the debtors have submitted a notice from the IRS referencing Form 941 liability for the period ending December 31, 1993, and stating "Your account is paid in full at this time," it is by no means clear that the statement refers to all four quarters of 1993 as opposed to the quarter ending December 31, 1993. Similarly, the debtors have provided evidence that they made payments to the IRS of the amounts billed for 941 taxes for the period ending December 31, 1992. Again, however, the court is unable to conclude that such payment satisfied their obligation for all four quarters, rather than simply the fourth quarter.
Of course, debtors are expected to file all required tax returns, and a bankruptcy court, as a court of equity, may properly refuse to confirm a plan — or dismiss a case altogether — where a debtor has failed to file returns that would disclose his or her correct tax liability. See, e.g., Vines v. Internal Revenue Service (In re Vines), 200 B.R. 940, 944-47 (M.D. Fla. 1996) (debtor's failure to file tax returns constituted prejudicial delay to creditors warranting dismissal of the case under § 1307(c)(1), Bankruptcy Code); In re Crayton, 169 B.R. 243, 245 (Bankr. S.D. Ga. 1994) (denying confirmation to debtor's plan and dismissing case based on debtor's lack of good faith in failing to file tax returns); In re Hazel, 68 B.R. 287, 289-90 (Bankr. E.D. Mich. 1986), aff'd, 95 B.R. 481 (E.D. Mich. 1988) (denying confirmation to debtor's plan based on a lack of good faith under § 1325(a)(3), Bankruptcy Code, because debtor sought to discharge tax claims for which the debtor failed to ever file tax returns and never intended to pay). If the debtors have records that would enable the two missing returns to be filed, they should be promptly filed. On the other hand, if, because of the passage of time or loss of records, the debtors are genuinely unable to file returns for the two quarters in question, the court would not be inclined to treat such failure, by itself, as indicative of bad faith or a bar to confirmation. Since no evidence was taken at the hearing on this particular issue, the court makes no ruling at this time as to whether failure to file the returns in question should bar confirmation.
Since so many of the reported cases in which this issue arises involve "tax protestors," it is important to note that there is no evidence before the court suggesting that the debtors in this case fall in that category or that this case was filed in bad faith.
The final issue raised is one of feasibility, and more specifically, of the debtors' ability to fund the proposed plan. The original schedules of income and expenses showed an excess of income over expenses of only $102.02 per month The schedules of income and expenses attached to the modified plan, however, show net monthly income of $3,400.00 and monthly expenses of $2,691.81, leaving $702.19 per month with which to make a monthly plan payment of $450.00. The debtors also argue, in effect, that the proof is in the pudding — that is, that they are current on their payments to the trustee and were also able, for a substantial period prior to the filing of their chapter 13 petition, to make monthly payments to the IRS in the amount of $400.00 per month under a payment plan. Of course, in light of the court's ruling that any plan will have to provide appropriate treatment for the IRS's secured claim, it is far from clear that the debtors will be able to propose a plan within their budget, but such a determination is better made in connection with the hearing on confirmation of such a plan, if it is proposed. The court simply notes that feasibility remains an open issue.
The schedules attached to the plan are confusing, in that they consist of a copy of the original schedules I and J, to which the debtors have attached a copy of a "Petition to Amend Schedules" filed March 11, 1998, which modifies certain line items but does not restate the schedules in their entirety.
ORDER
For the foregoing reasons, it is ORDERED:
1. Confirmation of the debtors' plan filed January 29, 1998, and the modified plan filed March 12, 1998, is denied.
2. Treating the debtors' "Answer to Complaint" filed March 17, 1998, as in part a motion under § 506(a), Bankruptcy Code, and Federal Rule of Bankruptcy Procedure 3012, to determine the value of a secured claim, the court determines that the claim of the Internal Revenue Service is secured to the extent of $15,698.14, and that the balance of the claim is unsecured.
3. The court makes no ruling as to what portion, if any, of the unsecured claim is entitled to priority. To the extent the debtors intend the "Answer to Complaint" to constitute an objection to the proof of claim filed by the Internal Revenue Service, such objection should be set for hearing on Chief Judge Bostetter's calendar with at least 30 days notice to counsel for the United States.
4. The debtors shall have ten (10) days from the entry of this memorandum opinion and order in which to (a) file a motion to alter or amend this memorandum opinion and order, (b) file a notice of appeal of this memorandum opinion and order to the United States District Court for the Eastern District of Virginia, or (c) file a modified plan. If the debtors fail to take one of the specified actions within such period, the clerk shall enter an order under Local Bankruptcy Rule 3015-2(G) dismissing this case.
5. The clerk shall mail a copy of this memorandum opinion and order to the parties listed below.