The IRS has announced [pdf] that it is acquiescing in the Ninth Circuit case of U.S. v. Snyder, 343 F3d 1171 (9th Cir. 2003) (via Findlaw.com). Not only is the case significant as it relates to tax liens, ERISA plans, and bankruptcy, but the case also illustrates how the term "flip-flopping" is not just reserved for politicians.
The case involved the following facts:
The debtor was a vested participant in an ERISA-qualified pension plan and the plan contained the usual anti-alienation provision. The debtor's interest in the defined benefit pension plan was about $200,000, with pay-out to begin when the debtor reached normal retirement at age 60, early retirement at age 55 through 59, total disability, or death. The debtor was 49 years old and had unpaid tax liabilities for the years 1983-1986, 1989-1995, and 1997. The IRS had made assessments and had duly recorded notices of federal tax liens for the taxes due in each of those years, except 1997. Federal tax liens had therefore attached by operation of law to the debtor's interest in his pension plan.
The debtor filed a Chapter 13 bankruptcy petition listing the IRS as an unsecured creditor in the amount of $158,228. The IRS filed a proof of claim for roughly that amount, but claimed $145,664 as secured by virtue of its liens on debtor’s interest in the plan. The debtor objected to the secured portion of the IRS’s claim, arguing that his interest in the plan was excluded from the bankruptcy estate pursuant to 11 U.S.C. § 541(c)(2), and that the IRS liens on that interest therefore could not secure the IRS’s claim in bankruptcy. The bankruptcy court overruled the debtor's objection and allowed the IRS’s claim as secured. The district court affirmed. Both courts held that the debtor’s interest in the plan became property of the bankruptcy estate for the limited purpose of securing the IRS’s claim.
On appeal, the Ninth Circuit reversed. In reaching its decision, the court noted the IRS's inconsistent positions on the issue, pointing out that in some instances the IRS was motivated in its inconsistencies by the result it sought to obtain. The court stated as follows:
During the past decade, the IRS has taken inconsistent positions on the question before us. In In re Lyons, 148 B.R.88 (Bankr. D.C. 1992), a bankruptcy court held that an IRS claim secured by a federal tax lien on the debtor’s pension was secured in bankruptcy, even though that pension otherwise qualified for exclusion from the bankruptcy estate pursuant to § 541(c)(2). In 1996, in reaction to Lyons, the IRS issued a litigation bulletin, in which it took the opposite position from the position it takes today:The Lyons approach is not consistent with section 506(a) of the Bankruptcy Code. Under section 506(a), a creditor’s rights in property are dependent on the bankruptcy estate’s interest in property; the determination of the estate’s interest is separate from and must precede the determination of the creditor’s interest. If the estate has no interest in the property at issue, as was the case in both the Patterson and Lyons situations, it is not possible for the claim of any creditor, including the [IRS], to be secured by that property under section 506(a). Therefore, Lyons is inconsistent with the statute, in that the Lyons analysis essentially gives one particular creditor (the [IRS]) an interest in property where the estate has no interest in that property. Accordingly, Lyons [is] viewed as legally unsound. I.R.S. Litig. Bulletin No. 431, 1996 WL 33105615 (Aug. 1996).In 1998, in In re Persky, 1998 WL 695311 (E.D. Penn. Oct. 5, 1998), the IRS in litigation took the same position it took in the litigation bulletin in 1996. It was to the IRS’s advantage in Persky to increase the amount of the Perskys’ total unsecured debt so as to defeat their eligibility for Chapter 13 relief under 11 U.S.C. § 109(e). The IRS therefore argued that its lien on the debtors’ spendthrift trust was not a lien on property in which the estate had an interest under § 541(c)(2), and thus did not operate to secure the IRS’s claim in bankruptcy pursuant to § 506(a). See also Amy Madigan, Note, Using Unfiled Dischargeable Tax Liens to Attach to ERISA Qualified Pension Plan Interests After Patterson v. Shumate, 14 Bankr. Dev. J. 461, 490-93 (1998) (describing an unpublished case in which the IRS argued that an ERISA-qualified pension plan was excluded from the bankruptcy estate pursuant to § 541(c)(2), where exclusion was to the IRS’s advantage because it would permit the attachment of an unfiled dischargeable tax lien on the debtor’s pension plan).Two years after Persky, the IRS took the opposite position. In April 2000, the Assistant Chief Counsel for the IRS wrote:
Not following Lyons leads to results that are straightforward: ERISA-qualified plans and similar interests are excluded from the bankruptcy estate with respect to the [IRS] and all other creditors. Because they are not property of the estate, they cannot be used in determining the value of the [IRS’s] secured claim. On the other hand, to the extent that the [IRS] has a lien that survives the bankruptcy, it can pursue collection outside bankruptcy. However, given the statutory framework of sections 541 and 506 and the Supreme Court’s reasoning in Patterson . . . , upon reconsideration we now believe that the holding in Lyons is correct. The wording of each section, on its face, supports the court’s reasoning. In addition, there is nothing in the legislative history that would call for a different result. I.R.S. Chief Couns. Advis. 200041029, 2000 WL 33120271 (Apr. 11, 2000).
Courts had split on the issue as well and the Snyder opinion gives a good run-down of all of the differing case law which had developed on the issue. In the end, the court adopts the view espoused in the group of cases which had aligned with the IRS's position in its 1996 Litigation Bulletin, stating as follows:
We agree with the position taken in the first group of cases described above. That is, we agree with the position the IRS took in its 1996 litigation bulletin and in Persky, and disagree with the position it took in 2000.
The court goes on to state in dicta that, although exclusion of the debtor's interest in the plan from the bankruptcy estate precludes the IRS from attaining secured status in the bankruptcy proceeding, the IRS’s liens against the debtor's interest continue to exist, but outside of bankruptcy. This means that the IRS will be able to reach the assets in the plan upon the debtor's retirement, when the debtor is entitled to payments from the plan. Since the life-span of a tax lien is only ten years from the date of assessment, potentially the lien might expire before the IRS is able to collect.
By the way, for those who aren't familiar with the IRS's "Action on Decision" procedure under which the Acquiescence was issued, the Tax Bulletin explains the procedure as follows:
It is the policy of the Internal Revenue Service to announce at an early date whether it will follow the holdings in certain cases. An Action on Decision is the document making such an announcement. An Action on Decision will be issued at the discretion of the Service only on unappealed issues decided adverse to the government. Generally, an Action on Decision is issued where its guidance would be helpful to Service personnel working with the same or similar issues. Unlike a Treasury Regulation or a Revenue Ruling, an Action on Decision is not an affirmative statement of Service position. It is not intended to serve as public guidance and may not be cited as precedent.The Bulletin goes on to state that, prior to 1991, the Service published acquiescence or nonacquiescence only in certain regular Tax Court opinions and that the Service has expanded its acquiescence program to include other civil tax cases where guidance is determined to be helpful. The Bulletin explains that the "Service now may acquiesce or nonacquiescence in the holdings of memorandum Tax Court opinions, as well as those of the United States District Courts, Claims Court, and Circuit Courts of Appeal."
What does this actually mean when the Service acquiesces with respect to an opinion? According to the Bulletin:
Both “acquiescence” and “acquiescence in result only” mean that the Service accepts the holding of the court in a case and that the Service will follow it in disposing of cases with the same controlling facts.
Please note: All links to the Bankruptcy Code are via the Cornell Law School's Legal Information Institute. The site is a terrific resource for lawyers and others and is requesting donations from those who feel so inclined.
After the Sixth Circuit's decision in Rhiel v. Adams rocked the benefits and bankruptcy world late last year, most of us figured that it was a far-gone conclusion that 403(b) plans would, for the most part, be henceforth included in the bankruptcy estate, at least in states governed by the Sixth Circuit (i.e. Michigan, Ohio, Kentucky and Tennessee), unless the case were somehow overturned by the Supreme Court. (You can read about the case in this previous post--403(b) Plans Take a Turn for the Worst in the Sixth Circuit and More on the Sixth Circuit's Bankruptcy Decision.) However, there is some disturbing albeit predictable news from the bankruptcy trenches---I have received word from bankruptcy attorneys that, even in states not governed by the Sixth Circuit, bankruptcy trustees are taking the Rhiel v. Adams decision to heart and trying to rely on the Rhiel case to include 403(b) plan assets as part of the bankruptcy estate. As you may recall, the Rhiel case held that a husband and wife's interests in 403(b) plans were included in the bankruptcy estate and not exempt under section 542(c)(2) of the Bankruptcy Code. The case was a departure from the general rule that participants can exclude their interests in "ERISA qualified plans" from the bankruptcy estate in a bankruptcy proceeding.
The Sixth Circuit seems to have been in the limelight lately for its controversial bankruptcy decisions involving retirement plans. As you may recall, at the end of last year, the Sixth Circuit issued a controversial decision involving 403(b) plans and bankruptcy which was the focus of a previous discussion at Benefitsblog (and also here at ERISAblog)--"403(b) Plans Take a Turn for the Worst in the Sixth Circuit." The Sixth Circuit was at the helm again in another controversial bankruptcy case involving a retirement plan which has been reversed by the U.S. Supreme Court. The case is Yates v. Hendon, No. 02-458. You can access the case here.
The question presented in Yates was whether a working owner of a business is an ERISA plan "participant" and thus has the right to enforce the plan's anti-alienation provisions against a bankruptcy trustee. The Sixth Circuit had said no to this question in this 2002 decision. The Supreme Court issued an opinion today that said yes (in a 9-0 decision) so long as the plan covers one or more employees other than the business owner and his or her spouse.
Under the facts of the case, a debtor in bankruptcy--a physician--was the sole owner of a professional corporation which maintained a profit sharing/pension plan. The plan had four participants, one of which was the physician. The debtor-physician borrowed $20,000 from the plan at 11 percent interest in 1989, was supposed to make monthly payments, but failed to. In June of 1992, the term of the loan was extended for five years. Still no monthly installments were paid. In mid-November of 1996, however, at a time when the physician was apparently insolvent, the physician used proceeds of a house sale to make payments to the plan in amounts totaling $50,467.46. This figure represented repayment of the loan in full, with accrued interest.
On December 2, 1996 - three weeks after the repayment - an involuntary bankruptcy petition was filed against the physician under Chapter 7, Title 11, of the United States Code. Eight months later the trustee in bankruptcy commenced an adversary proceeding against the plan and its trustee, asking the court to (a) set the repayment aside as a preferential transfer and (b) order that the money be paid over to the bankruptcy trustee. According to the Court, it was undisputed that the $50,467.46 transfer made to the plan in November, 1996, qualified as a preference under 11 U.S.C. § 547. The Bankruptcy Court, in holding that the Bankruptcy Trustee could recover this money, held that the profit sharing plan's spendthrift provision did not prevent the recovery since the debtor was sole shareholder of the business, and "must be considered an employer and not an employee of the business for purposes of ERISA." The Sixth Circuit had affirmed.
The U.S. Supreme Court, in reversing the Sixth Circuit, based its decision upon a thorough analysis of the provisions of ERISA, after which it concluded that "Congress intended working owners to qualify as plan participants" but noted that plans covering only sole shareholders and their spouses fall outside the Title I domain. (The Yates case involved a sole shareholder and a plan which covered 4 employees, including the shareholder and his spouse.) Justice Ginsburg wrote the opinion. Justice Scalia and Thomas wrote concurring opinions which you can access here and here. Justice Scalia states that the Court has used a "sledgehammer to kill a knat" and would have deferred to the guidance provided by the Department of Labor without conducting an extensive statutory analysis. Justice Thomas would have remanded and directed the Court of Appeals to address whether the common-law understanding of the term "employee," as used in ERISA, would have included the business owner.
A previous post--"403(b) Plans Take a Turn for the Worst in the Sixth Circuit"--discusses the Sixth Circuit's opinion in Rhiel v. Adams holding that certain 403(b) annuities do not satisfy the trust requirement of section 542(c)(2) of the Bankruptcy Code and that such plans are not exempt from the bankruptcy estate. The reporting of the case has garnered quite a bit of interest from readers, one of which has commented that a substantial number of qualified defined benefit plans do not utilize trusts either, but rather utilize annuity contracts as their funding vehicle under Internal Revenue Code section 404(a)(2). The point being made is that the case could have application to certain defined benefit plans as well, meaning that these types of plans could also be at risk and possibly subject to bankruptcy, at least in the Sixth Circuit. The reader notes that many of the insurance companies which provide these types of defined benefit plans should take note of the case.
Private retirement plans established under the provisions of ERISA now hold a large part of the population's personal assets. Untold numbers of participants in these plans have found and will find themselves seeking the protection of the bankruptcy courts. Prior to the 1992 U.S. Supreme Court case of Pattersen v. Shumate, the law was in a state of disarray and the courts were split over whether or not the anti-alienation provisions of ERISA protected these assets from bankruptcy. Shumate seemed to lay to rest some of the confusion surrounding the interplay between the bankruptcy laws and ERISA, holding that participants could exclude their interests in "ERISA qualified plans" from the bankruptcy estate in a bankruptcy proceeding.
However, with bankruptcies on the rise and ERISA plans becoming many times the only source of assets, creditors and bankruptcy trustees have become more determined in pursuing these assets. One such pursuit ended in a very unhappy result for participants in the recent case of Rhiel v. Adams in which the Sixth Circuit Court of Appeals reached a surprising conclusion in the 403(b) arena, throwing the state of the law in disarray once again at least with respect to 403(b) plans.
In the Adams case, the court held that a husband and wife's interests in 403(b) plans were included in the bankruptcy estate and not exempt under section 542(c)(2) of the Bankruptcy Code. Section 541(a) of the Bankruptcy Code provides that the bankruptcy estate is comprised of all legal and equitable interests of the debtor(s) while section 542(c)(2) then provides an exclusion from the estate as follows:
A restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title. 11 U.S.C. § 542(c)(2).The lower federal district court had held that the 403(b) plans were 'ERISA-qualified' as contemplated by the Supreme Court in Pattersen v. Shumate. As such, they were not the property of the bankruptcy estate, and were not subject to administration by the bankruptcy Trustee. However, on appeal, the Sixth Circuit reversed the lower court and remanded the case for further proceedings based upon the fact that the husband and wife had not shown that the section 542(c)(2) "in a trust" language had been satisfied. According to the Sixth Circuit, the interest of the debtor had to have been held "in a trust" in order for section 542(c)(2) to apply, meaning that the 403(b) annuities did not satisfy this trust requirement and that the annuities were not exempt from the bankruptcy estate.
The court in reaching its conclusion seems to almost ignore the U.S. Supreme Court case of Pattersen v. Shumate. The U.S. Supreme Court in Shumate had held that the § 541(c)(2) language--"applicable nonbankruptcy law"--included ERISA and that the anti-alienation provision contained in the ERISA qualified plan at issue in the Shumate case (a pension plan) satisfied the literal terms of § 541(c)(2). The court in Shumate held further that the sections of ERISA and the Internal Revenue Code requiring a plan to provide that benefits may not be assigned or alienated clearly imposed a "restriction on the transfer" of a debtor's "beneficial interest" within § 541(c)(2)'s meaning, and that the terms of the plan provision in question complied with those requirements.
Although the Shumate case did not involve a 403(b) plan, but rather a pension plan, there is language in the Shumate case (which the dissent in the Adams case emphasizes) which could have been used to support a result that the 403(b) interests should not have been included in the estate as follows:
The natural reading of the provision [e.g. § 541(c)(2)] entitles a debtor to exclude from property of the estate any interest in a plan or trust that contains a transfer restriction enforceable under any relevant nonbankruptcy law.As the dissent states, the Sixth Circuit could have reached a different result by relying on this language in Shumate--"any interest in a plan or trust"--as well as on the reasoning espoused by the Supreme Court in Shumate, i.e. that of (1) ensuring that the treatment of pension benefits not "vary based on the beneficiary's bankruptcy status"; (2) giving "full and appropriate effect to ERISA's goal of protecting pension benefits" and (3) ensuring that the "important policy underlying ERISA: uniform national treatment of pension benefits" be preserved.
In my opinion, the following arguments of Sixth Circuit Judge Jennie D. Latta's dissent are highly persuasive:
(1) Judge Latta notes the Sixth Circuit's own language in which it stated that it would not "rely on the literal language of the statute where such reliance would lead to absurd results or an interpretation which is inconsistent with the intent of Congress." As Judge Latta aptly states, "[t]he majority’s reading is inconsistent with the clear intent of Congress that ERISA-qualified pension plans not be subject to creditor claims."
(2) "Outside of bankruptcy, no creditor of the Adams would be able to reach the debtors’ beneficial interests in their pension plans to satisfy claims, and this is true not because these interests are exempt from execution pursuant to state law, but because they are exempt from execution pursuant to federal law. See Guidry v. Sheet Metal Workers Nat. Pension Fund, 493 U.S. 365, 110 S. Ct. 680 (1990)(permitting no equitable exception to ERISA’s anti-alienation provision). The filing of a bankruptcy case should not change this result."
(3) "The narrow reading of § 541(c)(2) advanced by the majority of the Panel nullifies the anti-alienation provision of ERISA for non-trust, qualified pension plans. The majority advances no policy argument in favor of this reading. Were we called upon simply to construe § 541(c)(2), without the benefit of the Supreme Court’s opinions in Guidry and Shumate, then a narrow, “plain-meaning” reading would be appropriate, but I believe that we must go beyond § 541(c)(2) and include within our discussion the plain meaning of ERISA’s anti-alienation requirement. When this is done, it is clear that ERISA-qualified pension plans, whether held in trust or not held in trust, are excluded from the bankruptcy estate."