MEMORANDUM OPINION AND ORDER SUSTAINING TRUSTEE'S OBJECTION TO CLAIM NO. 424
K. Rodney May, United States Bankruptcy Judge.
The Internal Revenue Service assessed penalties of $347,490 against the Debtor pursuant to 26 U.S.C. § 6698(a),1 because the Chapter 7 Trustee filed the partnership's tax return for the year ending April 30, 2011 (the "2011 Return") by the date to which the filing deadline could have been extended, but without having timely requested the extension. The United States filed a proof of claim (Claim No. 424-1) in the amount of $356,695.46 for the penalties plus $9,205.46 of interest.2 The claim also includes a $1,535.15 balance for FICA taxes that are not in dispute.3 The United States asserts that the entire claim should be given priority as an administrative expense claim.4
The Trustee objected to the claim and filed a motion to determine Debtor's tax liability under § 505.5 The Trustee contends that the claim should be disallowed because there was reasonable cause for filing the 2011 Return by the extended filing deadline; alternatively, even if the penalty is owed, it should have the status of a general unsecured claim that is equitably subordinated to all other unsecured claims.
The Court heard argument on July 10, 2017.6 For the reasons stated below, the Court will sustain the Trustee's objection, allowing the claim as an equitably subordinated unsecured claim.
The facts are not in dispute.7 Debtor was formed as a limited partnership in 1973 to manage and operate the resort in Longboat Key, Florida, known as the Colony Beach & Tennis Club. Debtor filed for protection under Chapter 11 on October 5, 2009.8 The Debtor operated in the Chapter 11 for several months, then closed forever. On June 11, 2010, William Maloney ("Trustee") was appointed as trustee.9 Two months later, on August 13, 2010, the case was converted to Chapter 7. Mr. Maloney continued to serve as trustee.10
The Debtor was a pass-through entity. Any tax liability for its income was passed through to the 297 limited partners.11 The Debtor was required annually to file a Form 1065 informational return and distribute Schedule K-1's to the limited partners.12
Form 1065 returns are due by the 15th day of the 4th month following the end of the partnership's fiscal year.13 That deadline could be extended, routinely, for an additional five months, as long as the Debtor requested the extension prior to the original deadline.14 The Debtor's 2011 Return, for the period ending April 30, was due to be filed by August 15, 2011. If properly extended, the 2011 Return would be considered timely if it had been filed by January 17, 2012.15
There is no correspondence or other evidence to establish that an extension of the original filing deadline for the 2011 Return was ever requested. Nor is there any evidence that the IRS received an extension request. Nevertheless, the 2011 Return was filed on January 17, 2012.
In the absence of an allowed extension, the 2011 Return was considered by the IRS to have been filed late. It assessed the late-filing penalties on February 6, 2012, and filed the claim at issue on December 12, 2012.16
If the United States' claim is allowed and given priority as an administrative expense, holders of general unsecured claims will receive a 68% dividend. Otherwise, they will receive a dividend of 100%.
The penalty at issue here relates to a tax owed by persons other than the Debtor. Except in limited circumstances, not present here, this court may "determine the amount or legality of any ... penalty relating to a tax ... whether or not previously assessed, whether or not paid, and whether or not contested before the adjudication by a judicial administrative tribunal of competent jurisdiction."17
It is undisputed that the 2011 Return would have been timely filed if an extension had been requested before August 15, 2011. The fact that the 2011 Return was filed on the hypothetical extended deadline, January 17, 2012, confirms only the Trustee's claim that he was operating on the assumption that his accountants had filed the extension request; but, there is no indication that anyone had done that. Thus, the 2011 Return was filed late and the Debtor is subject to penalties pursuant to § 6698 unless it proves that the return was filed late for "reasonable cause."
"Reasonable cause" is not defined in the Internal Revenue Code.18 In United States v. Boyle,19 however, the Supreme Court held that to show "reasonable cause" under IRC § 6651(a), the taxpayer must demonstrate the exercise of ordinary business care and prudence and the inability to file the return within the prescribed time.20 Lower court decisions since then have adopted versions of this test and it is appropriate to apply it here.21
For example, in In re Hudson Oil Co., Inc.,22 the trustee argued that debtor should be relieved of late filing penalties under IRC § 6651 because the debtor's books were in such disarray that he could not timely file an accurate return.23 The debtor had requested an extension to file, but the IRS advised that it would cancel the extension unless $1 million in estimated taxes was paid, something the trustee was unable to do.24 In a contested matter under § 505, the bankruptcy court found that there was reasonable cause for the late filing because it was impossible for the trustee to put the return together by the deadline.25
"[Taxpayer] did not file the return late because he somehow mistakenly missed the deadline. [Taxpayer] filed the return late because, in reality, he did not have sufficient time to prepare it. The trustee, his accountants, the estate, and the debtors were put in an impossible situation from the start when it came to filing the [return]."26
A court also found reasonable cause for the late filing by a partnership in In re Refco Public Commodity Pool, L.P.27 Refco had invested nearly all of its assets in a Cayman Islands company on which it relied for a Schedule K-1.28 The Cayman Islands company itself was in a liquidation proceeding and had material inaccuracies in its records.29 Without a Form K-1 from the Cayman Islands company, Refco could not prepare its tax return.30 The bankruptcy court determined that Refco's failure to timely file returns was due to events "beyond its control."31
According to the Trustee, his filing of the 2011 Return on the date to which the initial filing deadline could have been extended was due to "reasonable cause:" he was appointed at a time when Debtor was involved in complex litigation which required his full attention; Debtor's financial records were in disarray, which impeded his ability to reconcile the accounts; and, he faced "significant business, record-keeping and operational challenges."32
Here, it is plausible that the Trustee's attention was diverted by ongoing litigation (in which he played the role as mediator between the principal antagonists) shortly before the extension request was due. But, the record in this case undercuts the Trustee's position. The 2010 Return (for the period ending April 30, 2010) was also filed late. No extension was requested for that filing either. It was not until April 28, 2011 (eight months after the initial due date), that the Trustee filed an application to employ accountants for the purpose of preparing and filing the 2010 Return.33 The Trustee also did not file an application to employ accountants to prepare and file the 2011 Return until January 12, 2012, only five days before the return would have been due if an extension had been granted.
The Trustee acknowledges that he did not personally file for an extension for the 2011 Return and he did not delegate the obligation to file the extension to the accountant.34 Rather, he states only that he assumed that Debtor's former accountants, whom he did not seek to employ until five months later, were going to file the request for extension of the 2011 Return deadline.35 Nevertheless, he maintains that he expected them to file for the extension as a matter of course, even though they had not yet been retained to do that.36 This record does not establish ordinary business care and prudence.
Even if the Trustee's assumptions were justified, this does not constitute reasonable cause. A taxpayer or reporting entity has a non-delegable duty to timely file a tax return,37 and that duty is not excused because of reliance on an agent.38 A party required to file a tax return cannot passively rely on an accountant to timely file a return39 or an application for an extension to file the return.40
Also, there is no evidence that the Trustee was unable to comply with his obligations because of events beyond his control. Filing for an extension request requires only a "very simple form, a low level formality [that] doesn't even have to be signed."41 The Trustee acknowledges that "filing an extension for a tax return is a fairly simple, nominal event."42 The complexities to which the Trustee was attending are irrelevant. The issue here is the failure to timely file a simple request for an extension. Accordingly, reasonable cause does not exist to waive the § 6698 penalties.43
Nevertheless, it is appropriate in this case to deny the United States' claim as an administrative expense under § 503(b) and to equitably subordinate it. First, the claim does not fall within the statutory category of administrative expenses for tax penalties. Section 503(b)(1)(C) only provides for administrative expense status to "any fine, penalty, or reduction in credit relating to a tax of a kind specified in subparagraph (B). . . ." Subparagraph (B) of § 503(b)(1) refers to "any tax incurred by the estate. . . ."44 The United States' claim for § 6698 penalties does not relate to any tax owed by the Debtor or the bankruptcy estate.45 The estate was required to file an informational return; but, the tax liability was passed through to the limited partners. The IRC § 6698 penalty is only coercive of compliance with the reporting deadlines. Accordingly, the penalty claim is not entitled to administrative status under § 503(b)(1)(C).
The United States asserts, however, that the claim should be allowed as a "generic" administrative expense, citing a 2015 decision by a California bankruptcy court, In re 800Ideas.com, Inc.46 In that case, the estate was assessed penalties because the Chapter 7 trustee did not timely file the corporate tax return for an "S Corporation," which, like a partnership, is a pass-through entity whose income is taxed at the shareholder level.47 There, the court accepted the United States' argument that its claim for late-filing penalties was entitled to administrative expense priority.48 The court determined that the late-filing penalty was excluded from § 503(b)(1)(C), but reasoned that a trustee was "not exempt from his obligation to comply with federal tax reporting requirements"49 and allowed the claim as a general, unlisted administrative expense under § 503(b).50
This Court declines to adopt that reasoning. First, the Court must look at the statute's plain meaning when interpreting the Code.51 Section 503(b)(1)(B) and (C) specifically state what types of penalties are entitled to allowance as an administrative expense. It is appropriate to give meaning to the exclusion of penalties that are unrelated to taxes owed by the bankruptcy estate. Additionally, allowing the United States' claim as an administrative expense would not benefit the estate, but, instead, would harm unsecured creditors who were without fault for the untimely 2011 Return.
In 800ideas.com, the impact of the penalty fell on the trustee because the claim, as an administrative expense, reduced the trustee's compensation.52 Further, the debtor's failure to timely file returns impacted collection of the underlying taxes, because the shareholders received their Schedule K-1's late.53
Neither of these issues are present here. The Trustee will be paid in full, regardless of the United States' claim receiving administrative status or not, and there is nothing in the record to indicate that Debtor's partners' K-1's were untimely or that their individual returns were not timely or accurately filed because of Trustee's failure to timely request an extension of the filing deadline. Accordingly, the circumstances are dissimilar enough to deny the United States a "generic" § 503 administrative expense claim.
There is ample equitable cause, however, to subordinate the United States' claim. Section 510(c)(1) allows a court, under principles of equitable subordination, to "subordinate for purposes of distribution all or part of an allowed claim to all or part of another allowed claim." The equitable subordination doctrine can be applied even when a claim has apparent legal validity.54 While equitable subordination traditionally requires a showing of misconduct by the creditor,55 this is not a requirement for tax penalties.56 Therefore, a tax penalty claim may be reordered in a given case under "principles of equitable subordination," as warranted by particular facts.57
Here, the equities justify subordination of the United States' claim to the claims of general unsecured claims:
1. The timing of the filing of the Debtor's Form 1065 information return had no bearing on the IRS collecting the underlying taxes for 2011, which were payable by the limited partners.58
2. The magnitude of the penalty claim is based on the number of partners.59 A partnership with only 30 partners would be assessed one-tenth of the penalty of a non-compliant firm with 300 partners. But, the number of partners is irrelevant to the compliance with the filing deadlines that the IRS § 6698 penalty is meant to coerce.
3. The parties that would be impacted by the United States' claim are the general unsecured creditors who had nothing to do with the late filing by the Trustee.60
For the foregoing reasons, it is ORDERED that:
1. The Debtor's Objection is hereby SUSTAINED in part.
2. The United States' claim (Claim No. 424-1) shall be allowed in the amount of $358,230.61.
3. A portion of said claim, in the amount of $356,965.46, will be allowed as a general unsecured claim, but will be equitably subordinated to payment in full of all other allowed general unsecured claims.
4. The $1,535.15 balance of Claim 424-1, attributable to undisputed FICA taxes, shall be allowed as an administrative expense claim.