The Statute of Limitations
How one taxpayer carefully reviewed the Statute and saved over $1.5 million.
July 15, 2010
When the Internal Revenue Service (IRS) filed a lawsuit against John S. Falcone to collect the trust fund recovery penalty (TFRP) that was assessed against him, he carefully reviewed the Statute of Limitations (“SOL”) and discovered that the lawsuit was out of time. It did appear at first that the lawsuit was within the SOL on collection, because Falcone had filed an offer in compromise (OIC), and a Chapter 7 bankruptcy (Bankruptcy), both of which usually suspend or toll the running of the Statute of Limitation. See IRC §6502. Falcone, however, concluded after careful analysis that the IRS lawsuit was filed after the SOL expired. The United States District Court, in a case of first impression, agreed, and held that the lawsuit was barred because the 10-year SOL on collection was not suspended when the bankruptcy court vacated its previously entered discharge order with consent of the parties. U.S.A. v. Falcone, (Slip Copy) 2010 WL 1372435 (D.N.J.), 105 A.F.T.R.2d 2010-1710.
An automatic stay comes into effect when a bankruptcy petition is filed precluding the IRS from pursuing its collection efforts. See 26 U.S.C. § 6503(h); 11 U.S.C. § 362(a). A discharge terminates the automatic stay. See 11 U.S.C. 362(c)(2)(C). The IRS argued that the consent order vacating the discharge order had the effect of nullifying it, as if it had never been entered. In other words, the IRS argued that the consent order vacating the discharge order should apply retroactively. Falcone argued that the discharge order was effective even though it was subsequently vacated or dismissed. Pursuant to the Internal Revenue Code (IRC), “the running of the period of limitations … on the making of … collection shall, in a case under (the Bankruptcy Code), be suspended for the period during which the (IRS) is prohibited by reason of (the automatic stay) from collecting (and for an additional six months.)” If the period of limitation was suspended, the IRS lawsuit against Falcone was filed timely; however, if it continued to run, the IRS lawsuit was barred.
The court sided with Falcone and held that consent order vacating the discharge order did not apply retroactively, in effect, to nullify the discharge. Thus, the SOL was not suspended or tolled during the period between the issuance of the discharge order and the time it was vacated. As a result, the IRS lawsuit against Falcone was dismissed because it was brought after the 10-year SOL on collection expired.
The TFRP was assessed against Falcone on March 7, 1994. This was the date on which the 10-year SOL on collection had begun to run. Falcone filed a Bankruptcy petition on January 10, 1995. As a result, the automatic stay on collection arose, and IRS was prevented from taking any collection action until the stay ceased to exist, that is, when the bankruptcy was discharged. See IRC §6503(h); 11 U.S.C § 362(a).
A discharge was issued on June 30, 1995. This discharge terminated the automatic stay. See 11 U.S.C. § 362 (c)(2)(C) (“the stay … continues until ... the time a discharge is granted”). On January 19, 1996, a creditor of Falcone, National Union (“National”), filed a motion with the Bankruptcy Court to have the discharge order vacated, claiming it was entered prematurely. Fed. R. Bankr. P. 4004(c)(1)(B) provides that “[i]n a chapter 7 case, on expiration of the time fixed for filing a complaint objecting to discharge …, the court shall forthwith grant the discharge unless … a complaint objecting to discharge has been filed ….” Falcone did not contest that fact that National timely filed an objection to discharge and he agreed that the discharge was entered prematurely. A Consent Order vacating the Discharge Order and on January, 19, 1996, the Bankruptcy Court entered the Consent Order vacating the original Discharge Order.
The contested issue was whether or not the Consent Order vacating the Discharge had the effect of voiding the discharge altogether, as if it had never been entered. If it did not apply retroactively, then the automatic stay was terminated, the IRS was not prohibited from pursuing collection, and the SOL was not tolled.
Once the discharge was vacated, National and Falcone litigated the dischargeablility of his debt to National. Interestingly, the bankruptcy court concluded that Falcone’s debt to National was not dischargeable. See National Union Fire Ins. Co. v. Falcone, Adversary Proc. #95-3054. More importantly, a final discharge order was entered concerning Falcone’s other debts, which would include the IRS, on August 9, 1999. As a result of this discharge order, the automatic stay on collection was lifted, and the SOL began to run again.
On November 9, 2000, Falcone filed an application for an Offer in Compromise with the IRS. Generally, the submission of an Offer in Compromise tolls the SOL in a collection action. See IRC § 6331(k)(1) (no levy while offer is pending). The IRS rejected the offer on July 19, 2001. Still not having received full payment, the IRS instituted the lawsuit which is the subject matter of this article on May 13, 2009.
Offer in Compromise
Generally, submission of an OIC tolls the SOL in a collection action. However, the Community Renewal Tax Relief Act of 2000 (“Renewal Act”), Pub.L. No. 106-554, 114 Stat. 2763 (2000), effective December 21, 2000, eliminated the statutory suspension of the limitations period pertaining to Offers in Compromise. Thus, although the OIC was pending from November 9, 2000, until July 19, 2001, when it was rejected, the SOL was suspended for only 42 days, that is, from November 9, 2000 until December 21, 2000, the effective date of the Renewal Act. The IRS and Falcone agreed with this. Eliminating the suspension of the SOL meant that after December 21, 2000, the IRS could have taken collection action against Falcone, but chose not to. The IRS was precluded from collection action against Falcone for only 42 days, the period the statutory suspension was in effect, and thus, the ten year limitation period was extended for 42 days beyond the 10-year period.
Practice Point. Although it had no effect on the facts of this case, the Worker Assistance Act, effective on March 9, 2002, reinstated the statutory suspension of collection action when an OIC is pending; however, the reinstatement had no effect on the facts of this case, because the OIC had been rejected prior to its enactment.
Falcone argued that the Consent Order vacating the Discharge Order did not have retroactive application, that is, the automatic stay was terminated by the discharge order. Once the Consent Order was issued, a new automatic stay went into effect, and as such, tolling arose. Falcone’s computation of the SOL with adjustments for tolling or suspensions would appear as follows:
Thus, the IRS Lawsuit filed May 13, 2009, was filed too late.
The Government argued that the Bankruptcy Court’s June 30, 1995 discharge order, which was vacated, was without legal effect; that is, it was void, and therefore, the SOL was suspended throughout the period between the filing of the petition and the second and final discharge. It therefore posed the following SOL computation:
IRS Lawsuit filed, May 13, 2009 — filed timely.
In a well reasoned opinion, Judge Wolfson, concluded that, “Determining that the Consent Order to Vacate retroactively imposed the stay could affect the previously-vested rights of all the creditors in, and other parties related to, Falcone’s bankruptcy.” The Court found In re Hill, 305 B.R. 100 (Bankr.M.D.Fla.2003) particularly instructive.
In that case, the bankruptcy court entered a dismissal order, on May 14, 2002, because the debtor was more than 30 days delinquent to the Chapter 13 Trustee. Per 11 U.S.C § 362(c)(2), the automatic stay was terminated upon dismissal. However, shortly thereafter, on May 24, 2002, the debtor filed a motion to vacate the dismissal order because she had complied with her financial requirements. Her home was sold at a sheriff’s sale on July 9, 2002 before the court heard her motion. The court granted her motion and vacated the dismissal order on July 18, 2002 [therefore, the automatic stay was revived]. Id. The mortgage company who sold the home subsequently petitioned the court for clarification as to whether the July 18th order retroactively imposed the stay [emphasis added] and, consequently, voided the sheriff’s sale. After conducting a thorough review of the case law, the court determined that “the strong weight of authority concludes that the dismissal of a case terminates the automotive stay, and the court is without authority to impose the stay retroactively”. The court, accordingly, refused to invalidate the sale, stating
Courts will not “give to statutes a retrospective operation, whereby rights previously vested are injuriously affected, unless compelled to do so, by language, so clear and positive as to leave no room to doubt that such was the intention of the legislature. Landgraft v. United States, 511 U.S. 244, 271 (1944) (quoting Chew Heong v. United States, 112 U.S. 536 (1884). This quote encapsulates the presumption against the retroactive application of statutes.”
The Court said further that:
While not presented with the interpretation of a statute here, the same principle applies to interpreting the Consent Order to Vacate. Determining that the Consent Order to Vacate retroactively imposed the stay could affect the previously-vested rights of all the creditors in, and other parties related to, Falcone’s bankruptcy. I will not open that juridical “can of worms” since there is no clear indication that the Consent Order to Vacated was drafted with that intention in mind.
Falcone’s careful review of the SOL paid off. The IRS’s lawsuit against him to collect over $1.5 million was dismissed as untimely. The court held that the IRS could have pursued collection against him between June 30, 1995 and January 19, 1996, and for six months thereafter, but chose not to. Therefore, the SOL was not tolled during that time period, nor was it added to the 10-year limitation period.
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Thomas F. DiLullo, CPA, JD, LLM (in taxation) is a practicing New Jersey Tax Lawyer. DiLullo has practiced Federal and State Tax law in New Jersey since 1984. In recent years, his tax practice has focused on helping people with tax problems who owe more Federal or State taxes than they could afford to pay, persons disputing the amount of taxes they owe, and on business and individual tax planning.