534 B.R. 839
Bankr. M.D. Ga.2015Background
- Debtors prosecuted an objection to the IRS proof of claim asserting a $86,385 priority claim based on the 10% early-withdrawal exaction of I.R.C. § 72(t) (the “Exaction”).
- The IRS asserted § 507(a)(8) priority either as an income tax (§ 507(a)(8)(A)) or alternatively as a penalty that compensates the government for actual pecuniary loss (§ 507(a)(8)(G)).
- Parties stipulated to material facts; the IRS had timely filed and amended its proof of claim. The government bore the burden to prove priority.\
- The core legal question required a functional (not label-based) analysis of whether § 72(t) is a “tax” for § 507(a)(8) purposes or a non-pecuniary penalty.\
- The court held a hearing and resolved competing precedent (notably United States v. Reorganized CF & I Fabricators and In re Cassidy) in applying the functional test and bankruptcy policy of equal distribution.
Issues
| Issue | Plaintiff's Argument (Debtors) | Defendant's Argument (IRS) | Held |
|---|---|---|---|
| Whether the § 72(t) 10% exaction is a "tax" under § 507(a)(8)(A) | §72(t) is primarily a deterrent/penalty and thus not a tax entitled to priority | The Tax Code labels it a "tax"; CF&I requires functional analysis but IRS contends revenue or mixed purpose suffices | Not a tax for §507(a)(8); primary purpose is deterrence, so no priority |
| Whether the Exaction is a penalty compensating for actual pecuniary loss under §507(a)(8)(G) | Exaction is punitive/deterrent and not tied to actual government pecuniary loss | Exaction recoups lost revenue from deferred taxation (or recaptures earnings) so compensates pecuniary loss | Not a compensatory penalty; no cognizable relation to actual pecuniary loss, so no priority |
| Whether CF & I or subsequent cases (e.g., Nat'l Fed.) foreclose considering deterrent purpose or lawful/unlawful conduct | Debtors: CF & I permits functional inquiry including bankruptcy policy; deterrent purpose bars priority | IRS: CF & I and Nat'l Fed. suggest penalty means punishment for unlawful conduct; because withdrawals are lawful, §72(t) cannot be a penalty for §507 | Court: CF & I does not limit the analysis to unlawful conduct; functional, purposive inquiry (including §507 policies) controls |
| Burden of proof on priority and relevance of Tax Code labeling | Debtors: labels irrelevant; IRS must prove §507 entitlement | IRS: label and consistent Tax Code treatment (and Tax Court interpretations) carry persuasive weight | Labels are not dispositive; IRS bears burden and must show primary government-support purpose or compensatory pecuniary loss |
Key Cases Cited
- United States v. Reorganized CF & I Fabricators of Utah, Inc., 518 U.S. 213 (functional test governs whether an exaction is a tax or penalty for bankruptcy priority)
- In re Cassidy, 983 F.2d 161 (10th Cir. 1992) (held § 72(t) is a non-pecuniary deterrent penalty, not a § 507 priority tax)
- New York v. New York, 315 U.S. 510 (examining whether exactions support the government and distinguishing taxes from penalties for priority)
- New Jersey v. Anderson, 203 U.S. 483 (federal courts apply functional test to decide whether state exaction is a tax for federal priority rules)
- United States v. Sotelo, 436 U.S. 268 (treating labeled "penalty" as a tax for nondischargeability where function and history so indicate)
- Rousey v. Jacoway, 544 U.S. 320 (recognizing §72(t) as a substantial tax penalty functioning to deter early IRA withdrawals)