Barrows v. IRS CV-97-550-JD 09/25/98 P UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW HAMPSHIRE
Jerry Barrows, et al.
v. Civil No. 97-550-JD
Internal Revenue Service
O R D E R
The appellants, Gerald and Angela Barrows, were debtors in a
Chapter 7 bankruptcy proceeding in which the appellee, the
Internal Revenue Service, filed a proof of claim after
disallowing a number of tax deductions from the appellants' 1987
income tax return. The Barrows appeal the bankruptcy court's
decisions regarding the allowance of the deductions, its denial
of their first motion to reconsider, and its final amended
judgment (document no. 3) .
Background1
The appellants filed a joint federal income tax return for
the tax year 1987 in October, 1988. On June 26, 1991, the IRS
issued a statutory notice of deficiency reflecting outstanding
federal income tax liabilities for 1987 of $50,736.00, plus
1The facts discussed herein are either the findings of fact of the bankruptcy court or undisputed, unless otherwise noted. interest and various penalties. The alleged deficiency resulted
from unreported dividend income, unreported interest income, and
unreported proceeds of stock sales. The deficiency also
reflected the disallowance of legal expenses, travel expenses,
and miscellaneous deductions because the appellants failed to
adeguately substantiate the expenses, or because the appellants
failed to establish that the expenses were for ordinary and
necessary business purposes or were expended for the purposes
alleged. After several failed attempts by the appellants to file
a proper petition in tax court, the court dismissed the
appellants' case for lack of jurisdiction on March 10, 1992. The
IRS then assessed the deficiency against the appellants on July
10, 1992.
Meanwhile, the appellants had filed a petition under Chapter
11 of the Bankruptcy Code on January 19, 1990. On July 9, 1990,
the Internal Revenue Service ("IRS") filed a proof of claim for
$200,646.39. The proof of claim asserted a proposed tax
assessment for 1987, and estimated claims for 1988 and 1989. On
July 31, 1990, the appellants' bankruptcy case was converted to a
Chapter 7 proceeding. On November 11, 1990, the IRS filed a
second proof of claim for $216,601.54, asserting the same tax
allegedly owed for the years 1987, 1988, and 1989 as the first
proof of claim, but adding accrued interest and penalties.
2 On August 30, 1995, the IRS filed an amended proof of claim
of $71,565.10, asserting the appellants' tax liability and
related interest and penalties for 1987. The liabilities for
1988 and 1989 were removed from the proof of claim. On May 2,
1996, the bankruptcy court issued an order directing the IRS to
file an amplified statement in support of their proof of claim.
The IRS filed the amplified statement on May 31, 1996, along with
a motion for summary judgment on the entire $71,565.10 allegedly
due, using the amplified statement as the memorandum in support
of the motion for summary judgment.
The appellants filed an objection to the motion for summary
judgment on June 6, 1996, challenging the objection as premature.
They argued that nothing in the IRS's statement amplified any of
the documents at issue, and therefore the IRS had not explained
the disputed claim in any greater detail than before. The
appellants then specifically contested the IRS's disallowance of
certain miscellaneous deductions.
On July 23, 1996, the bankruptcy court held a hearing on the
appellants' objection to the IRS's claim and motion for summary
judgment. At the hearing the court determined that the only
issue in dispute was the disallowance of $106,958.00 in
miscellaneous itemized deductions. The court also found that
summary judgment was unwarranted as the IRS's explanations for
3 disallowing certain deductions were not apparent until the
evidentiary hearing. The findings, although made in an oral
order issued from the bench at the hearing, were also reflected
in the court's order of August 1, 1996. Specifically, the court
stated in the August 1, 1996, order:
As indicated above, the hearing has also served to determine that the only guestion in dispute with regard to the IRS's tax claim is the disallowance of $106,958 from the total miscellaneous deductions claimed on the debtor's tax return for 1987 of $113,048, because Gerald Barrows conceded that he had failed to report certain interest and dividend income for the tax year 1987 .
In re Barrows, Bk. No. 90-68, slip op. at 3 (Bankr. N.H. Aug. 1,
1996) ("August 1, 1996, order"). The bankruptcy court
established a schedule setting dates on which the appellants were
to submit any evidence they might have had substantiating their
deductions, and the IRS in turn was to submit any additional
evidence it might have had.
On January 14, 1997, the bankruptcy court issued a second
order setting a new schedule because the August 1, 1996, order
was not served properly and the parties did not have notice of
it. The order of January 14, 1996, stated that the IRS "shall
submit any documentation it may have in response to the further
documentation that the debtors provided to the IRS." In re
Barrows, Bk. No. 90-68, slip op. at 5 (Bankr. N.H. Jan. 14, 1997)
4 ("January 14, 1997, order").
The bankruptcy court held an evidentiary hearing on the
miscellaneous itemized deductions remaining in dispute on March
17, 1997. On March 21, 1997, the court issued an interlocutory
order establishing certain allowable deductions for 1987 and
disallowing the rest. On April 2, 1997, the appellants filed a
motion for reconsideration of the order entered on March 21,
1997. On May 1, 1997, the court held a hearing on the motion for
reconsideration, after which it entered an order denying the
motion. The IRS was ordered to file a proposed final judgment on
the appellants' objection to the claim, which it did on May 9,
1997 .
On May 12, 1997, the appellants filed a second motion for
reconsideration of the May 1, 1997, order denying their first
motion for reconsideration. On July 17, the court held a hearing
on the appellants' second motion for reconsideration. The court
granted the motion in so far as it allowed the appellants to
deduct an additional $7,194.28 of miscellaneous itemized expenses
for 1987, reflecting the IRS's concession of an item at the March
17, 1997, hearing. The court also directed the IRS to prepare an
amended final order to incorporate the additional allowance.
On July 31, 1997, the appellants filed a motion for a new
trial, which was denied. On August 28, 1997, the bankruptcy
5 court issued its amended final judgment establishing the IRS's
claim for 1987 at $40,093.28.
On appeal, the appellants seek reversal of: 1) the March
21, 1997, interlocutory order summarizing the findings of the
court from the March 17, 1997, hearing; 2) the May 1st, 1997,
order denying the appellants' first motion to reconsider; and 3)
the August 28, 1997, amended final judgment establishing the
amount of the IRS claim at $40, 093.28.2 The appellants assert
six grounds on which they allege the bankruptcy court erred,
although they do not correlate the alleged errors with the
specific orders they seek reversal of. The court will address
each of the alleged errors seriatim.
Discussion
This court reviews a bankruptcy court's conclusions of law
de novo. See Prebor v. Collins (In re I Don't Trust), 143 F.3d
1, 3 (1st Cir. 1998). The bankruptcy court's factual findings
and application of properly construed law to fact are reviewed
for clear error. See Winthrop Old Farm Nurseries v. New Bedford
Inst. For Sav. (In re Winthrop Old Farm Nurseries), 50 F.3d 72,
2Although both Angela and Gerald Barrows filed and signed an appeal, subseguent filings are signed solely by Gerald Barrows. The court understands both Angela and Gerald Barrows to be appellants in this case.
6 73 (1st Cir. 1995). Evidentiary rulings are reviewed for abuse
of discretion. See Williamson v. Busconi, 87 F.3d 602, 603 n.l
(1st Cir. 1996).
A. Default
The appellants first assert that the bankruptcy court erred
in not entering a default judgment against the IRS for its
alleged failure to submit documentation. The appellants aver
that the IRS failed on two occasions to respond to the bankruptcy
court's orders reguiring the IRS to submit certain information to
the court.
In its August 1, 1996, order, the bankruptcy court directed
the IRS to "submit any documentation it may have in response to
whatever documentation the debtors provide to the IRS . . . ."
In re Barrows, Bk. No. 90-68, slip op. at 5 (Bankr. N.H. Aug. 1,
1996) ("August 1, 1996, order"). The IRS did not submit any
further documentation. In a subseguent order dated January 14,
1997, the bankruptcy court determined that the IRS's lack of
response was attributable to the defective service of the August
1st order. See January 14, 1997, order at 1. The court
therefore granted the IRS until February 18, 1997, to "submit any
documentation it may have in response to the further
documentation that the debtors provided to the IRS." Id. The
7 IRS again did not submit any further documentation. The
appellants assert that the IRS therefore defaulted.
Entry of a default judgment is committed to the discretion
of the bankruptcy court, and the decision will not be reversed
unless the bankruptcy court abused its discretion. See Jones
Truck Lines, Inc. v. Foster's Truck & Equipment Sales (In re
Jones Truck Lines, Inc.), 63 F.3d 685, 686 (8th Cir. 1995).
The IRS had already filed an amended proof of claim on
August 30, 1995, followed by an amplified statement of the claim
pursuant to court order on May 31, 1996. The proof of claim
established the presumptive validity and amount of the claim.
See Fed. R. Bankr. P. 3001(f) ("A proof of claim . . . shall
constitute prima facie evidence of the validity and amount of the
claim."). At this point, the burden to overcome the presumption
of validity is placed on the objecting party. See In re
Hemingway Transp., Inc., 993 F.2d 915, 925 (1st Cir. 1993)
(citing Norton Bankruptcy Law and Practice, Bankruptcy Rules at
191 (Clark Boardman Callaghan 1992)). Having established the
presumptive validity of its claim, the IRS did not have to submit
additional documentation or risk default, and nothing in the
bankruptcy court's orders indicate that the IRS faced default if
they failed to provide additional documentation. See August 1,
1996, order at 5; January 14, 1997, order at 1. If anything, the orders indicate that the IRS may be precluded from submitting
additional documentation at a later date if they failed to submit
the documents in accordance with the court ordered schedule. In
other words, additional submissions were optional. The
bankruptcy court therefore did not abuse its discretion when it
did not find the IRS in default.
B. Exclusion of Evidence
The appellants next contend that the bankruptcy court erred
when it refused to allow them to enter certain documents into
evidence. The appellants do not specify which documents are
contested, although from the appellants' citation to the trial
transcript it appears that the excluded evidence was a summation
of financial transactions drafted by the appellants. See Brief
and Appendix for the Pro Se Debtor Plaintiff Appellant at 5
("Appellants' Brief"); Transcript of Morning Session Only of
Final Hearing on Objection to Claim of IRS (Claim No. 23) Filed
by Debtor Before the Honorable James E. Yacos, J.U.S.B.C. at 29
(March 17, 1997) ("Morning Tr."). The transcript does not
indicate the bankruptcy court's reasoning behind its decision.
The Federal Rules of Evidence are applicable to cases under
the Bankruptcy Code, see Fed. R. Bankr. 9017, and pursuant to the
best evidence rule, the appellants were reguired to provide the original document unless an exception was applicable, see Fed. R.
Evid. 1002, 1004. The appellants did not establish that any
exceptions were applicable, and as the document was a summation
of other documents and not the original, it was properly
excluded. Moreover, the mere fact that the appellants may be
reguired by court order to provide certain information in
discovery to other parties does not establish the admissibility
of that information at trial. See F. Bankr. R. 7034; Fed. R.
Civ. P. 26 (b)(1). The bankruptcy court did not abuse its
discretion.
C. Burden of Proof
The appellants also contend that the bankruptcy court erred
in failing to resolve prior to the evidentiary hearing on March
17, 1997, which side carried the ultimate burden of persuasion,
and in relying on previously undisclosed case law in making its
determination. The appellants fail to indicate any authority,
and the court is unaware of any, that supports the appellants'
contention that a court is obligated to provide or explain
controlling law to the parties, even those appearing pro se, in
advance of trial. The appellants had notice that the court had
not yet resolved the burden of persuasion guestion. They
therefore were aware that the court might find it was the
10 appellants who carried the ultimate burden of persuasion.3 See
August 1, 1996, order at 2-3. If this determination affected the
appellants' trial preparation, prudence suggests they should have
been prepared to carry the burden of persuasion.
In the event the appellants also intended to argue that the
bankruptcy court erroneously reguired them to carry the burden of
persuasion, the court will also review the substantive legal
standard applied by the bankruptcy court. In general, courts
have placed the ultimate burden of persuasion of proving the
validity and amount of a claim on the claimant in a bankruptcy
proceeding. See Juniper Dev. Group v. Kahn (In re Hemingway
Transp., Inc.), 993 F.2d 915, 925 (1st Cir. 1993); see also,
Norton Bankruptcy Law and Practice, Bankruptcy Rules, at 189
(Clark Boardman Callaghan 1996) ("Of course, once the presumption
[of the validity and amount of a claim established by the proof
3Indeed, at the July 23, 1996, hearing the court stated that the IRS had established the specifics of its tax claim "sufficient to throw the burden of proof to the debtor to document the items in guestion - the deductibility of the items in guestion. That burden of proof is the burden of persuasion and not just the burden of going forward . . . ." Transcript Of Hearing On Objection To Claim Of IRS, Filed By Debtors; Motion For Summary Judgment Filed By IRS Before The Honorable James E. Yacos, J.U.S.B.C. at 61 (July 23, 1996) ("July 23 Tr."). Although in its subseguent order the court indicated that the law was unresolved, this statement should clearly have put the appellants on notice that they might carry the burden of persuasion.
11 of claim] is overcome, the ultimate burden to establish the
validity of a claim is placed on the creditor.").
Requiring the claimant in a bankruptcy proceeding to carry
the burden reflects the "general principle [of placing] the
claimant in the same position it would have been in as a civil
plaintiff outside of the bankruptcy context." Thinking Machs.
Corp. v. New Mexico Taxation and Revenue Dept., 211 B.R. 426, 430
n.5 (D. Mass. 1997). Unlike a private civil claimant, however,
in cases outside the bankruptcy context the IRS enjoys the
benefit of having "taxpayers bear the burden of proving that a
tax deficiency is erroneous." Delaney v. Commissioner of
Internal Revenue, 99 F.3d 20, 23 (1st Cir. 1996). Both the
Bankruptcy Code and the Federal Rules of Bankruptcy Procedure are
silent as to whether the general rule in bankruptcy proceedings
requiring the claimant to carry the ultimate burden of persuasion
is supplanted in cases where the claimant is a taxing authority.
See Franchise Tax Bd. v. MacFarlane (In re MacFarlane), 83 F.3d
1041, 1045 (9th Cir. 1996); Thinking Machs., 211 B.R. at 428-29.
The circuits are split as to which party should bear the
burden of persuasion in disputes in bankruptcy proceedings, with
the Third, Fourth, and Seventh Circuits holding that the
taxpayer/debtor should bear the burden in the bankruptcy context,
and the Fifth, Eighth, Ninth, and Tenth Circuits holding that the
12 burden should rest on the taxing authority. See Franchise Tax
Bd. v. MacFarlane (In re MacFarlane), 83 F.3d 1041, 1045 (9th
Cir. 1996), cert, denied, -- U.S. 117 S.Ct. 1243 (1997);
Brown v. Internal Revenue Service (In re Brown), 82 F.3d 801, 805
(8th Cir. 1996); Placid Oil Co. v. Internal Revenue Service (In
re Placid Oil Co.), 988 F.2d 554, 557 (5th Cir. 1993); United
States Internal Revenue Service v. Charlton, 2 F.3d 237, 239-40
(7th Cir. 1993); Internal Revenue Service v. L e w (In re Landmark
Equity Corp.), 973 F.2d 265, 268-71 (4th Cir. 1992); Fullmer v.
United States (In re Fullmer), 962 F.2d 1463, 1466 (10th Cir.
1992); Resvn Corp. v. United States, 851 F.2d 660, 663 (3d Cir.
1988) . The First Circuit has not yet addressed the issue. See
Thinking Machs., 211 B.R. at 429.
Legislative history reflects the fact that the Bankruptcy
Code, in resolving claims against an estate, "does not endeavor
to supplant the substantive law under which the claim against the
estate . . . arose." In re Landmark Equity Corp., 973 F.2d at
270 .4 Where "the internal goals of the bankruptcy system reguire
alteration of externally created substantive rights, including
'(1) eguality of distribution between the creditors, (2) a fresh
start to the debtor, and (3) economical administration [of the
4The burden of proof is part of substantive tax law. See Dick v. New York Life Ins. Co., 359 U.S. 437, 446 (1959).
13 bankruptcy system,]'" displacing the substantive law may be
warranted. Id. (quoting Report of the Commission on the
Bankruptcy Laws of the United States, H.R. Doc. No. 137, 93d
Cong., 1st Sess., P t . I, 75 (1973) (alteration in the original)).
Congress has not indicated an intent to displace the
substantive tax law requirement that the taxpayer bear the burden
of proof regarding a claim. See In re Landmark Equity Corp., 973
F.2d at 270 ("[N]o portion of the Bankruptcy Code expresses a
policy or intent to replace any aspect of the federal tax law
with any special legal requirement to be applied only in the
context of a bankruptcy proceeding."). Nor does the court find a
conflict between the bankruptcy system's goals and the allocation
of the burden of persuasion in tax cases that compels supplanting
the substantive tax law. The first goal of the bankruptcy
system, equal distribution among creditors, might be adversely
affected to some extent if the taxpayer-debtor carried the burden
of proof, favoring the IRS over other creditors. See MacFarlane,
83 F.3d at 1045. However, Congress has already accorded taxing
authorities as a class more favorable treatment under the
Bankruptcy Code. Tax claims receive statutory priority over
other creditors' claims, see 11 U.S.C.A. § 507(a)(8)(A) (West
Supp. 1998), and unlike other creditors' claims, tax-related
debts cannot be discharged in bankruptcy, see 11 U.S.C.A.
14 523(a) (1) (West 1993) . See also. Thinking Machs., 211 B.R. at
430; 15 Collier on Bankruptcy, 51X5.03[5] (15th ed. 1997) (The
MacFarlane position "overlooks the frequent disparate treatment
of the government as tax-creditor found in the Bankruptcy Code
regarding such matters as the priority and dischargeability of
claims."). Second, although one could envision some detrimental
effect on the goal of providing a "fresh start" to the debtor by
the bankruptcy process, the court does not find the effect to be
significant. Conversely, the third goal, the efficient
administration of bankruptcy cases, would be facilitated by
placing the burden of persuasion on the taxpayer-debtor. The
taxpayer has control over information relevant to the tax claim.
Requiring the taxpayer to come forward with such information
would reduce problems frequently encountered during the discovery
process, and thereby free the bankruptcy court from becoming
embroiled in discovery disputes. The court therefore does not
find that the goals of the banking system require supplanting the
substantive tax law.
In contrast, the court finds two compelling policy reasons
for maintaining the substantive tax law in bankruptcy proceedings
and requiring the debtor to carry the burden of persuasion where
the claimant is a taxing authority. First, if the burden of
proof was allocated differently between the bankruptcy forum and
15 other forums, there would be a great incentive for taxpayers to
forum shop. Simply by filing for bankruptcy, the taxpayer could
shift the potential responsibility for establishing the validity
and amount vel non of a tax claim to the taxing authority.
Second, as observed by the court in Thinking Machs., "if the
taxpayer knows that the burden of proof falls upon the taxing
authority, it would have little incentive to maintain the
necessary records, thereby making the government's case more
difficult if not impossible to establish." 211 B.R. at 431
(citations and guotations omitted). The bankruptcy court did not
err in holding that the burden of persuasion rested with the
appellants and not the IRS.
D. New Legal Theory
The appellants also argue that the bankruptcy court erred by
allowing the IRS to assert a new "legal theory" at trial,
although the appellants do not specify what legal theory they
refer to. However, in their first motion to reconsider they
argued that the IRS should not have been permitted to assert a
new "legal theory" disallowing expenses simply because the
expenses listed in the appellants' check ledger did not
correspond to those listed in their tax return. The appellants
also assert that the "legal theory" was untimely.
16 The court does not find that any new legal theory was
advanced. Instead, after reviewing the transcript, the court
finds that the bankruptcy court simply determined that the
appellants failed to provide sufficient evidence to establish
that the appellants were entitled to certain deductions. See
Transcript of Afternoon Session Only of Final Hearing on
Objection to Claim of IRS (Claim No. 23) Filed by Debtor Before
the Honorable James E. Yacos, J.U.S.B.C. at 29-80 (March 17,
1997). Moreover, the appellants have not established that the
bankruptcy court's determinations were clearly erroneous.
E. Items in Dispute
Finally, the appellants assert that the bankruptcy court
mistakenly found the only item in dispute at the March 17, 1997,
hearing was a disallowance of $106,958.00 out of $113,048.00 in
miscellaneous expense deductions, and therefore it erroneously
precluded them from arguing the validity of other deductions.
The burden is on the appellants to show that the bankruptcy
court's findings of fact were clearly erroneous. See Bankr. R.
8013; see also, Ballato v. Ballato, 190 B.R. 447, 448 (M.D. FI.
1995) .
On May 31, 1996, the IRS filed both its motion for summary
judgment and its amplified statement. The motion sought summary
17 judgment on the entire claim asserted by the IRS. The appellants
filed an objection, which they titled an "initial objection,"
asserting that summary judgment was premature, and that the IRS
had not adeguately amplified their claim. In the objection the
appellants contested only the miscellaneous itemized deductions.
See Debtors' "Initial Objection" to United States Motion for
Summary Judgment on Debtor's Objection to Internal Revenue
Service Proof of Claim #23 (8/28/95) at 2, 3. The record does
not indicate that the appellants filed any other objections with
the court. Moreover, at the July 23, 1996, hearing on the
appellants' objection to the IRS's motion for summary judgment,
the appellants were asked whether they were contesting other
items, to which the appellants replied in the negative. See July
23 Tr. at 61. In addition, the appellants never responded or
objected to the oral order the judge issued from the bench at the
July 23 hearing, when the judge stated that "[t]he hearing has
also served to determine that the only guestion in dispute with
regard to the Government's tax claim is the disallowance of the -
of 106,000 and $958 of the total miscellaneous deductions claimed
on the tax return for 1987 of $113,048." July 23 Tr. at 65.
Indeed, the subject matter of the July 23 hearing revolved almost
exclusively around the miscellaneous deductions.
Following the July 23 hearing the bankruptcy court issued
18 the August 1, 1996, order which provided the basis for the March
17, 1997, evidentiary hearing. In the August 1, 1996, order, the
bankruptcy court again stated that "[t]he July 23, 1996,] hearing
has also served to determine that the only guestion in dispute
with regard to the IRS's tax claim is the disallowance of
$106,958 from the total miscellaneous expense deductions claimed
on the debtor's tax return for 1987 of $113,048, because the
debtor Gerald Barrows conceded that he had failed to report
certain interest and dividend income for tax year 1987." August
1, 1996, order at 3. The appellants argue that because the order
only stated that the appellants conceded interest and dividend
income, the March 17, 1997, evidentiary hearing should have
encompassed consideration of additional items. See Appellants'
Brief at 4. They also argue that the July 23, 1996, hearing
clearly established that the only item conceded was interest
income.
This court disagrees. Given the content of the appellants'
written objection, the subject matter of the July 23, 1996,
hearing, the appellants' response to the court's guestioning and
their silence in the face of the court's oral order, the
bankruptcy court's factual conclusion was not clearly erroneous.
To the extent that the appellants did wish to pursue other
objections, they failed to do so below and the objections are
19 waived. Finally, the court does not find compelling the
appellants' argument that the bankruptcy court only stated they
had conceded interest and dividend income. See August 1, 1996,
order at 3. It is not clear that the court was intending to make
an exclusive list, and in so far as the statement is in conflict
with the preceding determination that only miscellaneous
deductions were contested, it would appear that the list was not
intended to be exclusive. The court therefore finds the
appellants failed to establish that the bankruptcy court's
conclusions were clearly erroneous.
In light of the above discussion, the court finds the
appellants have not met their burden of establishing that the
court erred, factually or legally, in the interlocutory order
issued on March 21, 1997, as amended by the court in following
orders. They also failed to establish either that the court's
amended final judgment, or its rejection of their first motion
for reconsideration, after accounting for the concession of the
IRS as reflected in their second motion for reconsideration, was
in error.
20 Conclusion
For the reasons discussed above, the decision of the
bankruptcy court is affirmed.
SO ORDERED.
Joseph A. DiClerico, Jr. District Judge
September 25, 1998
cc: Gerald Barrows, pro se Angela Barrows, pro se William M. Kostak, Esguire George Vannah, Clerk, US Bankruptcy Court
21 22