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Bankruptcy court cannot partially disallow penalties.

The Eleventh Circuit recently held that penalties assessed by the IRS for failure to file, failure to pay and failure to pay estimated tax must either be sustained in full or disallowed in full when reviewed by the courts. According to the appeals court, a bankruptcy court erred in disallowing two-thirds of the penalties the Service asserted; the Code allows only a full waiver or none at all, depending on whether the taxpayer satisfies the statutory requirements for waiver (Sanford, 11th Cir., 1992, vac'g and rem'g unreported DC).

In Sanford, an elderly and ailing taxpayer had relied on his ex-wife and her accountant to handle his personal business and tax matters. In 1989, the taxpayer was forced into bankruptcy, and the IRS asserted an unsecured priority claim for taxes, interest and penalties for 1983 through 1988, including penalties under Secs. 6651(a)(1) (failure to file), 665 1 (a) (2) (failure to pay) and 6654 (failure to pay estimated tax).

The taxpayer did not dispute his tax liability, but he did urge the bankruptcy court to eliminate or reduce the penalties, arguing that he had shown good cause for failing to file the returns and to pay tax for the years at issue. The bankruptcy court ordered payment of all the tax liabilities, but reduced the amount of the penalties by two-thirds. After the district court upheld the bankruptcy court's decision, the Service appealed.

As the Eleventh Circuit noted, a claim against a bankruptcy estate is to be allowed only if the claim would be enforceable outside of bankruptcy. Under Sec. 665 1 (a)(1) and (2), the penalties for failures to file and to pay will be imposed "unless" the taxpayer can show reasonable cause for those failures. The court reasoned that the statutory term "unless" does not allow for partial waiver; penalties must be imposed in full except when the taxpayer establishes reasonable cause, in which case the penalties should not be assessed at all.

The penalty for underpayment of estimated tax may be waived, under Sec. 6654(c)(3)(A), "to the extent that," by reason of unusual circumstances, the imposition of such penalty would be against equity and good conscience. The court noted that, in Mr. Sanford's case, the penalty for failure to pay estimated tax either had to be waived in full or sustained in full. According to the court, the taxpayer's ill health and reliance on his ex-wife and accountant were the cause of the underpayments; these "unusual circumstances" either justified all of the underpayments or none at all.

In light of its decision, the court returned the case to the bankruptcy court to determine whether the taxpayer met the waiver requirements of Sec. 6651 or 6654, directing the bankruptcy court to waive the penalties in full for each year for which the statutory requirements were met.
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Title Annotation:U.S. Court of Appeals for the 11th Circuit's decision in Sanford
Author:Peterson, Lori E.
Publication:The Tax Adviser
Date:Jun 1, 1993
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