by The debt created by the IRS’s first-time-homeowner’s tax credit, which requires a debtor to repay the credit over fifteen years, was a nondischargeable “tax” rather than a dischargeable “loan.” In re Shin, No. 17-13509 (Bankr. E.D. Va. Feb. 16, 2021).
The debtor bought a house with his mother and sister, taking the $7,500.00 first-time homeowner federal tax credit offered by the IRS. The Internal Revenue Code, sections 36(f)(1) and (7), provides that homeowners receiving the tax credit must repay that credit over fifteen years by increasing their yearly taxes. The tax recapture is automatically accelerated upon sale of the property within the fifteen-year payback period. For several years, the debtor paid the recapture tax to the IRS, but when he and his co-owners sold the house, there remained $5,000.00 in unpaid recapture tax. The debtor filed for chapter 7 bankruptcy and received a discharge. After the case was closed the debtor moved to reopen to allow him to seek a ruling that the recapture tax was discharged. The IRS opposed the motion.
Section 350(b) provides that a bankruptcy court has discretion to reopen a closed case “to administer assets, to accord relief to the debtor, or for other cause.” Although a motion to reopen generally does not involve an adjudication on the merits, a bankruptcy court will not reopen where reopening would be an exercise in futility.
The question before the bankruptcy court was whether the tax credit was a loan creating a debt which could be discharged in bankruptcy, as argued by the debtor, or whether it was a nondischargeable tax debt under sections 507(a)(8) and 523(a)(1), as argued by the IRS. The answer to the question depends not on the label given to the exaction, but to its “actual effects.”
The court noted that two cases addressing the issue of whether a first-time-homeowner tax credit creates a tax debt came to opposite conclusions. In In re Bryan, A.P. No. 13-1151, 2014 WL 789089 (Bankr. N.D. Cal. Feb. 27, 2014), the court relied on the designation of the recapture as a “tax” in the Tax Code to hold that the exaction was a nondischargeable tax debt. Expressing the opposite view, the court in In re Betancourt, 582 B.R. 480 (Bankr. W.D. Mo. 2018), found that the tax credit operated more like an interest-free loan than a tax and was, therefore, dischargeable.
The Shin court disagreed with the reasoning of both courts, finding that, in Bryan, the court failed to apply the functionality test set out by the Supreme Court in United States v. Reorganized CF&I Fabricators of Utah, Inc., 518 U.S. 213, 221 (1996), and, in Betancourt, the court misapplied the functionality test by relying too much on the descriptor given by the IRS rather than looking at recapture as a revenue-generating tool for the government. Further, the court found Betancourt’s analysis of the tax debt under bankruptcy provisions side-stepped the fundamental issue of whether the debt was a “tax.”
Finding that the recapture tax operates as a “tax,” the court agreed with the conclusion reached in Bryan. The court found the tax credit functions as a tax whose repayment is spread over a longer period of time than it would have been without the credit. On that basis, the court found that reopening the debtor’s case to allow him to challenge the dischargeability of the recapture tax would be futile. It denied the motion.