Leonard Hutchinson v. Irs

FOR PUBLICATION

UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT

IN RE LEONARD E. HUTCHINSON; No. 19-60065
SONYA C. HUTCHINSON,
Debtors, BAP No.
19-1047

LEONARD E. HUTCHINSON; SONYA C.
HUTCHINSON, ORDER AND
Plaintiffs-Appellants, AMENDED
OPINION
v.

UNITED STATES OF AMERICA,
DEPARTMENT OF TREASURY,
INTERNAL REVENUE SERVICE; JAMES
SALVEN, Chapter 7 Trustee,
Defendants-Appellees.

Appeal from the Ninth Circuit
Bankruptcy Appellate Panel
Gan, Faris, and Brand, Bankruptcy Judges, Presiding

Argued and Submitted October 13, 2020
San Francisco, California

Filed October 19, 2021
Amended December 23, 2021
2 IN RE HUTCHINSON

Before: Ferdinand F. Fernandez, Kim McLane Wardlaw,
and Daniel P. Collins, Circuit Judges.

Order;
Opinion by Judge Collins

SUMMARY *

Bankruptcy

The panel affirmed the Bankruptcy Appellate Panel’s
decision affirming the bankruptcy court’s dismissal of
Chapter 7 debtors’ adversary complaint concerning tax liens
asserted by the Internal Revenue Service.

The IRS recorded liens for unpaid taxes, interest, and
penalties against debtors’ residence. After debtors filed for
bankruptcy, the IRS filed a proof of claim for both the
secured and unsecured portions of its then-existing claim for
unpaid taxes, interest, and penalties. The portion of the
claim that was secured by liens on debtors’ residence and
attributable only to penalties was over $162,000. Debtors
had filed an adversary proceeding against the United States
and the Chapter 7 trustee, asserting that the IRS’s claim for
penalties was subject to avoidance by the trustee, and that
because the trustee had not attempted to avoid this claim,
debtors were empowered to do so under 11 U.S.C. § 522(h).
Debtors sought to avoid the liens and to preserve the liens
for debtors’ benefit. The trustee cross-claimed against the

*
This summary constitutes no part of the opinion of the court. It
has been prepared by court staff for the convenience of the reader.
 IN RE HUTCHINSON 3

United States, asserting the right, as trustee, to avoid the
liens and alleging that, to the extent the liens were avoided,
their value should be recovered for the benefit of the
bankruptcy estate. The bankruptcy court dismissed the
adversary complaint for failure to state a claim, and it
entered a stipulated judgment in which the trustee and the
United States agreed that the penalty portions of the IRS’s
liens were avoided pursuant to 11 U.S.C. § 724(a). The BAP
affirmed the dismissal.

Affirming the dismissal of debtors’ first cause of action,
the panel held that § 522(h) did not authorize debtors to
avoid the liens that secured the IRS’s penalties claim. Under
§ 522(h) a transfer (including a lien) can be avoided by a
debtor if (1) the transfer is avoidable by the trustee under
§ 724(a); (2) the trustee does not attempt to avoid the
transfer; and (3) the debtor could have exempted the
property under § 522(g)(1) if the trustee had avoided the
transfer. One of the components of the third of these
requirements is that “the debtor could have exempted such
property” under § 522(b) “if such property had not been
transferred.” Debtors contended that they met this
component because § 522(b) allowed them to exempt their
interest in their principal residence up to the extent of their
$100,000 homestead exemption under California law. The
panel held that this contention was foreclosed by DeMarah
v. United States (In re DeMarah), 62 F.3d 1248 (9th Cir.
1995), which held that, because, under § 522(c)(2)(B),
Congress has denied debtors the right to remove tax liens
from their otherwise exempt property, they may not avoid a
lien for tax penalties under § 522(h). The panel held that
debtors’ first cause of action also failed because the trustee
did attempt to avoid the tax lien to the extent that it secured
the penalties claim.
4 IN RE HUTCHINSON

Debtors further contended that, even if the trustee acted
to avoid the liens, the property should have been preserved
for debtors’ benefit, rather than for the benefit of the estate.
Therefore, either their second cause of action should not
have been dismissed or they should have been allowed to
intervene in the trustee’s cross-claim against the United
States. The panel held that debtors could not preserve for
their own benefit the portions of the tax liens that were
avoided by the trustee, and their complaint was therefore
properly dismissed in its entirety with prejudice. The panel
held that, under the plain language of 11 U.S.C. § 551, a
transfer that is avoided by the trustee under § 724(a) is
preserved for the benefit of the estate. The panel held that
this aspect of § 551 is not overridden by § 522(i)(2), which
provides that property may be preserved for the benefit of
the debtor to the extent of a homestead exemption, because,
under DeMarah, § 522(i)(2) is subordinate to
§ 522(c)(2)(B)’s bright-line rule that debtors lack the right to
remove tax liens from their otherwise exempt property.

COUNSEL

David R. Jenkins (argued), David R. Jenkins APC, Fresno,
California, for Debtors-Appellants.

Robert J. Branman (argued) and Bruce R. Ellisen, Attorneys,
Tax Division; David A. Hubbert, Deputy Assistant Attorney
General; Richard E. Zuckerman, Principal Deputy Assistant
Attorney; McGregor W. Scott, United States Attorney; Tax
Division, United States Department of Justice, Washington,
D.C., for Appellee United States of America.
 IN RE HUTCHINSON 5

Russell W. Reynolds (argued) and Kelsey A. Seib, Coleman
& Horowitt LLP, Fresno, California, for Appellee James
Salven.

ORDER

The opinion filed on October 19, 2021, and reported at
15 F.4th 1229, is amended by changing the penultimate
textual sentence of Section III to read as follows:

The only way to read these provisions
sensibly together is to conclude that, with
respect to a tax lien covered by
§ 522(c)(2)(B), a debtor may not invoke
§ 522(i)(2) in order to override § 551’s
otherwise applicable rule that, after the
trustee avoids a lien under § 724(a), the lien
“is preserved for the benefit of the estate.” Id.
§ 551.

An amended version of the opinion, reflecting this
change, accompanies this order.

With the opinion as amended, the panel has unanimously
voted to deny the petition for panel rehearing filed on
November 24, 2021 (Dkt. Entry 39).

Accordingly, the petition for rehearing is DENIED. No
further petitions for rehearing or rehearing en banc will be
entertained.
6 IN RE HUTCHINSON

OPINION

COLLINS, Circuit Judge:

Plaintiffs Leonard E. Hutchinson and Sonya C.
Hutchinson, Chapter 7 debtors, appeal from the decision of
the Bankruptcy Appellate Panel for the Ninth Circuit
(“BAP”) affirming the bankruptcy court’s dismissal with
prejudice of their adversary complaint concerning certain tax
liens asserted by the Internal Revenue Service (“IRS”). We
affirm.

I

In 2011, the IRS recorded liens for unpaid taxes, interest,
and penalties against Plaintiffs’ residence in Orosi,
California. After Plaintiffs filed for Chapter 7 bankruptcy in
June 2017, the IRS in August 2017 filed a proof of claim for
both the secured and unsecured portions of its then-existing
claim for unpaid taxes, interest, and penalties. The portion
of the claim that was secured by the liens on Plaintiffs’ home
and attributable only to penalties was over $162,000.

However, even before the IRS filed that claim, Plaintiffs
preemptively filed the instant adversary proceeding against
the United States and the Chapter 7 Trustee appointed in
their case, James Salven. In the first cause of action in their
complaint, Plaintiffs asserted that, because the IRS’s claim
for penalties was a “claim of a kind specified in section
726(a)(4)” of Title 11 of the U.S. Code, the “lien that
secures” that penalties claim was subject to avoidance by the
trustee under § 724(a). See 11 U.S.C § 724(a) (“The trustee
may avoid a lien that secures a claim of a kind specified in
section 726(a)(4) of this title.”); see also id. § 726(a)(4)
(generally describing claims “for any fine, penalty, or
forfeiture”). Plaintiffs alleged that, because Salven had not
 IN RE HUTCHINSON 7

attempted to avoid the IRS’s penalties claim, Plaintiffs were
empowered to do so under 11 U.S.C. § 522(h). See id.
§ 522(h) (describing certain circumstances in which a
“debtor may avoid a transfer of property of the debtor” if
“the trustee does not attempt to avoid such transfer”); id.
§ 101(54) (broadly defining “transfer” to include, for
example, the “creation of a lien”). Plaintiffs therefore sought
to “avoid the lien” securing the penalties claim to the extent
that it encumbered their Orosi home and to the extent of the
“lesser” of the amount of the penalties claim or the amount
of Plaintiffs’ homestead exemption (which was $100,000).
See Law v. Siegel, 571 U.S. 415, 417–18 (2014) (noting that
the “Bankruptcy Code provides that a debtor may exempt
certain assets from the bankruptcy estate,” and that one such
exemption, “commonly known as the ‘homestead
exemption,’” protects a specified amount of “equity in the
debtor’s residence”). In their second cause of action,
Plaintiffs alleged that, to the extent the liens were avoided,
they should be preserved “for the benefit of the Plaintiffs.”

Salven filed an answer to the complaint, together with a
cross-claim against the United States. In his first cause of
action, Salven asserted the right, as trustee, to avoid the liens
securing the IRS’s penalties claim. In his second cause of
action, Salven alleged that, to the extent that the liens were
avoided, their value should be recovered for the benefit of
the bankruptcy estate.

The Government filed a motion to dismiss Plaintiffs’
adversary complaint, which the bankruptcy court granted in
January 2018. Hutchinson v. United States (In re
Hutchinson), 579 B.R. 860, 865 (Bankr. E.D. Cal. 2018).
Plaintiffs appealed to the BAP, but the BAP dismissed the
appeal as interlocutory in light of Salven’s still-pending
cross-claim against the Government. In February 2019, the
8 IN RE HUTCHINSON

bankruptcy court entered a stipulated judgment in which
Salven and the Government agreed that the “penalty
portions” of certain of “the IRS’s liens” against Plaintiffs’
Orosi residence “are avoided pursuant to 11 U.S.C.
§ 724(a).” Given the resulting final judgment in the
adversary proceeding, Plaintiffs again appealed to the BAP,
which affirmed the dismissal of their adversary complaint.

Plaintiffs timely appealed to this court, and we have
jurisdiction under 28 U.S.C. § 158(d)(1). We review the
BAP’s decision de novo, and we review the underlying
bankruptcy court decision using the same standard of review
the BAP did. Tracht Gut, LLC v. L.A. Cnty. Treasurer &
Tax Collector (In re Tracht Gut, LLC), 836 F.3d 1146, 1150
(9th Cir. 2016). Because the underlying decision was a
dismissal for failure to state a claim under Federal Rule of
Civil Procedure 12(b)(6), our review of that decision is de
novo. Id.; see also FED. R. BANKR. P. 7012(b) (stating that
FED. R. CIV. P. 12(b) “applies in adversary proceedings” in
bankruptcy court).

II

Section 522(h) does not authorize Plaintiffs to avoid the
liens that secure the IRS’s penalties claim, and their first
cause of action was therefore properly dismissed for failure
to state a claim.

In theory, a debtor’s ability to avoid certain “transfer[s]”
of property under § 522(h) could extend to tax liens. See
DeMarah v. United States (In re DeMarah), 62 F.3d 1248,
1250 (9th Cir. 1995) (citing In re Ridgley, 81 B.R. 65, 67
(Bankr. D. Or. 1987)); see also City of El Paso v. Am. W.
Airlines (In re Am. W. Airlines, Inc.), 217 F.3d 1161, 1165
(9th Cir. 2000) (“Because a tax lien is an involuntary parting
of an interest in property, it qualifies as a transfer within the
 IN RE HUTCHINSON 9

meaning of the Bankruptcy Code.”); 11 U.S.C. § 101(54)
(“transfer” includes the “creation of a lien,” “the retention of
title as a security interest,” and “each mode, direct or
indirect, absolute or conditional, voluntary or involuntary, of
disposing of or parting with . . . property; or . . . an interest
in property”). Under the terms of § 522(h), a transfer
(including a lien) can be avoided by the debtor if (1) the
transfer is “avoidable by the trustee under section . . .
724(a)”; (2) the “trustee does not attempt to avoid such
transfer”; and (3) “the debtor could have exempted such
property under subsection (g)(1) of this section if the trustee
had avoided such transfer.” 11 U.S.C. § 522(h); see also
DeMarah, 62 F.3d at 1250. The third of these requirements,
in turn, has several components. One of them is that “the
debtor could have exempted such property” under § 522(b)
“if such property had not been transferred.” See 11 U.S.C.
§ 522(g). 1 Plaintiffs contend that they meet that requirement
because § 522(b) allows them to exempt their interest in their
principal residence up to the extent of their $100,000
homestead exemption under California law. See id.
§ 522(b)(3)(A); CAL. CODE CIV. P. § 704.730(a)(2), (b)

1
The other requirements of § 522(g)(1) would presumably be met
in the context of a lien for tax penalties that is avoidable under § 724(a).
Such a tax lien is “not a voluntary transfer of such property by the
debtor,” and the “debtor did not conceal such property.” 11 U.S.C.
§ 522(g)(1)(A)–(B). Section 522(g) also requires that the property be
one “that the trustee recovers under section 510(c)(2), 542, 543, 550,
551, or 553,” id. § 522(g), but that condition would be met “if the trustee
had avoided such [lien]” under § 724(a), see id. § 522(h). Upon such
avoidance under § 724(a), then under § 550 the trustee could “recover,
for the benefit of the estate, the property transferred,” id. § 550(a), and
the lien also would be automatically “preserved for the benefit of the
estate” under § 551. As a result, the property would then be “property
that the trustee recovers under section . . . 550, 551.” See id. § 522(g).
10 IN RE HUTCHINSON

(2017) (setting applicable “homestead exemption” at
“$100,000”); see generally Law v. Siegel, 571 U.S. at 418.

However, we held in DeMarah that, because
§ 522(c)(2)(B) states that otherwise “exempt[]” property
remains subject to “a tax lien, notice of which is properly
filed,” see 11 U.S.C. § 522(c)(2)(B), any “property
exempted from the estate remains subject to tax liens,”
DeMarah, 62 F.3d at 1251. Because, under § 522(c)(2)(B),
“Congress has denied debtors the right to remove tax liens
from their otherwise exempt property,” we held that a debtor
“may not avoid the lien for his tax penalties” under § 522(h).
Id. at 1252.

We acknowledged in DeMarah that this reading of the
code could lead to a disparity in which trustees might be able
to avoid such liens under § 724(a), while debtors cannot. Id.
(reserving the question of whether a “trustee could avoid the
penalty portion of tax liens on nonexempt property”); cf. Gill
v. Kirresh (In re Gill), 574 B.R. 709, 716 (B.A.P. 9th Cir.
2017) (holding that a trustee is “expressly authorized . . . to
avoid, subordinate and preserve the penalty portion of the
IRS’s tax lien for the benefit of the estate’s unsecured
creditors”). But we explained that “Congress could logically
have wanted to allow tax penalties to be avoided if that
would benefit unsecured creditors,” while “eschew[ing]
benefiting debtors who had incurred those penalties by
failing to pay their taxes.” DeMarah, 62 F.3d at 1252
(emphasis added).

Under our binding decision in DeMarah, Plaintiffs
cannot invoke § 522(h) to avoid a properly filed tax lien,
even if that lien would be avoidable by the trustee under
§ 724(a). Plaintiffs contend in their brief that “the DeMarah
Court failed to properly construe the relevant provisions of
the Bankruptcy Code in reaching its decision,” but as a three-
 IN RE HUTCHINSON 11

judge panel we lack the authority to reconsider DeMarah’s
clear and directly applicable holding. See Miller v. Gammie,
335 F.3d 889, 899–900 (9th Cir. 2003) (en banc).

In all events, Plaintiffs’ effort to invoke § 522(h) fails for
a second, and independent reason. As noted earlier, here the
trustee did “attempt to avoid” the tax lien to the extent that it
secured the penalties claim, see 11 U.S.C. § 522(h)(2), and
he largely succeeded in that effort. See supra at 7. Because
this clear requirement of § 522(h) was not met here,
Plaintiffs could not invoke that section even if (contrary to
DeMarah) it were otherwise applicable.

We affirm the dismissal of Plaintiffs’ first cause of
action.

III

Plaintiffs contend that even if Salven, as trustee, acted to
avoid the liens, the property should have been preserved for
Plaintiffs’ benefit, rather than for the benefit of the estate.
At the hearing on the Government’s motion to dismiss,
Plaintiffs argued that their second cause of action therefore
should not be dismissed or that, alternatively, they should be
allowed to intervene in Salven’s cross-claim against the
Government. We conclude that Plaintiffs cannot preserve
for their own benefit the portions of the tax liens that were
avoided by the trustee, and that their complaint was therefore
properly dismissed in its entirety with prejudice.

A transfer that is avoided by the trustee “under section
. . . 724(a) . . . is preserved for the benefit of the estate but
only with respect to property of the estate.” 11 U.S.C. § 551.
Because Salven, as trustee, avoided the penalty portions of
the tax liens pursuant to § 724(a), it follows that, under the
plain language of § 551, those liens are preserved for the
12 IN RE HUTCHINSON

benefit of the estate. See Heintz v. Carey (In re Heintz),
198 B.R. 581, 585–86 (B.A.P. 9th Cir. 1996) (holding that,
regardless of whether the debtor claims an exemption, any
interest of the debtor in property at the commencement of
the bankruptcy case is “property of the estate” as that phrase
is used in § 551).

Plaintiffs contend, however, that this aspect of § 551 is
overridden by § 522(i)(2), which provides:

Notwithstanding section 551 of this title, a
transfer avoided under section 544, 545, 547,
548, 549, or 724(a) of this title, under
subsection (f) or (h) of this section, or
property recovered under section 553 of this
title, may be preserved for the benefit of the
debtor to the extent that the debtor may
exempt such property under subsection (g) of
this section or paragraph (1) of this
subsection.

11 U.S.C. § 522(i)(2). According to Plaintiffs, they can
“exempt such property under subsection (g)” because, to the
extent that they are relying on their homestead exemption
under California law, they assertedly have met all of the
requirements of subsection (1) of § 522(g). See supra at 9 &
n.1. And because the trustee acted under § 724(a) in
avoiding the IRS liens securing the penalties claim, Plaintiffs
argue that the plain language of § 522(i)(2) establishes that,
to the extent of Plaintiffs’ homestead exemption, the avoided
liens “may be preserved for the benefit of the debtor[s]”
 IN RE HUTCHINSON 13

rather than the estate. 11 U.S.C. § 522(i)(2). We reject this
contention. 2

Plaintiffs’ reliance on § 522(i)(2) fails because, under
our decision in DeMarah, that provision is equally
subordinate to § 522(c)(2)(B)’s bright-line rule that debtors
lack “the right to remove tax liens from their otherwise
exempt property.” 62 F.3d at 1252. We acknowledged in
DeMarah that the property was arguably subject to
exemption under the literal terms of § 522(g)(1), as
incorporated into § 522(h), and that, if these provisions
“existed in a vacuum,” that would suggest that the debtor
could avoid the tax lien under § 522(h) to the extent of the
exemption. Id. at 1251. But those provisions do not exist in
a vacuum, and we held that any such lien-avoidance
authority of the debtor under § 522(h) could not be invoked
to make an end-run around § 522(c)(2)(B)’s settled rule that
tax liens apply to exempt property. Id. at 1251–52. We
perceive no principled basis on which to reach a different
conclusion when § 522(g)’s exemption authority is instead
incorporated into § 522(i)(2).

2
Plaintiffs’ reading of § 522(i)(2) implicitly rests on the assumption
that a “transfer” qualifies under that subsection if it is avoided either
“under section 544, 545, 547, 548, 549, or 724(a) of this title” or “under
subsection (f) or (h) of this section.” The bankruptcy court and the BAP
instead took the view that the transfer had to satisfy both clauses, and
they held that Plaintiffs could not meet the resulting requirement that the
liens had to be avoided “under subsection (f) or (h) of this section.” That
was true, the courts concluded, because § 522(f) and § 522(h) only
address avoidance by the debtor, and here, the trustee avoided the liens.
We need not decide which reading of § 522(i)(2) is correct on this point.
Even assuming that Plaintiffs are right in asserting that avoidance “under
subsection (f) or (h)” is not required here, their invocation of § 522(i)(2)
still fails for the reasons we explain.
14 IN RE HUTCHINSON

Indeed, the text of § 522(c)(2)(B) makes quite clear that
its rule that debtors cannot use exemption authority to escape
tax liens applies even if (as here) the tax liens are otherwise
avoided by a trustee under § 724(a). Section 522(c)(2) has
two separate subsections describing liens that apply to
exempt property. The first of these says that exempt
property remains liable for “a debt secured by a lien that is
. . . not avoided under . . . section . . . 724(a).” 11 U.S.C.
§ 522(c)(2)(A) (emphasis added). That provision is
inapplicable here, because the trustee did avoid the relevant
tax liens under § 724(a). The second subsection of
§ 522(c)(2), however, provides that exempt property
remains liable for “a debt secured by a lien that is . . . a tax
lien, notice of which is properly filed,” and it says nothing at
all about whether that tax lien has otherwise been avoided.
11 U.S.C. § 522(c)(2)(B). Given the obvious contrast in
language, § 522(c)(2)(B) would operate, vis-à-vis a debtor,
to preserve “tax lien[s]” against otherwise exempt property
regardless of whether the trustee has avoided them. This
difference in language “belies any argument that the debtor
can escape a part of the tax lien.” DeMarah, 62 F.3d at 1252
(emphasis added).

Because § 522(c)(2) thus makes clear that a debtor’s
exemption power cannot escape a tax lien, regardless of
whether that lien was avoided by the trustee, it would be
completely contradictory to then construe § 522(i)(2) (or
§ 522(g), for that matter) as allowing a debtor, after a trustee
has avoided the tax lien, to then preserve the avoided lien
“for the benefit of the debtor” by claiming an exemption
under § 522(g). 11 U.S.C. § 522(i)(2) (emphasis added).
Such a result—having the trustee avoid the lien only to turn
over the benefits to the debtor, whose exempt property
would then be free of the lien—would create precisely the
kind of end-run around § 522(c)(2)(B) that we rejected in
 IN RE HUTCHINSON 15

DeMarah. Alternatively, if the result were that the trustee
avoided the lien only to turn over the benefits to the debtor,
whose exempt property would then be subject to the lien
under § 522(c)(2)(B), that would effectively nullify the
trustee’s express lien-avoidance power under § 724(a). The
only way to read these provisions sensibly together is to
conclude that, with respect to a tax lien covered by
§ 522(c)(2)(B), a debtor may not invoke § 522(i)(2) in order
to override § 551’s otherwise applicable rule that, after the
trustee avoids a lien under § 724(a), the lien “is preserved for
the benefit of the estate.” Id. § 551.

We therefore hold that the BAP properly concluded that
the penalty portions of the tax liens that Salven successfully
avoided were preserved for the benefit of the estate and not
Plaintiffs. 3

IV

Because Plaintiffs’ claims all failed as a matter of law,
the BAP correctly affirmed the bankruptcy court’s dismissal
of Plaintiffs’ adversary complaint with prejudice.

AFFIRMED.

3
We express no view as to whether that actually “leave[s] a pot of
funds available for distribution to unsecured creditors.” See United
States v. Hutchinson (In re Hutchinson), 615 B.R. 596, 598, 608 (E.D.
Cal.) (affirming denial of Government’s motion to compel trustee to
abandon the Orosi residence, in which the Government argued that,
despite the partial avoidance of the tax liens, the property was “of
inconsequential value to the estate” in light of remaining encumbrances),
vacated as moot, 2020 WL 5551702 (9th Cir. 2020) (dismissing appeal
as moot in light of trustee’s sale of Orosi residence). No issue concerning
the proper distribution of the proceeds of sale of the Orosi residence has
been presented to us.