Hardee v. Internal Revenue Service

IN THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

_____________________

No. 97-20423
_____________________

In The Matter Of: ROGER B HARDEE,

Debtor.

-------------

ROGER B HARDEE,

Appellant,

v.

INTERNAL REVENUE SERVICE; KENNETH R HAVIS, Trustee,

Appellees.

_________________________________________________________________

Appeal from the United States District Court
for the Southern District of Texas
_________________________________________________________________
April 1, 1998

Before KING, EMILIO M. GARZA, and DeMOSS, Circuit Judges.

KING, Circuit Judge:

Debtor-appellant Roger Hardee appeals the district court’s

judgment affirming the bankruptcy court’s judgment that the 26

U.S.C. § 6621(c) interest that he paid in excess of the regular

interest rate is excepted from a Chapter 7 discharge in

bankruptcy. We affirm.

I. FACTUAL & PROCEDURAL BACKGROUND

Debtor-appellant Roger Hardee timely filed his federal

income tax returns for the 1983 and 1984 tax years and received

refunds for each year. On October 16, 1995, the Internal Revenue
Service (IRS) made additional assessments for both years. For

1983, the IRS assessed unpaid taxes in the amount of $10,638 and

interest in the amount of $29,359.59 under § 6621(c) of the

Internal Revenue Code, which provides for increased interest on

substantial underpayments of tax attributable to tax-motivated

transactions. See 26 U.S.C. § 6621(c) (repealed 1989). For

1984, the IRS assessed unpaid taxes in the amount of $5061 and

interest under § 6621(c) in the amount of $11,514.82. On

December 18, 1995, the IRS assessed additional interest amounts

for 1983 and 1984 of $499.96 and $207.25, respectively.

On December 18, 1995, Hardee paid the IRS $33,173.36 and

$14,060.34 for the assessments on 1983 and 1984, respectively.

His remaining balance is $7314.19 for 1983 and $2722.73 for 1984.

These amounts represent the additional interest that Hardee must

pay under § 6621(c) above the regular rate of interest for

underpayments under § 6621(a).

On January 2, 1996, Hardee filed a petition for relief under

Chapter 7 of the Bankruptcy Code and subsequently received a

discharge. Hardee then commenced this adversary proceeding to

determine the dischargeability of the increased interest imposed

by § 6621(c) for his 1983 and 1984 tax liability. Hardee moved

for summary judgment in the bankruptcy court, asserting that the

additional interest was a dischargeable, “nonpecuniary loss

penalty” under 11 U.S.C. § 523(a)(7). The IRS opposed the motion

and filed a cross-motion for summary judgment asserting that the

additional interest was excepted from discharge under 11 U.S.C.

2
§§ 523(a)(1)(A) and 507(a)(8)(A) as part of the underlying

nondischargeable tax or under 11 U.S.C. §§ 523(a)(1)(A) and

507(a)(8)(G) as a “pecuniary loss penalty.”

The bankruptcy court denied Hardee’s motion and granted the

IRS’s. Hardee then filed an unsuccessful motion for

reconsideration. On appeal, the district court affirmed the

bankruptcy court’s judgment. Hardee now appeals to this court.

II. STANDARD OF REVIEW

In this case, the facts are undisputed, and both parties

agree that this case presents only questions of law, specifically

questions of statutory interpretation, which we review de novo.

See Bruner v. United States (In re Bruner), 55 F.3d 195, 197 (5th

Cir. 1995).

III. DISCUSSION

Section 6621(c) of the Internal Revenue Code, which has

since been repealed, set the rate of interest for substantial

underpayments (underpayments over $1000) of tax attributable to

tax-motivated transactions at 120 percent of the regular

underpayment rate. 26 U.S.C. § 6621(c) (repealed 1989).1 Hardee

1
The relevant portions of § 6621 in effect during the
relevant period read as follows:

(a) General rule.--
. . .
(2) Underpayment rate.--The underpayment rate
established under this section shall be the sum
of--
(A) the Federal short-term rate
determined under subsection (b), plus
(B) 3 percentage points.
. . .
(c) Interest on substantial underpayments

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argues that the increased interest imposed by § 6621(c) over and

above the regular rate is a penalty that was discharged by his

Chapter 7 bankruptcy proceeding. See 11 U.S.C. § 727(a).

Under Chapter 7, an individual debtor is entitled to a

discharge of all pre-existing debts with some exceptions,

including those provided for in § 523 of the Bankruptcy Code.

Id. § 727(a)-(b). Section 523 lists exceptions from discharge,

including taxes referred to in § 507(a)(2) and (a)(8), regardless

of whether a claim for such taxes has been filed, and certain

penalties payable to the government. Id. § 523(a)(1)(A),

(a)(7).2 Section 507(a)(8), which relates to the priority of

attributable to tax motivated transactions.--
(1) In general.--In the case of interest
payable under section 6601 with respect to any
substantial underpayment attributable to tax
motivated transactions, the rate of interest
established under this section shall be 120
percent of the underpayment rate established under
this section.

26 U.S.C. § 6621 (subsection (c) repealed 1989).
2
The relevant portions of § 523 read as follows:

(a) A discharge under section 727 . . . of this
title does not discharge an individual debtor from any
debt--
(1) for a tax or a customs duty--
(A) of the kind and for the periods
specified in section 507(a)(2) or 507(a)(8)
of this title, whether or not a claim for
such tax was filed or allowed;
. . .
(7) to the extent such debt is for a fine,
penalty, or forfeiture payable to and for the
benefit of a governmental unit, and is not
compensation for actual pecuniary loss, other than
a tax penalty--
(A) relating to a tax of a kind not
specified in paragraph (1) of this

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claims, includes taxes measured by income or gross receipts that

have been assessed within 240 days before the filing of the

debtor’s bankruptcy petition and penalties related to such taxes,

which constitute compensation for “actual pecuniary loss.” Id.

§ 507(a)(8).3

Both the district and bankruptcy courts held that the

increased interest payable under § 6621(c) is nonetheless

interest and part of the underlying tax debt and therefore that

it is excepted from discharge in a Chapter 7 bankruptcy under

§§ 523(a)(1)(A) and 507(a)(8)(A)(ii). Both courts went on to

hold that, even if § 6621(c) interest is a penalty, it is a

subsection; or
(B) imposed with respect to a
transaction or event that occurred before
three years before the date of the filing of
the petition; . . . .

11 U.S.C. § 523.
3
The relevant portions of § 507(a)(8) read as follows:

(8) Eighth, allowed unsecured claims of
governmental units, only to the extent that such claims
are for--
(A) a tax on or measured by income or gross
receipts--
. . .
(ii) assessed within 240 days, plus any
time plus 30 days during which an offer in
compromise with respect to such tax that was
made within 240 days after such assessment
was pending, before the date of the filing of
the petition; or
. . .
(G) a penalty related to a claim of a kind
specified in this paragraph and in compensation
for actual pecuniary loss.

11 U.S.C. § 507(a)(8).

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penalty for actual pecuniary loss to the government and it would

therefore be excepted from discharge under §§ 523(a)(1)(A) and

507(a)(8)(G). In response to Hardee’s argument that § 523(a)(7)

bars § 6621(c) interest from § 523’s exceptions to discharge,

both lower courts found § 523(a)(7) to be inapplicable because

the increased interest is not punitive in nature.

The cross-references between §§ 507 and 523 create several

possible paths to a disposition of this case. We will approach

the question of whether § 6621(c) additional interest is excepted

from discharge as the lower courts did--step by step, beginning

with whether the additional interest is interest or a penalty.4

A. Interest or Penalty?

The Supreme Court has considered whether interest is a

penalty or merely interest twice before in relation to the

Bankruptcy Act of 1898. In United States v. Childs, 266 U.S.

304, 307 (1924), the Court defined both penalty and interest: “A

penalty is a means of punishment; interest a means of

compensation.” In Meilink v. Unemployment Reserves Comm’n, 314

U.S. 564, 570 (1942), the Court distinguished a “penalty as a

fixed ad valorem amount taking no account of time” from “interest

4
Hardee argues that this issue has already been decided by
this court, but the cases upon which he relies refer to § 6621(c)
interest as a penalty while deciding another issue without
considering the nature of § 6621(c) interest. See Durrett v.
Commissioner, 71 F.3d 515, 517 (5th Cir. 1996) (reviewing whether
taxpayers lacked a profit motive bringing them within
transactions to which § 6621(c) applied); Heasley v.
Commissioner, 902 F.2d 380, 385-86 (5th Cir. 1990) (reviewing
whether a transaction was tax motivated). In both cases, the
description of the interest as a penalty is, at best, dicta.

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which does depend on time.” The Childs Court noted that “the

power that creates [an] obligation can assign the measure of its

delinquency--the detriment of delay in payment.” 266 U.S. at

308. The Meilink Court found that a “mere difference in rates”

does not establish that an increased rate is a penalty. 314 U.S.

at 567. The Court recognized that risk is an important factor

causing interest rates to vary from a general compensatory rate:

It is common knowledge that interest rates vary
not only according to the general use value of money
but also according to the hazard of particular classes
of loans. Delinquent taxpayers as a class are a poor
credit risk; tax default, unless an incident of
legitimate tax litigation, is, to the eye sensitive to
credit indications, a signal of distress. A rate of
interest on tax delinquencies which is low in
comparison to the taxpayer’s borrowing rate--if he can
borrow at all--is a temptation to use the state as a
convenient, if involuntary, banker by the simple
practice of deferring the payment of taxes.

Id. Therefore, the Court acknowledged that an exaction having in

part a deterrent effect does not make that exaction a penalty.

Additionally, the Meilink Court added that the expense of

handling a particular collection item can also legitimately vary

the rate of interest. Id.

More recently, the Supreme Court has had the opportunity to

determine whether a particular exaction was a tax or a penalty

under the current Bankruptcy Code. See United States v.

Reorganized CF & I Fabricators of Utah, Inc., 518 U.S. 213, 116

S. Ct. 2106 (1996). The Court took a functional approach to this

determination, looking beyond the labels in the Bankruptcy and

Internal Revenue Codes. Id. at 2111-12. This court has taken a

similar approach in the past. See Mahon v. United States

7
Internal Revenue Serv. (In re Unified Control Sys., Inc.), 586

F.2d 1036, 1037 (5th Cir. 1978) (considering whether an excise

tax was a penalty and noting that the label given an exaction in

the Internal Revenue Code is not dispositive and must be

considered in its context). However, while looking beyond them,

labels can inform a determination; in Childs, the fact that a

statute labeled different exactions as a penalty and as interest

was relevant to whether the interest was a penalty. 266 U.S. at

309-10; see also Unified Control Sys., 586 F.2d at 1037

(considering the label in context).

To determine whether the § 6621(c) additional interest is a

penalty, the following factors are relevant: (1) the language of

the provision, (2) the form of the sanctions, (3) the

confiscatory nature of the sanction, and (4) the legislative

history of the provision. See Unified Control Sys., 586 F.2d at

1038-39 (considering a 200% excise tax); see also Reorganized CF

& I Fabricators, 116 S. Ct. at 2113-14 (finding a 10% sanction on

the underfunding of a pension plan to be a penalty based upon the

legislative history of the provision and its function); Meilink,

314 U.S. at 569-70 (finding a 12% interest rate (2% higher than

the maximum allowable private rate under the state constitution)

to be interest and not a penalty based upon its function, form,

and label).

First, the language of the Internal Revenue Code denominates

the § 6621(c) exaction as interest. 26 U.S.C. § 6621. Section

6621(c) appears in the same section as the regular underpayment

8
rate and is a substitute for the regular underpayment rate. See

id. Additionally, the § 6621(c) rate is located in the

subchapter on interest and not in the subchapter on penalties.

See id. chs. 67-68. Labels are not dispositive, but the

placement of the provision and its label are informative, as in

Childs, when considered in relation to how Congress has

denominated and placed provisions that it considers to be

penalties.

Second, in form, § 6621(c) interest is applied in the same

manner as the regular rate of interest. See id. §§ 6601, 6622.

It is compounded daily and only accrues while the debt is overdue

and remains unpaid. Id. The taxpayer can end the imposition of

the interest by paying the tax debt. Nothing about § 6621(c)

interest suggests that it is applied in any way unlike the

application of the regular interest rate to a tax debt.

Third, the regular interest rate ranged between 9% and 13%

during the relevant time period, and the § 6621(c) 20% increase

over the regular interest rate ranged between 10.8% and 15.6%

during that period. Therefore, the increase due to § 6621(c)

ranged between 1.8% and 2.6%, which is similar to the increased

rate in Meilink; the § 6621(c) additional interest is not nearly

as burdensome an exaction as the one at issue in Unified Control

Systems (200%) and is significantly less so than the one at issue

in Reorganized CF & I Fabricators (10%). Therefore, § 6621(c)

interest rate is not confiscatory in nature.

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 Fourth, the legislative history of § 6621(c) is sparse.

That which is available lists § 6621(c) among other penalty

provisions enacted in response to the tax court backlog. See

H.R. CONF. REP. NO. 98-861, at 985 (1984) (in section describing

§ 6621, noting “that a number of the provisions of recent

legislation have been designed, in whole or in part, to deal with

the Tax Court backlog” and listing as examples “adjustment of

interest rates (sec. 6621),” valuation overstatement and

substantial understatement penalties, and increased damages for

delaying or frivolous tax court proceedings (emphasis added)),

reprinted in 1984 U.S.C.C.A.N. 1445, 1673. At most, this

association highlights the deterrent effect that Congress

intended the provision to have in order to aid in easing the

burden on the system of tax dispute resolution.

Under the above factors, § 6621(c) increased interest is

interest and not a penalty. It also fits neatly within the

Supreme Court precedent of Childs and Meilink. The § 6621(c)

exaction depends upon time, which distinguishes it from a

penalty. See Meilink, 314 U.S. at 570. Section 6621(c) reaches

delinquent taxpayers, who have engaged in certain tax-motivated,

sham transactions that Congress felt increased the burden upon

the tax court system. See H.R. CONF. REP. NO. 98-861, supra.

Congress can legitimately vary the interest rate because of its

desire to deter the transactions which lead to this burden and

the increased cost of collection created by this burden. See

Meilink, 314 U.S. at 567. The next step is to determine whether

10
§ 6621(c) interest is part of the underlying tax debt or just a

pecuniary penalty.

B. Pecuniary Penalty or Part of the Underlying Tax Debt?

This court has already determined that interest payable in

respect of a tax debt is a penalty “in compensation for actual

pecuniary loss” under § 507(a)(8)(G). See Jones v. United States

(In re Garcia), 955 F.2d 16, 18-19 (5th Cir. 1992). It follows

that § 6621(c) interest falls within § 507(a)(8)(G), making the

next step in our determination whether interest is part of the

underlying tax debt or just a pecuniary penalty. We expressly

left this question open in Garcia. See id. at 19.

In In re Larson, 862 F.2d 112, 118-19 (7th Cir. 1988), the

Seventh Circuit has directly addressed whether interest is part

of the underlying tax debt and answered in the affirmative. The

Larson court considered the Bankruptcy Code’s definition of

“claim” in § 101 and its exclusion of only post-petition interest

from an allowed claim in § 502. See id. at 119; see also 11

U.S.C. §§ 101(5) (defining “claim” to be a “right to payment,”

whether or not liquidated, fixed, matured, disputed, or secured),

502(b) (allowing a “claim in such amount, except to the extent

that-- . . . such claim is for unmatured interest”). Therefore,

the Larson court found that pre-petition interest is part of the

allowed claim, that is the underlying tax debt. Id.; accord

United States v. H.G.D. & J. Mining Co. (In re H.G.D. & J. Mining

Co.), 74 B.R. 122, 124-25 (S.D. W. Va. 1986), aff’d, 836 F.2d 546

(4th Cir. 1987) (unpublished table decision); In re Hall, 191

11
B.R. 814, 816-17 (Bankr. D. Alaska 1995); Pierce v. United States

(In re Pierce), 184 B.R. 338, 344 (Bankr. N.D. Iowa 1995);

Brinegar v. United States (In re Brinegar), 76 B.R. 176, 178-79

(Bankr. D. Colo. 1987); In re Treister, 52 B.R. 735, 737 (Bankr.

S.D.N.Y. 1985); 4 COLLIER ON BANKRUPTCY ¶ 523.07[7], at 523-38

(Lawrence P. King ed., 15th ed. rev. 1997); cf. Bruning v. United

States, 376 U.S. 358, 360 (1964) (in considering post-petition

interest, stating: “In most situations, interest is considered to

be the cost of the use of the amounts owing a creditor and an

incentive to prompt repayment and, thus, an integral part of a

continuing debt.”).

Following Larson’s reasoning, interest on a tax debt is part

of the underlying tax debt. Therefore, § 6621(c) interest is

part of the underlying tax debt and is treated like a tax under

§ 507 of the Bankruptcy Code. The interest at issue was assessed

within 240 days of the filing of the petition, and it is

therefore excepted from discharge under §§ 523(a)(1)(A) and

507(a)(8)(A)(ii).5

IV. CONCLUSION

For the foregoing reasons, we AFFIRM the district court’s

judgment affirming the bankruptcy court’s judgment.

5
Accordingly, we reject the holding in Faden v. United
States (In re Faden), No. 91-46948-H3-7, Adversary No. 92-4519
(Bankr. S.D. Tex. Nov. 12, 1993) (unpublished), that § 6621(c)
interest is a nonpecuniary penalty. We also decline to address
arguments made by Hardee in his reply brief. See NLRB v. Cal-
Maine Farms, Inc., 998 F.2d 1336, 1342 (5th Cir. 1993) (“As this
court has repeatedly held, we will not review arguments raised
for the first time in a reply brief.”).

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