2.7.a Interest Accrues Despite Payment Of Principal Out Of Estate

• Jurisdiction: United States

a. Prepetition penalties

RULE: Bankruptcy Code § 523(a)(7) provides that tax penalties, including tax fraud penalties, are dischargeable to the extent that they (1) relate to a dischargeable tax claim [§523(a)(7)(A)] or (2) where the event giving rise to the penalty occurred more than three years prior to filing the bankruptcy petition [§ 523(a)(7)(B)]. The majority of the opinions uphold the disjunctive in the language, and permit dischargeability on either one of the two circumstances described. In re Sgarlet, 271 B.R. 688 (Bankr. M.D. Fla. 2001); In re Wilson, 394 B.R. 531 (Bankr. Colo. 2008).

Some courts hold to the contrary, however.

Held, prepetition penalty was discharge-able if incurred more than three years prior to filing bankruptcy, and penalty for late filing of tax return was incurred on date the tax returns were due but unfiled. In re Polston, 239 B.R. 277 (Bankr. M.D. Pa. 1999).

Held, penalties were not dischargeable because they were imposed with respect to transactions that occurred within three years before the date of petition filing. In re Paulson, 152 B.R. 46 (Ba. W.D. Pa. 1992).

Held, events triggering tax penalties occurred within three years prior to bankruptcy filing, and thus were not dischargeable in Chapter 7. In re Allen, 272 B.R. 913 (Bankr. E.D. Va. 2002).

For nondischargeable tax but dischargeable penalty, see In re Lee, 186 B.R. 539 (S.D. Fla. 1995).

The majority rule regarding dischargeability of such penalties in Chapter 7 was discussed in In re Burns;, 887 F.2d 1541 (11 Cir. 1989). The court said, "A tax penalty is discharged if (a) the tax to which it relates is discharged, or (b) if the transaction or event giving rise to the penalty occurred more than three years prior to the filing of the bankruptcy petition. Since the statute (§523 (a)(7)) uses the disjunctive, a tax penalty that does not qualify for discharge under one of the two aforementioned circumstances may still qualify under the other."

In Burns, the debtor had filed a Chapter 7, but no claims were filed on nondischargeable prepetition taxes, pre- and postpetition interest or fraud penalties. Subsequently the debtor filed a Chapter 13 and claimed that the interest and penalties on the prior taxes had been discharged in the Chapter 7. The court stated, "The use of the disjunctive, without further qualification of either subsection, leaves no doubt that Congress intended to create two independent measures for the dischargeability of tax penalties." The court...