Barrows v. IRS CV-97-550-JD 09/25/98 P UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW HAMPSHIRE

Jerry Barrows, et al.

v. Civil No. 97-550-JD

Internal Revenue Service

O R D E R

The appellants, Gerald and Angela Barrows, were debtors in a

Chapter 7 bankruptcy proceeding in which the appellee, the

Internal Revenue Service, filed a proof of claim after

disallowing a number of tax deductions from the appellants' 1987

income tax return. The Barrows appeal the bankruptcy court's

decisions regarding the allowance of the deductions, its denial

of their first motion to reconsider, and its final amended

judgment (document no. 3) .

Background1

The appellants filed a joint federal income tax return for

the tax year 1987 in October, 1988. On June 26, 1991, the IRS

issued a statutory notice of deficiency reflecting outstanding

federal income tax liabilities for 1987 of $50,736.00, plus

1The facts discussed herein are either the findings of fact of the bankruptcy court or undisputed, unless otherwise noted. interest and various penalties. The alleged deficiency resulted

from unreported dividend income, unreported interest income, and

unreported proceeds of stock sales. The deficiency also

reflected the disallowance of legal expenses, travel expenses,

and miscellaneous deductions because the appellants failed to

adeguately substantiate the expenses, or because the appellants

failed to establish that the expenses were for ordinary and

necessary business purposes or were expended for the purposes

alleged. After several failed attempts by the appellants to file

a proper petition in tax court, the court dismissed the

appellants' case for lack of jurisdiction on March 10, 1992. The

IRS then assessed the deficiency against the appellants on July

10, 1992.

Meanwhile, the appellants had filed a petition under Chapter

11 of the Bankruptcy Code on January 19, 1990. On July 9, 1990,

the Internal Revenue Service ("IRS") filed a proof of claim for

$200,646.39. The proof of claim asserted a proposed tax

assessment for 1987, and estimated claims for 1988 and 1989. On

July 31, 1990, the appellants' bankruptcy case was converted to a

Chapter 7 proceeding. On November 11, 1990, the IRS filed a

second proof of claim for $216,601.54, asserting the same tax

allegedly owed for the years 1987, 1988, and 1989 as the first

proof of claim, but adding accrued interest and penalties.

2 On August 30, 1995, the IRS filed an amended proof of claim

of $71,565.10, asserting the appellants' tax liability and

related interest and penalties for 1987. The liabilities for

1988 and 1989 were removed from the proof of claim. On May 2,

1996, the bankruptcy court issued an order directing the IRS to

file an amplified statement in support of their proof of claim.

The IRS filed the amplified statement on May 31, 1996, along with

a motion for summary judgment on the entire $71,565.10 allegedly

due, using the amplified statement as the memorandum in support

of the motion for summary judgment.

The appellants filed an objection to the motion for summary

judgment on June 6, 1996, challenging the objection as premature.

They argued that nothing in the IRS's statement amplified any of

the documents at issue, and therefore the IRS had not explained

the disputed claim in any greater detail than before. The

appellants then specifically contested the IRS's disallowance of

certain miscellaneous deductions.

On July 23, 1996, the bankruptcy court held a hearing on the

appellants' objection to the IRS's claim and motion for summary

judgment. At the hearing the court determined that the only

issue in dispute was the disallowance of $106,958.00 in

miscellaneous itemized deductions. The court also found that

summary judgment was unwarranted as the IRS's explanations for

3 disallowing certain deductions were not apparent until the

evidentiary hearing. The findings, although made in an oral

order issued from the bench at the hearing, were also reflected

in the court's order of August 1, 1996. Specifically, the court

stated in the August 1, 1996, order:

As indicated above, the hearing has also served to determine that the only guestion in dispute with regard to the IRS's tax claim is the disallowance of $106,958 from the total miscellaneous deductions claimed on the debtor's tax return for 1987 of $113,048, because Gerald Barrows conceded that he had failed to report certain interest and dividend income for the tax year 1987 .

In re Barrows, Bk. No. 90-68, slip op. at 3 (Bankr. N.H. Aug. 1,

1996) ("August 1, 1996, order"). The bankruptcy court

established a schedule setting dates on which the appellants were

to submit any evidence they might have had substantiating their

deductions, and the IRS in turn was to submit any additional

evidence it might have had.

On January 14, 1997, the bankruptcy court issued a second

order setting a new schedule because the August 1, 1996, order

was not served properly and the parties did not have notice of

it. The order of January 14, 1996, stated that the IRS "shall

submit any documentation it may have in response to the further

documentation that the debtors provided to the IRS." In re

Barrows, Bk. No. 90-68, slip op. at 5 (Bankr. N.H. Jan. 14, 1997)

4 ("January 14, 1997, order").

The bankruptcy court held an evidentiary hearing on the

miscellaneous itemized deductions remaining in dispute on March

17, 1997. On March 21, 1997, the court issued an interlocutory

order establishing certain allowable deductions for 1987 and

disallowing the rest. On April 2, 1997, the appellants filed a

motion for reconsideration of the order entered on March 21,

1997. On May 1, 1997, the court held a hearing on the motion for

reconsideration, after which it entered an order denying the

motion. The IRS was ordered to file a proposed final judgment on

the appellants' objection to the claim, which it did on May 9,

1997 .

On May 12, 1997, the appellants filed a second motion for

reconsideration of the May 1, 1997, order denying their first

motion for reconsideration. On July 17, the court held a hearing

on the appellants' second motion for reconsideration. The court

granted the motion in so far as it allowed the appellants to

deduct an additional $7,194.28 of miscellaneous itemized expenses

for 1987, reflecting the IRS's concession of an item at the March

17, 1997, hearing. The court also directed the IRS to prepare an

amended final order to incorporate the additional allowance.

On July 31, 1997, the appellants filed a motion for a new

trial, which was denied. On August 28, 1997, the bankruptcy

5 court issued its amended final judgment establishing the IRS's

claim for 1987 at $40,093.28.

On appeal, the appellants seek reversal of: 1) the March

21, 1997, interlocutory order summarizing the findings of the

court from the March 17, 1997, hearing; 2) the May 1st, 1997,

order denying the appellants' first motion to reconsider; and 3)

the August 28, 1997, amended final judgment establishing the

amount of the IRS claim at $40, 093.28.2 The appellants assert

six grounds on which they allege the bankruptcy court erred,

although they do not correlate the alleged errors with the

specific orders they seek reversal of. The court will address

each of the alleged errors seriatim.

Discussion

This court reviews a bankruptcy court's conclusions of law

de novo. See Prebor v. Collins (In re I Don't Trust),

(1st Cir. 1998). The bankruptcy court's factual findings

and application of properly construed law to fact are reviewed

for clear error. See Winthrop Old Farm Nurseries v. New Bedford

Inst. For Sav. (In re Winthrop Old Farm Nurseries),

,

2Although both Angela and Gerald Barrows filed and signed an appeal, subseguent filings are signed solely by Gerald Barrows. The court understands both Angela and Gerald Barrows to be appellants in this case.

6 73 (1st Cir. 1995). Evidentiary rulings are reviewed for abuse

of discretion. See Williamson v. Busconi,

, 603 n.l

(1st Cir. 1996).

A. Default

The appellants first assert that the bankruptcy court erred

in not entering a default judgment against the IRS for its

alleged failure to submit documentation. The appellants aver

that the IRS failed on two occasions to respond to the bankruptcy

court's orders reguiring the IRS to submit certain information to

the court.

In its August 1, 1996, order, the bankruptcy court directed

the IRS to "submit any documentation it may have in response to

whatever documentation the debtors provide to the IRS . . . ."

In re Barrows, Bk. No. 90-68, slip op. at 5 (Bankr. N.H. Aug. 1,

1996) ("August 1, 1996, order"). The IRS did not submit any

further documentation. In a subseguent order dated January 14,

1997, the bankruptcy court determined that the IRS's lack of

response was attributable to the defective service of the August

1st order. See January 14, 1997, order at 1. The court

therefore granted the IRS until February 18, 1997, to "submit any

documentation it may have in response to the further

documentation that the debtors provided to the IRS."

The

7 IRS again did not submit any further documentation. The

appellants assert that the IRS therefore defaulted.

Entry of a default judgment is committed to the discretion

of the bankruptcy court, and the decision will not be reversed

unless the bankruptcy court abused its discretion. See Jones

Truck Lines, Inc. v. Foster's Truck & Equipment Sales (In re

Jones Truck Lines, Inc.),

(8th Cir. 1995).

The IRS had already filed an amended proof of claim on

August 30, 1995, followed by an amplified statement of the claim

pursuant to court order on May 31, 1996. The proof of claim

established the presumptive validity and amount of the claim.

See Fed. R. Bankr. P. 3001(f) ("A proof of claim . . . shall

constitute prima facie evidence of the validity and amount of the

claim."). At this point, the burden to overcome the presumption

of validity is placed on the objecting party. See In re

Hemingway Transp., Inc.,

(1st Cir. 1993)

(citing Norton Bankruptcy Law and Practice, Bankruptcy Rules at

191 (Clark Boardman Callaghan 1992)). Having established the

presumptive validity of its claim, the IRS did not have to submit

additional documentation or risk default, and nothing in the

bankruptcy court's orders indicate that the IRS faced default if

they failed to provide additional documentation. See August 1,

1996, order at 5; January 14, 1997, order at 1. If anything, the orders indicate that the IRS may be precluded from submitting

additional documentation at a later date if they failed to submit

the documents in accordance with the court ordered schedule. In

other words, additional submissions were optional. The

bankruptcy court therefore did not abuse its discretion when it

did not find the IRS in default.

B. Exclusion of Evidence

The appellants next contend that the bankruptcy court erred

when it refused to allow them to enter certain documents into

evidence. The appellants do not specify which documents are

contested, although from the appellants' citation to the trial

transcript it appears that the excluded evidence was a summation

of financial transactions drafted by the appellants. See Brief

and Appendix for the Pro Se Debtor Plaintiff Appellant at 5

("Appellants' Brief"); Transcript of Morning Session Only of

Final Hearing on Objection to Claim of IRS (Claim No. 23) Filed

by Debtor Before the Honorable James E. Yacos, J.U.S.B.C. at 29

(March 17, 1997) ("Morning Tr."). The transcript does not

indicate the bankruptcy court's reasoning behind its decision.

The Federal Rules of Evidence are applicable to cases under

the Bankruptcy Code, see Fed. R. Bankr. 9017, and pursuant to the

best evidence rule, the appellants were reguired to provide the original document unless an exception was applicable, see Fed. R.

Evid. 1002, 1004. The appellants did not establish that any

exceptions were applicable, and as the document was a summation

of other documents and not the original, it was properly

excluded. Moreover, the mere fact that the appellants may be

reguired by court order to provide certain information in

discovery to other parties does not establish the admissibility

of that information at trial. See F. Bankr. R. 7034; Fed. R.

Civ. P. 26 (b)(1). The bankruptcy court did not abuse its

discretion.

C. Burden of Proof

The appellants also contend that the bankruptcy court erred

in failing to resolve prior to the evidentiary hearing on March

17, 1997, which side carried the ultimate burden of persuasion,

and in relying on previously undisclosed case law in making its

determination. The appellants fail to indicate any authority,

and the court is unaware of any, that supports the appellants'

contention that a court is obligated to provide or explain

controlling law to the parties, even those appearing pro se, in

advance of trial. The appellants had notice that the court had

not yet resolved the burden of persuasion guestion. They

therefore were aware that the court might find it was the

10 appellants who carried the ultimate burden of persuasion.3 See

August 1, 1996, order at 2-3. If this determination affected the

appellants' trial preparation, prudence suggests they should have

been prepared to carry the burden of persuasion.

In the event the appellants also intended to argue that the

bankruptcy court erroneously reguired them to carry the burden of

persuasion, the court will also review the substantive legal

standard applied by the bankruptcy court. In general, courts

have placed the ultimate burden of persuasion of proving the

validity and amount of a claim on the claimant in a bankruptcy

proceeding. See Juniper Dev. Group v. Kahn (In re Hemingway

Transp., Inc.),

(1st Cir. 1993); see also,

Norton Bankruptcy Law and Practice, Bankruptcy Rules, at 189

(Clark Boardman Callaghan 1996) ("Of course, once the presumption

[of the validity and amount of a claim established by the proof

3Indeed, at the July 23, 1996, hearing the court stated that the IRS had established the specifics of its tax claim "sufficient to throw the burden of proof to the debtor to document the items in guestion - the deductibility of the items in guestion. That burden of proof is the burden of persuasion and not just the burden of going forward . . . ." Transcript Of Hearing On Objection To Claim Of IRS, Filed By Debtors; Motion For Summary Judgment Filed By IRS Before The Honorable James E. Yacos, J.U.S.B.C. at 61 (July 23, 1996) ("July 23 Tr."). Although in its subseguent order the court indicated that the law was unresolved, this statement should clearly have put the appellants on notice that they might carry the burden of persuasion.

11 of claim] is overcome, the ultimate burden to establish the

validity of a claim is placed on the creditor.").

Requiring the claimant in a bankruptcy proceeding to carry

the burden reflects the "general principle [of placing] the

claimant in the same position it would have been in as a civil

plaintiff outside of the bankruptcy context." Thinking Machs.

Corp. v. New Mexico Taxation and Revenue Dept.,

, 430

n.5 (D. Mass. 1997). Unlike a private civil claimant, however,

in cases outside the bankruptcy context the IRS enjoys the

benefit of having "taxpayers bear the burden of proving that a

tax deficiency is erroneous." Delaney v. Commissioner of

Internal Revenue,

(1st Cir. 1996). Both the

Bankruptcy Code and the Federal Rules of Bankruptcy Procedure are

silent as to whether the general rule in bankruptcy proceedings

requiring the claimant to carry the ultimate burden of persuasion

is supplanted in cases where the claimant is a taxing authority.

See Franchise Tax Bd. v. MacFarlane (In re MacFarlane),

(9th Cir. 1996); Thinking Machs.,

.

The circuits are split as to which party should bear the

burden of persuasion in disputes in bankruptcy proceedings, with

the Third, Fourth, and Seventh Circuits holding that the

taxpayer/debtor should bear the burden in the bankruptcy context,

and the Fifth, Eighth, Ninth, and Tenth Circuits holding that the

12 burden should rest on the taxing authority. See Franchise Tax

Bd. v. MacFarlane (In re MacFarlane),

(9th

Cir. 1996), cert, denied, -- U.S.

(1997);

Brown v. Internal Revenue Service (In re Brown),

(8th Cir. 1996); Placid Oil Co. v. Internal Revenue Service (In

re Placid Oil Co.),

(5th Cir. 1993); United

States Internal Revenue Service v. Charlton,

(7th Cir. 1993); Internal Revenue Service v. L e w (In re Landmark

Equity Corp.),

(4th Cir. 1992); Fullmer v.

United States (In re Fullmer),

(10th Cir.

1992); Resvn Corp. v. United States,

(3d Cir.

1988) . The First Circuit has not yet addressed the issue. See

Thinking Machs.,

.

Legislative history reflects the fact that the Bankruptcy

Code, in resolving claims against an estate, "does not endeavor

to supplant the substantive law under which the claim against the

estate . . . arose." In re Landmark Equity Corp.,

.4 Where "the internal goals of the bankruptcy system reguire

alteration of externally created substantive rights, including

'(1) eguality of distribution between the creditors, (2) a fresh

start to the debtor, and (3) economical administration [of the

4The burden of proof is part of substantive tax law. See Dick v. New York Life Ins. Co.,

(1959).

13 bankruptcy system,]'" displacing the substantive law may be

warranted.

(quoting Report of the Commission on the

Bankruptcy Laws of the United States, H.R. Doc. No. 137, 93d

Cong., 1st Sess., P t . I, 75 (1973) (alteration in the original)).

Congress has not indicated an intent to displace the

substantive tax law requirement that the taxpayer bear the burden

of proof regarding a claim. See In re Landmark Equity Corp.,

("[N]o portion of the Bankruptcy Code expresses a

policy or intent to replace any aspect of the federal tax law

with any special legal requirement to be applied only in the

context of a bankruptcy proceeding."). Nor does the court find a

conflict between the bankruptcy system's goals and the allocation

of the burden of persuasion in tax cases that compels supplanting

the substantive tax law. The first goal of the bankruptcy

system, equal distribution among creditors, might be adversely

affected to some extent if the taxpayer-debtor carried the burden

of proof, favoring the IRS over other creditors. See MacFarlane,

. However, Congress has already accorded taxing

authorities as a class more favorable treatment under the

Bankruptcy Code. Tax claims receive statutory priority over

other creditors' claims, see

(a)(8)(A) (West

Supp. 1998), and unlike other creditors' claims, tax-related

debts cannot be discharged in bankruptcy, see 11 U.S.C.A.

14 523(a) (1) (West 1993) . See also. Thinking Machs.,

; 15 Collier on Bankruptcy, 51X5.03[5] (15th ed. 1997) (The

MacFarlane position "overlooks the frequent disparate treatment

of the government as tax-creditor found in the Bankruptcy Code

regarding such matters as the priority and dischargeability of

claims."). Second, although one could envision some detrimental

effect on the goal of providing a "fresh start" to the debtor by

the bankruptcy process, the court does not find the effect to be

significant. Conversely, the third goal, the efficient

administration of bankruptcy cases, would be facilitated by

placing the burden of persuasion on the taxpayer-debtor. The

taxpayer has control over information relevant to the tax claim.

Requiring the taxpayer to come forward with such information

would reduce problems frequently encountered during the discovery

process, and thereby free the bankruptcy court from becoming

embroiled in discovery disputes. The court therefore does not

find that the goals of the banking system require supplanting the

substantive tax law.

In contrast, the court finds two compelling policy reasons

for maintaining the substantive tax law in bankruptcy proceedings

and requiring the debtor to carry the burden of persuasion where

the claimant is a taxing authority. First, if the burden of

proof was allocated differently between the bankruptcy forum and

15 other forums, there would be a great incentive for taxpayers to

forum shop. Simply by filing for bankruptcy, the taxpayer could

shift the potential responsibility for establishing the validity

and amount vel non of a tax claim to the taxing authority.

Second, as observed by the court in Thinking Machs., "if the

taxpayer knows that the burden of proof falls upon the taxing

authority, it would have little incentive to maintain the

necessary records, thereby making the government's case more

difficult if not impossible to establish."

(citations and guotations omitted). The bankruptcy court did not

err in holding that the burden of persuasion rested with the

appellants and not the IRS.

D. New Legal Theory

The appellants also argue that the bankruptcy court erred by

allowing the IRS to assert a new "legal theory" at trial,

although the appellants do not specify what legal theory they

refer to. However, in their first motion to reconsider they

argued that the IRS should not have been permitted to assert a

new "legal theory" disallowing expenses simply because the

expenses listed in the appellants' check ledger did not

correspond to those listed in their tax return. The appellants

also assert that the "legal theory" was untimely.

16 The court does not find that any new legal theory was

advanced. Instead, after reviewing the transcript, the court

finds that the bankruptcy court simply determined that the

appellants failed to provide sufficient evidence to establish

that the appellants were entitled to certain deductions. See

Transcript of Afternoon Session Only of Final Hearing on

Objection to Claim of IRS (Claim No. 23) Filed by Debtor Before

the Honorable James E. Yacos, J.U.S.B.C. at 29-80 (March 17,

1997). Moreover, the appellants have not established that the

bankruptcy court's determinations were clearly erroneous.

E. Items in Dispute

Finally, the appellants assert that the bankruptcy court

mistakenly found the only item in dispute at the March 17, 1997,

hearing was a disallowance of $106,958.00 out of $113,048.00 in

miscellaneous expense deductions, and therefore it erroneously

precluded them from arguing the validity of other deductions.

The burden is on the appellants to show that the bankruptcy

court's findings of fact were clearly erroneous. See Bankr. R.

8013; see also, Ballato v. Ballato,

(M.D. FI.

1995) .

On May 31, 1996, the IRS filed both its motion for summary

judgment and its amplified statement. The motion sought summary

17 judgment on the entire claim asserted by the IRS. The appellants

filed an objection, which they titled an "initial objection,"

asserting that summary judgment was premature, and that the IRS

had not adeguately amplified their claim. In the objection the

appellants contested only the miscellaneous itemized deductions.

See Debtors' "Initial Objection" to United States Motion for

Summary Judgment on Debtor's Objection to Internal Revenue

Service Proof of Claim #23 (8/28/95) at 2, 3. The record does

not indicate that the appellants filed any other objections with

the court. Moreover, at the July 23, 1996, hearing on the

appellants' objection to the IRS's motion for summary judgment,

the appellants were asked whether they were contesting other

items, to which the appellants replied in the negative. See July

23 Tr. at 61. In addition, the appellants never responded or

objected to the oral order the judge issued from the bench at the

July 23 hearing, when the judge stated that "[t]he hearing has

also served to determine that the only guestion in dispute with

regard to the Government's tax claim is the disallowance of the -

of 106,000 and $958 of the total miscellaneous deductions claimed

on the tax return for 1987 of $113,048." July 23 Tr. at 65.

Indeed, the subject matter of the July 23 hearing revolved almost

exclusively around the miscellaneous deductions.

Following the July 23 hearing the bankruptcy court issued

18 the August 1, 1996, order which provided the basis for the March

17, 1997, evidentiary hearing. In the August 1, 1996, order, the

bankruptcy court again stated that "[t]he July 23, 1996,] hearing

has also served to determine that the only guestion in dispute

with regard to the IRS's tax claim is the disallowance of

$106,958 from the total miscellaneous expense deductions claimed

on the debtor's tax return for 1987 of $113,048, because the

debtor Gerald Barrows conceded that he had failed to report

certain interest and dividend income for tax year 1987." August

1, 1996, order at 3. The appellants argue that because the order

only stated that the appellants conceded interest and dividend

income, the March 17, 1997, evidentiary hearing should have

encompassed consideration of additional items. See Appellants'

Brief at 4. They also argue that the July 23, 1996, hearing

clearly established that the only item conceded was interest

income.

This court disagrees. Given the content of the appellants'

written objection, the subject matter of the July 23, 1996,

hearing, the appellants' response to the court's guestioning and

their silence in the face of the court's oral order, the

bankruptcy court's factual conclusion was not clearly erroneous.

To the extent that the appellants did wish to pursue other

objections, they failed to do so below and the objections are

19 waived. Finally, the court does not find compelling the

appellants' argument that the bankruptcy court only stated they

had conceded interest and dividend income. See August 1, 1996,

order at 3. It is not clear that the court was intending to make

an exclusive list, and in so far as the statement is in conflict

with the preceding determination that only miscellaneous

deductions were contested, it would appear that the list was not

intended to be exclusive. The court therefore finds the

appellants failed to establish that the bankruptcy court's

conclusions were clearly erroneous.

In light of the above discussion, the court finds the

appellants have not met their burden of establishing that the

court erred, factually or legally, in the interlocutory order

issued on March 21, 1997, as amended by the court in following

orders. They also failed to establish either that the court's

amended final judgment, or its rejection of their first motion

for reconsideration, after accounting for the concession of the

IRS as reflected in their second motion for reconsideration, was

in error.

20 Conclusion

For the reasons discussed above, the decision of the

bankruptcy court is affirmed.

SO ORDERED.

Joseph A. DiClerico, Jr. District Judge

September 25, 1998

cc: Gerald Barrows, pro se Angela Barrows, pro se William M. Kostak, Esguire George Vannah, Clerk, US Bankruptcy Court

21 22