The opinion of the court was delivered by: Hon. Robert J. Jonker
The United States of America ("the IRS") appeals from a judgment of the Bankruptcy Court. The Bankruptcy Court rejected on summary judgment the IRS's bid to treat tax assessments related to the debtor's 2000 and 2001 income tax returns as priority claims under 11 U.S.C. § 507(a)(8)(A)(iii).*fn1 If the IRS obtains priority status on the 2000 and 2001 debts, it will receive all or virtually all of the Chapter 7 debtor's estate. Without priority status, the IRS will receive only a pro rata distribution on those tax claims, which will leave the debtor's only other creditor, Brae Asset Fund, L.P., with a substantial amount of the debtor's estate.
The pivotal question is one of statutory interpretation. The IRS claims that section 507(a)(8)(A)(iii) priority applies because the IRS exercised its right to assess the 2000 and 2001 tax years within the six-year statute of limitations period for substantial understatements of income, instead of pursuing those tax assessments on a fraud theory. Brae argues that the assessments are not entitled to priority because, regardless of how the IRS decided to treat the tax debts, the debtor, as a matter of fact, filed fraudulent tax returns in 2000 and 2001, thus falling within an explicit statutory exception to priority. The Bankruptcy Court adopted Brae's statutory construction, gave the IRS an opportunity to contest the factual claim of fraud, and then ruled for Brae on summary judgment after the IRS elected not to contest the factual claim of fraud. This appeal followed.
Factual and Procedural Background
The debtor, Patrick Martin, filed for bankruptcy in 2005. There are two creditors to whom his Chapter 7 bankruptcy estate will be distributed: the IRS and Brae. Brae's claims for $1,813,709.90 are general unsecured claims that will be paid only after any priority claims. In early 2006, the IRS assessed to the debtor approximately $360,000 in additional taxes and accuracy penalties for the tax years 2000, 2001, and 2002. It applied the 2002 assessment under the standard, three-year statute of limitations. See 26 U.S.C. § 6501(a). It applied the 2000 and 2001 assessments under the six-year statute of limitations that applies to substantial omissions. See 26 U.S.C. § 6501(e)(1). The IRS chose not to classify the debtor's returns as fraudulent or to assess him a civil fraud penalty under 26 U.S.C. § 6663.
All parties concede that the IRS's claim for approximately $120,000 related to the 2002 tax year is entitled to priority under section 507(a)(8)(A)(i). The question is how to classify the IRS's claims for approximately $240,000 related to the 2000 and 2001 tax years. Brae will suffer a reduced--or no--distribution if the IRS's claims for 2000 and 2001 receive priority treatment. In bankruptcy court, the IRS asserted that its claims related to 2000 and 2001 were entitled to priority under 11 U.S.C. § 507(a)(8)(A)(iii). Brae objected to the priority treatment of those claims, and filed an adversary proceeding. After a hearing on Brae's objection, the Bankruptcy Court directed the IRS to file a summary judgment motion regarding the nature of its claim. In that motion, the IRS contended that it had unilateral authority to determine whether the 2000 and 2001 claims fell into the fraud exception to section 507(a)(8)(A)(iii); that it had decided not to classify the tax debts as fraudulent; and that it was therefore entitled to priority.
On November 19, 2008, the Bankruptcy Court rendered a bench opinion rejecting the IRS's argument that it had sole authority to treat the claim as arising from fraud. The court determined that the 2000 and 2001 debts could not be treated as priority claims under section 507(a)(8)A)(iii) if those debts were actually the result of fraud as defined in 11 U.S.C. § 523(a)(1)(C), even if the IRS had chosen not to assess a fraud penalty on the claims and had assessed the tax under a non-fraud statute of limitations. The court concluded that a trial was necessary to determine whether the tax debts were, in fact, ones "with respect to which the debtor made a fraudulent return." See 11 U.S.C. § 523(a)(1)(C).
On July 6, 2009, Brae filed for summary judgment on the priority status of the IRS's 2000 and 2001 claims. It contended that there was no genuine issue of material fact that the debtor's 2000 and 2001 tax returns were fraudulent as defined in section 523(a)(1)(C) and therefore not entitled to priority under section 507(a)(8)(A)(iii). The IRS responded, but it did not dispute that the debts were fraudulent as a matter of fact. Instead, it reasserted its statutory interpretation arguments from its earlier summary judgment motion. In light of the IRS's failure to demonstrate an issue of material fact regarding whether the tax debts were the product of fraudulent returns, and after finding independent support in the record to conclude that the debtor had filed fraudulent returns, the Bankruptcy Court concluded that the tax debts arose from fraudulent returns. It therefore granted Brae's motion for summary judgment and denied priority treatment to the 2000 and 2001 tax debts. The Bankruptcy Court did not reach a final decision on whether the debtor would be bound to a finding of non-dischargeability under section 523(a)(1)(C), however, because no one had initiated a non-dischargeability proceeding. The IRS appealed to this Court.
The standard of review on appeal is clear error as to the Bankruptcy Court's findings of fact and de novo as to its conclusions of law. In re Batie, 995 F.2d 85, 88 (6th Cir. 1993). The IRS contends that the Bankruptcy Court erred in three ways. First, it contends that Brae lacked standing to object to the priority treatment of the IRS's claims. Second, it contends that the tax debts from 2000 and 2001 are entitled to priority under section 507(a)(8)(A)(iii) as a matter of law so long as the IRS assessed them for a lawful reason other than fraud. Third, it contends that if the 2000 and 2001 debts are not entitled to priority, then the Bankruptcy Court's determination that the tax debts were the product of fraudulent returns should be res judicata against the debtor for the purposes of dischargeability.
I. Brae has Standing to Contest the IRS's Priority Claim
The Bankruptcy Court concluded that Brae had standing to object to the priority treatment of the IRS's claims because the trustee did not object and because Brae stood to suffer a reduced distribution if the IRS's claims received priority treatment. The IRS contends that Brae lacked standing to object, arguing that Brae does not have a cognizable interest in ...