Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.
The Right Intention but the Wrong Result: The Misapplication of Section 1341
in Cooper v. United States
In Cooper v. United States, 1 the U.S. District Court for the Western District of North Carolina held that the relief provision of section 1341 could be invoked by the trustee of a bankruptcy estate. Additionally, the court held that even though the debtor may not have been entitled to section 1341 2 relief, the debtor’s misconduct, causing the preclusion of section 1341 benefits, should not be imputed to the trustee. 3
Although the district court’s holding that the trustee has standing is correct, the court erred in applying section 1341 to a situation that did not fall within the literal language of the statute. Section 1341(a)(1) requires that a taxpayer include an item in gross income when it “appeared that the taxpayer had an unrestricted right to such” income. 4 Many courts have held that a taxpayer who commits an intentional wrongdoing cannot create an “appearance of an unrestricted right to an item of income.” 5 The government argued in Cooper that the taxpayer’s income was obtained as a result of his fraudulent actions, therefore precluding the use of section 1341. 6 However, because the debtor was in bankruptcy, the court focused its analysis on whether the bad acts of the debtor should be imputed to the trustee, 7 overlooking the fact that the debtor likely did not have a right to a favorable tax computation in the first place under section 1341. Furthermore, the government argued that the “plain language of the Bankruptcy Code bars the court from considering the trustee’s status as an innocent successor to the debtor’s claims.” 8 Again, the court reasoned that the trustee, not the debtor, was seeking a refund computation and that not allowing the use of section 1341 would harm the “innocent victimized creditors.” 9 But, that argument seems misplaced if the trustee had no right to the benefits of section 1341 at the outset.
Although the Cooper court makes a compelling equity argument, the court’s final decision does not give deference to precedent and, more importantly, the statutory requirements of section 1341. This case highlights a situation in which a court sought to tailor an equitable result without properly applying the statutory schematic as done by many previous courts. Following the decision of the Cooper court will create confusion as to the proper application of section 1341. Furthermore, it opens the question whether a trustee can have greater rights in bankruptcy than the debtor.
This Note argues that by allowing the trustee to make use of the favorable provisions of section 1341, the court failed to apply the statutory requirements of that section. If the court had adhered to the language of section 1341, it would have found that the debtor was not entitled to section 1341 relief, and therefore, neither was the trustee.
Part I of this Note presents the factual background and the opinion of the Cooper case. Part II briefly discusses section 1341 and its legislative history. Part III analyzes the district court’s opinion in light of the statutory requirements of section 1341 and section 541 of the Bankruptcy Code. Additionally, this Note argues that the court correctly granted the trustee standing to claim section 1341 relief but that the holding should be limited to situations in which the debtor also would have been able to claim such relief. Part IV concludes that the court erred in allowing the trustee to make use of the favorable tax computations afforded by section 1341 by stretching to reach a particular result through the misapplication of the first requirement of section 1341.