FEDERAL TAX CONSIDERATIONS IN THE ADMINISTRATION OF A RECEIVERSHIP SEPTEMBER 2013

1. FEDERAL TAX CONSIDERATIONS IN THE ADMINISTRATION OF A RECEIVERSHIP SEPTEMBER 2013 when the pressure is on Conrad O’Brien

2. FEDERAL TAX CONSIDERATIONS • Consideration must be given to potential tax liability before victim distributions. • Can Receiver be liable for unpaid taxes if all assets are used for victim restitution? • Yes

3. FEDERAL DEBT PRIORITY – IMPACT ON RECEIVERSHIPS • Federal Debt Priority Statute (31 U.S.C. § 3713(b)): • (a)(1) A claim of the United States Government shall be paid first when - • (A) a person indebted to the Government is insolvent and - • (i) the debtor without enough property to pay all debts makes a voluntary assignment of property; • property of the debtor, if absent, is attached; or • (iii) an act of bankruptcy is committed; or • (B) the estate of a deceased debtor, in the custody of the executor or administrator, is not enough to pay all debts of the debtor.

4. FEDERAL DEBT PRIORITY – IMPACT ON RECEIVERSHIPS • (2) This subsection does not apply to a case under title 11. • (b) A representative of a person or an estate (except a trustee acting under title 11) paying any part of a debt of the person or estate before paying a claim of the Government is liable to the extent of the payment for unpaid claims of the Government.

5. FEDERAL DEBT PRIORITY – IMPACT ON RECEIVERSHIPS • James v. United States, 366 U.S. 213, 218, 81 S. Ct. 1052, 1054-55 (1961) “It had been a well-established principle ... that unlawful, as well as lawful, gains are comprehended within the term ‘gross income’ ... This revealed, we think, the obvious intent of that Congress to tax income derived from both legal and illegal sources, to remove the incongruity of having the gains of the honest laborer taxed and the gains of the dishonest immune.” • Pre-appointment tax years are a minefield of potential liability for receivers. • Receivers goal of efficient and timely distributions are often frustrated by the pace of the IRS.

6. SEC v. CREDIT BANCORP,297 F.3d 127 (2d Cir. 2002) • Sovereign immunity prevents a receiver from forcing the issue. • “It is well established that ‘[t]he United States, as sovereign, is immune from suit save as it consents to be sued.... [T]he terms of its consent to be sued in any court define that court's jurisdiction to entertain the suit.’.... Any waiver of the government's sovereign immunity is to be strictly construed in favor of the government.” • “The Declaratory Judgment Act, with certain exclusions not relevant here, allows a federal court to declare the rights and obligations of the parties properly before it in any “case of actual controversy within its jurisdiction, except with respect to Federal taxes.” citing 28 U.S.C. § 2201(a)

7. SEC v. CREDIT BANCORP • “The Receiver sought to bring the United States into this action in its capacity as the IRS. He sought a declaration that customer debts have priority over Bancorp's federal tax debts, and he sought a declaration as to his own liability for Bancorp's federal taxes if he proceeds with the partial distribution plan. We conclude that, in the absence of some other waiver of sovereign immunity, the Declaratory Judgment Act deprived the district court of the power to grant the declarations sought by the Receiver. [...] That absence of power is further reflected in the Anti-Injunction Act. That statute provides, with exceptions not relevant here, that ‘no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person, whether or not such person is the person against whom such tax was assessed’.” citing 26 U.S.C. § 7421(a).

8. CLOSING AGREEMENTS • Treasury Regulation Section 301.7121-1(a), states: “In general. The Commissioner may enter into a written agreement with any person relating to the liability of such person (or of the person or estate for whom he acts) in respect of any internal revenue tax for any taxable period ending prior or subsequent to the date of such agreement. A closing agreement may be entered into in any case in which there appears to be an advantage in having the case permanently and conclusively closed, or if good and sufficient reasons are shown by the taxpayer for desiring a closing agreement and it is determined by the Commissioner that the United States will sustain no disadvantage through consummation of such an agreement.”

9. CHANGE IN IRS POLICY – NO MORE CLOSING AGREEMENTS • SEC v. Byers (Wextrust), 1:08-cv-07104-DC (S.D.N.Y.) (see docket no. 851). • After approximately 3 years of negotiations between the IRS and the Receiver which until resolved prevented victim distributions. Judge Chin orders the IRS and the Receiver to brief the issues preventing resolution. After submitting briefs, Receiver and Government negotiate compromise and enter into stipulated order permitting investor victims to stand in the shoes of the government for purposes of any tax liabilities owed.

10. CHANGE IN IRS POLICY – NO MORE CLOSING AGREEMENTS • SEC v. Young, 2:09-cv-01637-JP (E.D.Pa.) (see docket nos. 319, 320). • Receiver files motion to resolve pre-Receivership tax claims and compel the response of the IRS. After submitting briefs, Receiver and Government enter into stipulated order agreeing that IRS liability is subordinated to investor victim restitution.

11. NEW PROCEDURE – SETTLING WITHIN THE RECEIVERSHIP PROCEEDING • Tax Division Directive No. 137: “Tax Claims Against Embezzlers, Swindlers, Etc. v. Recovery by Investors, Dupes, and Victims, Etc.” • “When both the tax claim and the claim of the investor or victim arise from the same transaction and the investor or victim can trace its property to the fund in issue, the Tax Division will recognize the priority of the claim of the investor or victim.” • “When the tax claim and the claim of the investor or victim do not arise from the same transaction, the Tax Division will recognize the priority of the claim of the investor or victim when the investor or victim can trace his claim to the property at issue and either (a) title never passed to the wrongdoer, such as in the case of theft, or (b) when a constructive trust, including all tracing requirements, has been imposed prior to assessment of the tax, or would be imposed and the tax has not been assessed.”

12. NEW PROCEDURE – SETTLING WITHIN THE RECEIVERSHIP PROCEEDING • Define Your Victims – Investors Only: • Directive 137: “As used here, “investor” denotes a willing participant or customer who was misled or defrauded by the perpetrator (see Cunningham v. Brown, 265 U.S. 1, 7 (1924)). “Victim” denotes a person who did not willingly participate or willingly part with money or property, such as when there is theft, including embezzlement.”

13. TAKEAWAYS • Keep your appointing agency closely involved. If agency can act as a liaison between Receiver and the IRS/DOJ, the process will go more smoothly. • Consider potential tax issues as early in receivership proceedings as possible, and avoid making distributions until they are resolved. • Be aware that general creditors, no matter how sympathetic, will not receive priority from the government, and therefore no payments to this class of creditors should be made until you have certainty that the potential tax liabilities are satisfied. • There may be gray areas in distinguishing between investor victims and other general creditors.