For tax practitioners representing clients with insolvency issues, the Federal Priority Statute, 31 U.S.C. § 3713, presents significant personal liability risks. Under Section 3713(b), a representative who pays 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.

While liability determinations often focus on insolvency and knowledge, a recent decision from the U.S. District Court for the District of Maryland, United States v. Neuberger, No. 1:22-cv-02977, provides critical guidance on the quantification of that liability. Specifically, the court addressed whether a representative’s personal liability includes after-accruing penalties and statutory interest under the Internal Revenue Code (IRC) or if it is capped at the amount of the claim known at the time of the wrongful distribution.

Factual Background

The case centers on the tax liabilities of Lehcim Holdings, Inc. ("Lehcim"). For the tax years 2010 through 2020, Lehcim claimed substantial tax deductions for interest accruing on loans the IRS later determined were not bona fide. By July 2018, the defendant, Isaac M. Neuberger, was aware of the IRS’s preliminary conclusion regarding these improper deductions.

On March 14, 2019, the IRS issued a "30-day letter" to Lehcim. As the court noted, this letter "identified the proposed tax deficiencies, associated penalties, and interest for Lehcim for the years 2010 to 2015 in the amount of $1,880,987.96". Following this, on November 20, 2019, the IRS mailed a statutory notice of deficiency.

Despite having notice of the United States’ claim, Mr. Neuberger "helped engineer and oversee an elaborate plan...to transfer money among various entities, including Lehcim, to repay the loans that the IRS had concluded were not bona fide". This repayment plan, executed between June 2019 and March 2020, involved the distribution of over $8.8 million, leaving Lehcim insolvent.

Following a bench trial on liability, the court found Mr. Neuberger personally liable under Section 3713(b) because he was Lehcim’s representative, had knowledge of the tax claim, and paid other entities when Lehcim was insolvent. The court then requested additional briefing to determine the specific amount of damages owed.

The Government’s Position on Damages

The United States argued that Mr. Neuberger’s liability should mirror the taxpayer’s liability under the IRC, essentially treating the representative as the taxpayer for collection purposes. The government contended that "if Lehcim owes it, then, under the Federal Priority Statute, so does Mr. Neuberger, including statutory interest".

The government sought a judgment of over $3.3 million, comprised of the original assessment plus penalties accruing under 26 U.S.C. §§ 6651(a) and 6662(a), and interest accruing under 26 U.S.C. § 6621 "from the date the taxes were due until they are paid". The government characterized this calculation as mere "statutory arithmetic".

Court’s Analysis: Distinguishing the Federal Priority Statute from the IRC

The court decisively rejected the government’s attempt to automatically apply IRC accruals to a Federal Priority Statute claim. Judge Erin Aslan emphasized that "[a]lthough this [Section 3713] case involves collection of a tax debt, it is not an action against the taxpayer or under the Internal Revenue Code".

The court observed that the United States "failed to offer clear legal or evidentiary support" for the position that the intricate tax code calculations govern damages in a Section 3713 case. The court noted that the government’s reliance on statutes concerning the computation of penalties and interest under the IRC was misplaced because the "cause of action in this case arises under the Federal Priority Statute, not the tax code, which necessarily shapes the scope of available remedies".

Distinction Between Estate Executors and Other Representatives

The government relied heavily on cases involving estate executors to support its claim for full penalties and interest. The court distinguished these cases, noting that the statutory scheme for executors is distinct. Liability under Section 3713(a)(1)(B) attaches when an estate is insufficient to pay debts, reflecting a fiduciary duty where the executor is "responsible for the payment of income and estate taxes... owed by [the taxpayer’s] estate".

However, for non-executor representatives, liability under Section 3713(a)(1)(A) requires a specific triggering event—such as a voluntary assignment of property—and the representative’s liability is not necessarily coextensive with the estate’s ongoing tax obligations in the same manner.

Calculating the Damage Cap: The "Time of Payment" Rule

In the absence of clear binding authority, the court adopted the reasoning of United States v. Estate of Dickerson ex rel. Tate and similar Tax Court decisions. The court concluded that "the operative variable in determining the damages is the amount of the United States’ claim at the time of the representative’s payment".

The court cited precedent establishing that "in order to qualify for first priority in payment under 31 U.S.C. § 3713(a), the debt owed to the United States Government must be in existence at the time the insolvent person assigns the property". Consequently, the government was "not entitled to the after-accruing interest and failure-to-pay penalties it seeks as part of its damage calculation".

Applying this to the facts, the court determined damages based on the "30-day letter" received regarding the audit. The court held:

"Mr. Neuberger is liable for the $1,880,987.96 in unpaid taxes, penalties, and interest identified in the IRS’s March 14, 2019 (or 30-day) letter. This represents the amount of the United States’ claim that had accrued and of which Mr. Neuberger had knowledge prior to and during execution of the repayment plan...".

Prejudgment Interest and Equitable Factors

The court also addressed the issue of prejudgment interest. Unlike the mandatory interest provisions of the IRC (28 U.S.C. § 1961(c)(1)), the award of interest in a Federal Priority Statute case is discretionary and based on equitable factors.

The court declined to award prejudgment interest, noting that "case law does not find robust support for the award of prejudgment interest in Federal Priority Statute cases". Furthermore, the court looked to the nature of the representative’s conduct. Unlike cases where a representative enriches themselves at the public’s expense, the court found "there is no indication that Mr. Neuberger engaged in self-dealing".

Evidentiary Issues with Post-Trial Calculations

Tax professionals should also note the court’s procedural admonition regarding the government’s damage calculations. The United States attempted to submit reports calculating interest via commercial software as post-trial exhibits. The court criticized this approach, noting that "[t]hese post-trial exhibits were not entered into evidence and Mr. Neuberger did not have an opportunity to raise objections or test their veracity via cross-examination". While courts sometimes allow formulaic calculations in tax claims post-trial, the court found no authority permitting this for Section 3713 claims, reinforcing the need for strict evidentiary standards.

Conclusion

The Neuberger decision serves as a vital precedent for limiting the scope of damages under the Federal Priority Statute. By decoupling Section 3713 liability from the automatic accrual provisions of the IRC, the court limited the representative’s exposure to the claim amount known at the time of the wrongful distribution.

The court entered judgment against Mr. Neuberger in the amount of $1,880,987.96, rejecting the government’s request for over $3.3 million. This case highlights that while representatives face strict liability for prioritizing other creditors, that liability is not boundless and must be tethered to the specific government claim existing when the priority statute was violated.

Prepared with assistance from NotebookLM.