Opinion ID: 14457
Heading Depth: 2
Heading Rank: 1

Heading: Interest or Penalty?

Text: 12 The Supreme Court has considered whether interest is a penalty or merely interest twice before in relation to the Bankruptcy Act of 1898. In United States v. Childs, 266 U.S. 304, 307, 45 S.Ct. 110, 111, 69 L.Ed. 299 (1924), the Court defined both penalty and interest: A penalty is a means of punishment; interest a means of compensation. In Meilink v. Unemployment Reserves Comm'n, 314 U.S. 564, 570, 62 S.Ct. 389, 392, 86 L.Ed. 458 (1942), the Court distinguished a penalty as a fixed ad valorem amount taking no account of time from interest which does depend on time. The Childs Court noted that the power that creates [an] obligation can assign the measure of its delinquency--the detriment of delay in payment. 266 U.S. at 308, 45 S.Ct. at 111. The Meilink Court found that a mere difference in rates does not establish that an increased rate is a penalty. 314 U.S. at 567, 62 S.Ct. at 391. The Court recognized that risk is an important factor causing interest rates to vary from a general compensatory rate: 13 It is common knowledge that interest rates vary not only according to the general use value of money but also according to the hazard of particular classes of loans. Delinquent taxpayers as a class are a poor credit risk; tax default, unless an incident of legitimate tax litigation, is, to the eye sensitive to credit indications, a signal of distress. A rate of interest on tax delinquencies which is low in comparison to the taxpayer's borrowing rate--if he can borrow at all--is a temptation to use the state as a convenient, if involuntary, banker by the simple practice of deferring the payment of taxes. 14 Id. Therefore, the Court acknowledged that an exaction having in part a deterrent effect does not make that exaction a penalty. Additionally, the Meilink Court added that the expense of handling a particular collection item can also legitimately vary the rate of interest. Id. 15 More recently, the Supreme Court has had the opportunity to determine whether a particular exaction was a tax or a penalty under the current Bankruptcy Code. See United States v. Reorganized CF & I Fabricators of Utah, Inc., 518 U.S. 213, 116 S.Ct. 2106, 135 L.Ed.2d 506 (1996). The Court took a functional approach to this determination, looking beyond the labels in the Bankruptcy and Internal Revenue Codes. Id. at ---- - ----, 116 S.Ct. at 2111-12. This court has taken a similar approach in the past. See Mahon v. United States Internal Revenue Serv. (In re Unified Control Sys., Inc.), 586 F.2d 1036, 1037 (5th Cir.1978) (considering whether an excise tax was a penalty and noting that the label given an exaction in the Internal Revenue Code is not dispositive and must be considered in its context). However, while looking beyond them, labels can inform a determination; in Childs, the fact that a statute labeled different exactions as a penalty and as interest was relevant to whether the interest was a penalty. 266 U.S. at 309-10, 45 S.Ct. at 111; see also Unified Control Sys., 586 F.2d at 1037 (considering the label in context). 16 To determine whether the § 6621(c) additional interest is a penalty, the following factors are relevant: (1) the language of the provision, (2) the form of the sanctions, (3) the confiscatory nature of the sanction, and (4) the legislative history of the provision. See Unified Control Sys., 586 F.2d at 1038-39 (considering a 200% excise tax); see also Reorganized CF & I Fabricators, 518 U.S. at ---- - ----, 116 S.Ct. at 2113-14 (finding a 10% sanction on the underfunding of a pension plan to be a penalty based upon the legislative history of the provision and its function); Meilink, 314 U.S. at 569-70, 62 S.Ct. at 392 (finding a 12% interest rate (2% higher than the maximum allowable private rate under the state constitution) to be interest and not a penalty based upon its function, form, and label). 17 First, the language of the Internal Revenue Code denominates the § 6621(c) exaction as interest. 26 U.S.C. § 6621. Section 6621(c) appears in the same section as the regular underpayment rate and is a substitute for the regular underpayment rate. See id. Additionally, the § 6621(c) rate is located in the subchapter on interest and not in the subchapter on penalties. See id. chs. 67-68. Labels are not dispositive, but the placement of the provision and its label are informative, as in Childs, when considered in relation to how Congress has denominated and placed provisions that it considers to be penalties. 18 Second, in form, § 6621(c) interest is applied in the same manner as the regular rate of interest. See id. §§ 6601, 6622. It is compounded daily and only accrues while the debt is overdue and remains unpaid. Id. The taxpayer can end the imposition of the interest by paying the tax debt. Nothing about § 6621(c) interest suggests that it is applied in any way unlike the application of the regular interest rate to a tax debt. 19 Third, the regular interest rate ranged between 9% and 13% during the relevant time period, and the § 6621(c) 20% increase over the regular interest rate ranged between 10.8% and 15.6% during that period. Therefore, the increase due to § 6621(c) ranged between 1.8% and 2.6%, which is similar to the increased rate in Meilink; the § 6621(c) additional interest is not nearly as burdensome an exaction as the one at issue in Unified Control Systems (200%) and is significantly less so than the one at issue in Reorganized CF & I Fabricators (10%). Therefore, § 6621(c) interest rate is not confiscatory in nature. 20 Fourth, the legislative history of § 6621(c) is sparse. That which is available lists § 6621(c) among other penalty provisions enacted in response to the tax court backlog. See H.R. CONF. REP. NO. 98-861, at 985 (1984) (in section describing § 6621, noting that a number of the provisions of recent legislation have been designed, in whole or in part, to deal with the Tax Court backlog and listing as examples adjustment of interest rates (sec. 6621), valuation overstatement and substantial understatement penalties, and increased damages for delaying or frivolous tax court proceedings (emphasis added)), reprinted in 1984 U.S.C.C.A.N. 1445, 1673. At most, this association highlights the deterrent effect that Congress intended the provision to have in order to aid in easing the burden on the system of tax dispute resolution. 21 Under the above factors, § 6621(c) increased interest is interest and not a penalty. It also fits neatly within the Supreme Court precedent of Childs and Meilink. The § 6621(c) exaction depends upon time, which distinguishes it from a penalty. See Meilink, 314 U.S. at 570, 62 S.Ct. at 392. Section 6621(c) reaches delinquent taxpayers, who have engaged in certain tax-motivated, sham transactions that Congress felt increased the burden upon the tax court system. See H.R. CONF. REP. NO. 98-861, supra. Congress can legitimately vary the interest rate because of its desire to deter the transactions which lead to this burden and the increased cost of collection created by this burden. See Meilink, 314 U.S. at 567, 62 S.Ct. at 391. The next step is to determine whether § 6621(c) interest is part of the underlying tax debt or just a pecuniary penalty. 22