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COMMENTS CONCERNING THE TAX RECOMMENDATIONS OF THE
NATIONAL BANKRUPTCY
REVIEW COMMISSION
The following comments are the individual views
of the members of the Section of Taxation who prepared them and do not represent
the position of the American Bar Association or the Section of Taxation.
These comments were prepared by individual
members of the Special Task Force on the National Bankruptcy Review Commission
of the Section of Taxation. Principal responsibility was exercised by Paul H.
Asofsky and Robert E. McKenzie. Substantive contributions were made by Paul H.
Asofsky, Karrie L. Bercik, Harvey Berenson, Martin B. Cowan, John H.
Eggertsen, Molly Gallagher, Marc E. Grossberg, Thomas I. Hausman,
Milton B. Hyman, Robert A. Jacobs, Morgan D. King,
Robert E. McKenzie, Charles L. McReynolds, George Nelson,
Wm. Robert Pope, Jr., F. Brook Voght, Mark S. Wallace,
Kenneth C. Weil. The comments were reviewed by Kenneth W. Gideon of the
Section's Committee on Government Submissions.
Although many of the members of the Section of
Taxation who participated in preparing these comments have clients who would be
affected by the federal tax principles addressed by these comments or have
advised clients on the application of such principles, no such member (or the
firm or organization to which such member belongs) has been engaged by a client
to make a government submission with respect to, or otherwise to influence the
development or outcome of, the specific subject matter of these comments.
Contact Person: Paul H. Asofsky
Weil, Gotshal & Manges LLP
700
Phone: (713) 546-5118
Fax: (713) 224-9511
Dated: April 15, 1997
REPORT
OF THE
TASK FORCE
ON THE
TAX RECOMMENDATIONS
OF THE
NATIONAL BANKRUPTCY REVIEW COMMISSION
April 15, 1997 Paul H. Asofsky
Robert E. McKenzie
Co-Chairs
TABLE OF CONTENTS
PREFACE 6
Introduction 6
The Task Force 8
Summary of Principal Recommendations 10
The Commission 14
The Original Bankruptcy Commission and its Legacy
18
Role of the Section 19
The Challenge to the Commission 21
TASK FORCE POSITIONS 23
1. Subordination of Certain Tax Liens in Chapter 7: Section 724(b)(2)
of the Bankruptcy Code (Commission Track Number
100) 23
2. Extending the "Deemed Filed" Rule Beyond Chapter 11
(Commission Track Number 104) 26
3. Notice to Governmental Units
(Commission Track Numbers 105, 106 and 109) 31
4. Scheduling the Tax Basis of Assets
(Commission Track Numbers 107 and 108) 39
5. Burden of Proof (Commission Track Number 211)
44
6. Bringing Tax Returns and Payments Current
(Commission Track Number 212) 48
7. The Chapter 13 "Superdischarge"
(Commission Track Number 213) 60
8. Deferred Payments of Priority Taxes Under Section 1129(a)(9)(C)
of the Bankruptcy Code (Commission Track Number
214) 64
9. Setoffs (Commission Track Number 215) 71
10. Notice Requirements Under Section 505(b) of the Bankruptcy Code
(Commission Track Number 216) 74
11. The Estate of an Individual Family Farmer as a Taxable Entity:
Section 1231(b) of the Bankruptcy Code
(Commission Track Number 217) 77
12. Proposal to Create an Elective Short Taxable Year for
State and Local Tax Purposes (Commission Track
Number 217A) 82
13. Debtor's Duty to Give Notice of Pending Federal Tax Audits
(Commission Track Number 218) 85
14. Sanctions or Contempt Against a Governmental Authority for
Violation of the Automatic Stay (Commission Track
Number 219) 94
15. Suspension of Time Under Section 507(a)(8) of the Bankruptcy Code
During Period of Previous Bankruptcy Cases
(Commission Track Number 311) 97
16. Remedies Upon Default or Dismissal of Confirmed Plan
(Commission Track Number 312) 100
17. Effect of Offers in Compromise on the 240-Day Period
of Section 507(a)(8)(A)(ii) of the Bankruptcy Code
(Commission Track Number 313) 108
18. Nonassessed Taxes as Priority/Nondischargeable Debts
(Commission Track Number 314) 113
19. Special Bank Accounts for Postpetition Taxes and Other Payroll
Deductions (Commission Track Number 315) 117
20.
21. Bankruptcy Court Jurisdiction in Tax Matters, Including Declaratory
Judgments on Tax Matters (Commission Track
Numbers 329 and 433) 127
22. Dischargeability of Penalties Related to Nondischargeable Taxes
(Commission Track Number 331) 134
23. Lien Capping in Chapter 13 (Commission Track
Number 333) 139
24. Avoiding Tax Liens (Commission Track Number
334) 142
25. Priority for Excise and Employment Taxes
(Commission Track Number 335) 147
26. Tax Jurisdiction in No Asset Cases
(Commission Track Number 339) 153
27. Filing Partnership Tax Returns (Commission
Track Number 414) 156
28. Sections 728(c) and 728(d) of the Bankruptcy Code
(Commission Track Number 414A) 162
29. Effect of Discharge of Partnership Indebtedness on Basis of
Partner's Interest in Partnership (Commission
Track Number 415A) 164
30. The Trustee as Tax Matters Partner
(Commission Track Number 415B) 172
31. Postpetition Taxes as Ordinary Course Expenses
(Commission Track Number 421-4) 179
32. Abandonment (Commission Track Number 425) 186
33. Corporate Income Taxes in Year Petition is Filed
(Commission Track Number 432) 191
34. The Estate as Successor Under Section 505(b) of the Bankruptcy Code
(Commission Track Number 438A) 208
35. Fresh Start NOL Proposal (Commission Track
Number 4312) 202
36. Retroactive Challenge to Nonconforming Chapter 13 Plans
(Commission Track Number 441) 212
37. Failure of Tax Authority to File Chapter 13 Proof of Claim
(Commission Track Number 441A) 216
38. Interest on Deferred Chapter 13 Tax Payments
(Commission Track Number 503A) 222
39. Definition of "Willfully" for purposes of Section 523(a)(1)(C)
of the Bankruptcy Code (Commission Track Number
602) 228
40. Consolidated Return Issues Where Common Parent, But Not All
Subsidiaries, Is a Debtor (Commission Track
Number 604A) 233
41. Disclosure Statements (Commission Track
Number 701) 239
42. Subordination of Tax Penalties
(Commission Track Numbers 703 and 704) 243
APPENDIX A - Guide to Track Numbers and
Cross-References 247
APPENDIX B - Dissenting Views 250
APPENDIX C - Fresh Start NOL Proposal: Legislative Language 252
PREFACE
Introduction
This is the first report of a special Task Force (the "Task Force") of the Section of Taxation (the "Section") of the American Bar Association (the "Association") on the tax recommendations of the National Bankruptcy Review Commission (the "Commission"). Under the Section's procedures, this report constitutes individual comments of the members of the Task Force. These comments are therefore the individual views of the members of the Task Force who prepared them and do not represent the position of the Association or of the Section.
Because of the Commission's timetable, there is not sufficient time to invoke the procedures necessary to have this report adopted by the Section and by the Association.(1) However, because of the Section's commitment to improving the functioning of the bankruptcy laws in relation to tax matters and of the tax laws in relation to bankruptcy matters, the Section offers these individual comments for the benefit of the Commission at this time. It is anticipated that once the Commission makes its report to Congress, now scheduled to be released on or before October 20, 1997, this Task Force will prepare a final report on the Commission's definitive proposal. Because we anticipate that there will be a significant interval between adoption of the Commission's report and any hearings held by the relevant committees of Congress, at which the Association and the Section will have an opportunity to testify, the Task Force's final report will be submitted for formal adoption. In the interim, it is possible that there will be supplemental reports by way of individual comments issued by the Task Force to respond to new proposals that are put before the Commission.
Unfortunately, this report is lengthy, but the length is necessary. The Commission is considering a plethora of proposals that individually and in the aggregate would have an important impact on the interaction of bankruptcy and tax laws. Many of these proposals were the result of the participation at an early stage of the Commission's deliberations by the Department of Justice, the Internal Revenue Service and the National Association of Attorneys General. It should not be surprising, therefore, that these pending proposals largely reflect some frustration on their part that the present system does not allow them to collect taxes to which they are entitled without undue interference from the bankruptcy court. This Task Force report necessarily constitutes in large measure a response to those proposals. As will be seen, we support many of them, in the interests of a more efficient operation of the bankruptcy system and in the belief that the government should not lose its ability to collect taxes that are rightfully due from debtors merely as a result of technical flaws in the system. However, as we shall also point out, many of these proposals are unwise. In some cases, the perceived problems ought to be resolved by the normal operation by the bankruptcy rules process, the income tax regulations process and judicial process, and the Commission need not address them at this time. With respect to another group of proposals, we believe that if enacted, they will upset a delicate balance between the bankruptcy process and the tax collection process that is necessary to preserve the integrity of both. Finally, in a few cases we have made proposals of our own, some of which have previously been advanced by the private bar, to improve the operation of the system and to strengthen that delicate balance. We believe that if the Commission, and ultimately the Congress, adopts the positions set forth in this report, both the bankruptcy and tax collection systems will be strengthened.
The Task Force
In November 1996, the Chair of the Section of
Taxation of the American Bar Association, after consultation with the Council
of the Section, created the Task Force to monitor the work of the Commission
with respect to tax matters. Paul H. Asofsky of
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Paul H. Asofsky |
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Karrie L. Bercik |
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Harvey Berenson |
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Martin B. Cowan |
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John H. Eggertsen |
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Molly Gallagher |
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Thomas I. Hausman |
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Robert Joe Hull |
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Milton B. Hyman |
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Robert A. Jacobs |
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Morgan D. King |
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William H. Lyons |
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Robert E. McKenzie |
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Charles L. McReynolds |
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Wm. Robert Pope, Jr. |
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Timothy C. Sherck |
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Diane E. Tebelius |
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F. Brook Voght |
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Mark S. Wallace |
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Kenneth C. Weil |
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All of the foregoing individuals are tax attorneys with extensive experience in the bankruptcy field. A number of them actively participated on behalf of the Section in the development of the Bankruptcy Tax Act of 1980.
The huge inventory of proposals before the Commission also required us to reach outside the Task Force and solicit the assistance of some individuals with particular expertise in designated subject matter areas. The Task Force acknowledges the assistance of the following individuals in the preparation of particular sections of the report. These individuals have not participated in commenting on any portion of the report other than the particular proposal as to which their assistance was solicited.
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Sylvia Mayer Baker |
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Alex Gluzman |
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Marc E. Grossberg |
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J. Hayden Kepner |
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Wendy K. Laubach |
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George Nelson |
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Candace S. Schiffman |
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Michael St. James |
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Summary of Principal Recommendations
The following is an enumeration of the Task Force's recommendations on the more significant issues discussed herein.
The Task Force opposes proposals to repeal the downgrading of tax liens currently contained in section 724 of the Bankruptcy Code. Any viable system must provide for the payment of administrative expenses. But we think that private secured creditors should bear the burden of ad valorem real property taxes. We oppose extension of the "deemed filed" rule from chapter 11 to other bankruptcy chapters. We support efforts to strengthen notice to governmental units so that taxing authorities will not lose their claims because the wrong governmental officials received notice of the claims. State and local taxing authorities should receive notice of pending federal tax audits. Once such amendments are made it will be unnecessary to go further and increase penalties for failure to comply with the notice requirements. We oppose as unduly onerous proposals which would require debtors to schedule the basis of their assets.
We generally support the government's position that the burden of proof in bankruptcy court should be on the taxpayer, but some room must be made for exceptions that would not place trustees and creditors at a disadvantage. We favor maintaining the superdischarge in chapter 13 as it presently exists.
In general, we agree that a chapter 11 debtor should not be able to "backload" priority tax payments under section 1129(a)(9)(C) of the Bankruptcy Code. We foresee the necessity for some exceptions, but we would not allow the debtor to pay other commercial creditors while backloading the stretched out tax payments. When section 1129(a)(9)(C) is invoked, we would fix the interest rate for measuring the value of deferred payments at the regular federal statutory deficiency rate for taxes.
We think the government does not need any statutory increase in its setoff rights. It is adequately protected now.
Many technical amendments need to be made to section 346 of the Bankruptcy Code. The taxable year provisions in the case of individuals must be conformed to the federal rule in the Internal Revenue Code, because the statutory disparity between federal and local taxable years as it exists today is a mistake that has never been corrected. For similar reasons, a separate taxable entity should not be created in chapter 12 family farmer cases, because no such taxable entity is created under the Internal Revenue Code.
We don't believe that a debtor should be required to conduct negotiations with a taxing authority before pursuing contempt sanctions. Taxing authorities must be required to observe the bankruptcy laws the same as any other creditors.
We agree that time periods that run against taxing authorities should be tolled during previous bankruptcy cases of the same debtor and that the 240-day period within which the government can make an assessment of taxes that will be protected in bankruptcy must be suspended during a period when an offer in compromise is pending. We also agree that small business debtors should maintain separate bank accounts for postpetition taxes and withholdings.
We strongly oppose any effort to overrule the Supreme Court's decision in the Energy Resources case. To protect the integrity of that decision, we think it is necessary to give the bankruptcy court authority to enjoin the collection of trust fund taxes from nondebtors during the period when payments under a plan are being made. When payments under a confirmed plan are not made, the rights of governmental taxing authorities should be protected.
We oppose provisions that would limit the jurisdiction of the bankruptcy court to the power of a nonbankruptcy tribunal. The strength of the bankruptcy system is that it provides a forum for the bankruptcy court to expeditiously adjudicate all claims against a debtor so that distribution can be made.
We support a wide array of proposals that would conform the letter of the bankruptcy law to its purpose, notwithstanding that these would strengthen the government's hand in collecting taxes. Thus, we would not give a bankruptcy trustee or debtor in possession the rights of a bona fide purchaser in avoiding tax liens. On the other hand, we oppose fundamental changes in the priority and discharge provisions of the Bankruptcy Code.
There are places in current law that give the government too much protection from bankruptcy court procedures and they must be changed. It is time that the bankruptcy courts were given full jurisdiction to issue declaratory judgments on the tax consequences of a plan of reorganization, and the failure by the government to respond to an appropriate section 505(b) request should protect not only the trustee, the debtor and a successor to the debtor, but the creditors and the estate as well. Also, the subordination of certain tax penalties should be restored.
We have also proposed some technical amendments to the Internal Revenue Code and the Bankruptcy Code in places where the current provisions do not work well or are in need of clarification. Thus, we would make clear a trustee's duty to file partnership information returns, and we would allow such trustee to serve as the tax matters partner to fill a void in present law. We would write a standard of willfulness that appropriately governs priority and discharge of certain individual tax debts. We would clarify the effect of a discharge of a partnership's debt on a partner's basis for his partnership interest. We have a new proposal to deal with the troublesome issue of the tax effect of abandonment on the debtor and his estate. We would clarify the jurisdiction of the bankruptcy court over consolidated returns where the common parent corporation, but not all members of its group, is a debtor. We would strengthen the position of all parties by requiring specific standards for discussion of tax issues in chapter 11 disclosure statements. Finally, we have endorsed a proposal which partially redresses the imbalance created by repeal of the stock for debt exception.
On one proposal, there was no consensus after discussion. Under present law, the tax liability of a corporation for the year of filing a petition is divided into a prepetition claim and an administrative claim. Taxing authorities generally seek to reverse this rule. Some of our members agree with these taxing authorities and others wish to retain present law. We have not made a Task Force recommendation on this question, but have set forth the present law and stated the basis for our division.
Some of our positions would work to the benefit of the government and others would work to the benefit of debtors and creditors. What is most important is that taken as a whole, these proposals present the kind of balance that would make the bankruptcy system work better, and that is why we believe that Congress created the Commission.
The Commission
The National Bankruptcy Review Commission is an independent commission established pursuant to the Bankruptcy Reform Act of 1994.(2) The Commission was created to investigate and study issues relating to the Bankruptcy Code, solicit divergent views of parties concerned with the operation of the bankruptcy system, evaluate the advisability of proposals with respect to such issues and prepare a report to be submitted to the President, Congress and the Chief Justice not later than two years after the date of the first meeting.
The report, which is due October 20, 1997, must contain a detailed statement of the Commission's findings and conclusions, together with recommendations for legislative or administrative action.
The members comprising the Commission were
appointed by the President, Congress and Chief Justice. It was originally
chaired by former Representative Mike Synar (D-OK) who resigned on December 19,
1995 and died on January 9, 1996. On March 29, 1996, Brady C. Williamson, Esq.
of
Although the Commission was created by 1994 legislation, it did not receive funding until more than a year later. Nevertheless, individual Commissioners began working on projects of interest to them prior to the time that funds were appropriated and staff was hired. The Commission divided itself into a number of distinct "Working Groups." The Working Group on Government took jurisdiction over tax issues. The Working Group on Government consists of Chairman Williamson and Commissioners Shepard and Gose.
The Commission scheduled a meeting in
On December 23, 1996 Stephen H. Case, a prominent bankruptcy lawyer and an advisor to the Commission, together with Jennifer C. Frasier, an attorney on the Commission's staff, made the first attempt to systematize the Commission's tax process. Mr. Case and Ms. Frasier produced a matrix identifying 114 separate tax proposals before the Commission, identifying their source (Shepard, Department of Justice, IRS) and assigning a priority status to these proposals. It was clear that many of the items included in this matrix are relatively unimportant, and with very few exceptions, most strengthen the hand of governmental taxing authorities vis-a-vis debtors. Notwithstanding the absence of participation by the organized private bar in setting the Commission's tax agenda, there have been in public print for some time proposals from the private sector to change the bankruptcy laws relating to tax issues and the tax laws relating to bankruptcy issues.(6) Not surprisingly, they have a very different perspective. Although there is legitimate grounds for difference of opinion with respect to many of these proposals, they were not included in the Commission's matrix.
After the appointment of this Task Force, Mr. Asofsky, co-chair of the Task Force, wrote to Chairman Williamson, advising him of the formation of the Task Force and pointing out the one-sided nature of the Commission's agenda. It is assumed that the Commission heard this complaint from other sources as well. In early February of 1997, Chairman Williamson appointed an informal tax advisory committee (the "Advisory Committee") to assist the Commission in "sifting and winnowing" the Commission's tax agenda. This committee, for the first time, consisted of four government representatives(7), four private practitioners(8) and two members of the academic community.(9) The Advisory Committee has been meeting and talking in an attempt to unburden the agenda of items that are truly not important and can be resolved in the normal course of the legal process and to identify those important issues that the Commission must resolve. It is anticipated that the Advisory Committee will make a final report to the Commission in the near future. The Section welcomes the Chairman's initiative. It holds out the hope that the Commission will develop an agenda and a procedure that elicits all sides of controversial issues and will result in a balanced proposal by the Commission that government representatives, private groups and scholars can support in unity before the Congress.
At the May meeting of the Section in
The Original Bankruptcy Commission and its Legacy
The Commission was modeled after, and its work
will undoubtedly be measured against that of, the original Bankruptcy
Commission (the "1970 commission"). In 1970, Congress passed a
resolution creating a special commission to study the bankruptcy laws of the
The 1970 commission reported three years after its birth a two volume product consisting of a new comprehensive bankruptcy statute(11) and a report consisting of 12 well annotated chapters,(12) each setting forth the 1970 commission's deliberations and reasoning as the basis for its proposed statute. Mr. Plumb went beyond the report. Not only did he contribute a chapter to the 1970 commission's report explaining the few tax provisions included in the bill;(13) he produced a series of four law review articles published during a one year span that stretched 600 pages.(14) These articles remain today a gold mine of legislative history. They set forth the tax treatment of every major bankruptcy transaction relevant at the time, together with an explanation of the 1970 commission's proposals. There is no doubt that the Plumb articles informed every change in the legislative product that developed in the ensuing five years.
Many of Plumb's proposals, or variants thereof, were enacted as part of either the Bankruptcy Reform Act of 1978 or the Bankruptcy Tax Act of 1980. The success of the Plumb initiative is clearly attributable to the balance they reflected. Plumb's tax proposals can be said to be neither pro-government nor pro-taxpayer/debtor. Every one of them could be justified on the basis that it meshed the sometimes competing objectives of the tax laws and the bankruptcy laws. Transactions legitimately undertaken in bankruptcy did not have to be abandoned because of user-unfriendly tax code provisions not sensitive to the peculiar needs of the bankruptcy process and the government's legitimate claims as a creditor were recognized.
Role of the Section
The Section did not play a formal role during the deliberations of the 1970 Commission. However, in 1977, the Section created an ad hoc committee for bankruptcy revision which actively participated through regular communication with the Treasury Department, the Internal Revenue Service and the staff of the Joint Committee on Taxation during the legislative process. The Section gave detailed testimony on each version of the bill in a series of Congressional hearings.(15) In those hearings, the Section supported the IRS (in opposition to the bankruptcy bar) in adding to the Internal Revenue Code section 108(b) that provides "attribute reduction" as a quid pro quo for exclusion of discharge of indebtedness by bankrupt and insolvent taxpayers. On the other hand, the Section urged the retention of the stock-for-debt exception to discharge of indebtedness. As another example, the Section actively supported the Plumb proposal to eliminate the tight restrictions on tax-free reorganizations in bankruptcy that previously characterized section 371 of the Internal Revenue Code. On the other hand, the Section supported the Service in urging the overruling of a line of Tax Court cases that permitted the tax-free receipt of stock and securities in consideration of a claim for accrued but unpaid interest. And there were many other examples.
Section members regularly comment on proposed legislation, regulations and matters of tax policy. This Task Force believes that the views expressed herein represent the kind of balance for which the Section always strives. Thus, on many issues that are of importance to federal and state taxing authorities, we have taken a position in favor of the government. For example, we have supported their proposals to strengthen the notice requirements to taxing authorities. We have agreed with their proposal to conform the burden of proof on tax matters in the bankruptcy court to the burden of proof in other forums, although we have recommended an important exception. We have agreed that deferred payments of prepetition taxes under Bankruptcy Code § 1129(a)(9)(C) should not be backloaded, with exceptions that protect the interests of the government. We have agreed that the 240-day period in Bankruptcy Code § 507(a)(8) should be tolled during any period that an offer in compromise is outstanding. We have also agreed with many other proposals advanced by the government. On the other hand, we believe that there are some proposals pressed on the Commission by the taxing authorities that are injurious to the bankruptcy process and go too far, and we have said so emphatically. Among our more important disagreements with the government are that we oppose repeal of Bankruptcy Code § 724(b)(2). We oppose any rule that would require an up-front scheduling by a debtor of the basis of its assets. We oppose repeal of the chapter 13 superdischarge. We oppose the suggestion that the Supreme Court's decision in United States v. Energy Resources Co. be legislatively overturned. And we oppose attempts to limit the jurisdiction of the Bankruptcy Court to grant declaratory judgments as to the tax consequences of a plan of reorganization.
The Challenge to the Commission
The bankruptcy laws curtail the force and operation of every part of our law and jurisprudence. They impair the obligation of contract. They limit the jurisdiction of duly constituted courts. They divest individuals and entities of their property. They deny shareholders the right to corporate governance by directors of their own choosing. If they also sometimes restrict the right of government to collect taxes, it is because there is a compelling public interest in fair treatment of creditors and the rehabilitation of financially troubled debtors. We do not take lightly the political or economic imperative of assuring a free flow of revenues to the government or of preventing unscrupulous debtors from passing on their fiscal obligations to the taxpaying public at large.
The proposals suggested herein are designed to preserve the government's tax priority, foster the rehabilitation of debtors, treat all creditors fairly and create substantive tax rules that are not at odds with those purposes. They reflect our view that reform must have as its objective making the bankruptcy system work, rather than punishing wrongdoers.
TASK FORCE POSITIONS(16)
SUBORDINATION OF CERTAIN TAX LIENS IN CHAPTER 7:
SECTION 724(b)(2) OF THE BANKRUPTCY CODE
(COMMISSION TRACK NUMBER 100)
Present Law
The general rule in a Chapter 7 liquidation is that, upon any sale of property, the claims of secured creditors must be satisfied in full before any payment is made to claimants with a statutory priority or to general unsecured creditors. Bankruptcy Code 724(b), which governs the order of distribution of property subject to valid, nonavoidable federal, state and local tax liens, deviates from the general rule that unsecured priority claims do not trump perfected secured claims. Under section 724(b), a trustee is required to subordinate valid tax liens to the costs of administration and other unsecured priority claims occupying the first through seventh rungs on the priority ladder. This allows unsecured priority claimants "to step into the shoes of the tax collector"(17) and receive distribution from property of the estate before valid tax claims despite the fact that the tax claim is properly allowed and secured. Moreover, section 724(b) enables a trustee to administer property that is otherwise without value to the estate due to the existence of liens in order to generate a pool of funds from which priority claims can be paid.
Proposals Before The Commission
Commission Track Number 100. The Government Working Group proposes that
section 724(b)(2) be amended to limit the subordination of properly perfected
nonavoidable tax liens on real and personal property to only section 507(a)(3)
wage claims. See Government Working Group proposal number 2. The
Department of Justice and Commissioner Shepard had proposed that Section 724(b)
be repealed altogether. See Justice Proposal, p. 97;
Task Force Position
The Task Force opposes all of these proposals.
Reasons for Position
Section 724(b)(2) was intended to free up assets to pay costs of administration and satisfy claims of employees having priority. As a result of subsequent amendments to Section 724(b), the favored claimants were expanded to include individual farmers and fishermen, individuals making deposits for personal, family or household use and alimony, maintenance and support claims. For nearly 60 years Congress has consistently postponed or subordinated government tax entities to payment of administrative expenses and wage claims, even if the claims of the government entity were secured by tax liens.(18)
Tax claims are generally given priority over most unsecured claims because (1) there is a public interest in insuring an uninterrupted flow of revenues for the purpose of supporting governmental operations and (2) the government, as an involuntary creditor, is not in a position to protect its interests by negotiating adequate security arrangements with a taxpayer when a tax debt is created. Notwithstanding these important public policy considerations underpinning priorities for most tax claims, bankruptcy laws have always subordinated tax claims to administrative expenses and some other claims. Section 724(b) is a recognition that statutory tax liens are no more than governmentally created superpriorities. Downgrading tax liens in bankruptcy merely validates the scheme of priorities created by the bankruptcy system. Bankruptcy Code priorities must supersede the states' interests in buttressing their collection capabilities. Therefore, we oppose any effort to change the basic structure of section 724(b).
Notwithstanding the foregoing, present law distorts the relative positions of local taxing authorities and commercial secured creditors. The expectation of such creditors is that their security interests will be primed by ad valorem real property tax liens. That bankruptcy should not give these creditors a windfall gave rise to the enactment of section 362(b)(18) in 1994. A similar "fix" is needed in section 724(b). If an estate is administratively insolvent, the secured creditor should not receive a windfall at the expense of the local taxing authority. The private secured creditor should bear the burden of ad valorem real property taxes.
Finally, it has been argued that section 724(b) is complex and it is often misapplied in practice. If the provision can be simplified, the Commission should address that problem, but it should not repeal a legislative policy of long standing.
Other Institutional Positions
The National Bankruptcy Conference and Association of the Bar of the City of
EXTENDING THE "DEEMED FILED" RULE BEYOND CHAPTER 11
(COMMISSION TRACK NUMBER 104)
Present Law
Bankruptcy Rule 3002(a) sets forth the general rule regarding filing proofs of claim in a bankruptcy case, which is that all unsecured creditors must file proofs of claim in order for their claims to be allowed.(19) Bankruptcy Rule 3003, however, carves out an exception to Rule 3002(a) in cases under chapters 9 and 11 of the Bankruptcy Code.(20) Under Bankruptcy Rules 3003(b)(1), creditors in chapter 9 and chapter 11 cases whose claims are listed in the schedule of liabilities filed by the debtor and whose claims are not designated as disputed, contingent or unliquidated do not need to file proofs of claim in order for their claims to be allowed; the scheduled amount of their claims shall be prima facie evidence of the validity and amount of such claims.(21) This exception applies only in cases under chapter 9 and chapter 11 of the Bankruptcy Code; creditors of debtors in cases under chapter 7,(22) chapter 12(23) and chapter 13(24) must file proofs of claim regardless of whether their claims are listed in the debtor's schedule of liabilities.
The theory of the current rule is that chapter 9 and chapter 11 debtors will generally have significantly more creditors than will debtors filing under other chapters of the Bankruptcy Code. Chapter 9 and chapter 11 debtors are also likely to have some sort of accounting system in place that will readily identify most creditors and the amounts of their claims. Moreover, at least in the large chapter 11 cases, the general practice is for the chapter 11 debtor to notify the creditors as to exactly how their claims are scheduled. By allowing creditors to rely on the scheduled amounts of their claims, it is presumably simpler for everybody.
Debtors filing under chapters 7, 12 or 13, on the other hand, generally have fewer creditors, and may have less of an idea of just how much they owe and to whom. Their accounting practices are often poor or nonexistent. Moreover, an individual debtor is strongly encouraged to liberally schedule all potential claims against him in order to discharge as many potential liabilities as possible. To the extent that he fails to schedule a claim, regardless of how remote that claim may be, that claim may not be discharged in his bankruptcy case. The individual debtor is under no real obligation to determine the precise amount of any claims against his estate; he only needs to provide his best estimate as to the amount of the claims and to provide the correct names and addresses of his creditors so that they will receive notice of his bankruptcy.
In cases under chapter 7, for example, the general procedure is for the bankruptcy court to send out a notice to the scheduled creditors of the commencement of the case and to notify the creditors of their right to file a proof of claim. In addition, the bankruptcy court will notify the creditors as to whether or not there is expected to be sufficient assets in the debtor's estate to provide a distribution to the creditors. If the chapter 7 case is expected to be a "no asset" case (as the vast majority are), then the creditors are advised that there is no point in filing a proof of claim. If the bankruptcy court determines that assets are expected to be available to distribute to creditors, the bankruptcy court will set a bar date for filing proofs of claim, notify the creditors of the bar date, and send the creditors proof of claim forms to fill out and return.
Proposals Before The Commission
Commission Track Number 104. The Government Working Group proposes to expand the applicability of Rule 3003 so that creditors in all bankruptcy cases will be able to rely on the debtor's schedules in the same manner that creditors currently can in chapter 9 and chapter 11 cases. In other words, if a creditor's claim is listed in the debtor's schedule of liabilities and is not listed as contingent, disputed or unliquidated, that creditor need not file a proof of claim in order for its claim to be allowed as a claim against the debtor's bankruptcy estate in the scheduled amount. See Government Working Group Proposal Number 1. The Advisory Committee has recommended that this proposal be dropped as unimportant.
Task Force Position
The Task force does not support the Government Working Group proposal.
Reasons for Position
Although the proposal would not appear to unfairly prejudice debtors, the proposal could have the unintended consequence of significantly increasing the administrative burdens of the trustee appointed to administer the assets of debtors in chapter 7, chapter 12 or chapter 13 cases, as well as prejudicing the legitimate creditors that care enough to file proofs of claim. The trustee appointed in bankruptcy cases has the responsibility of distributing the debtor's non-exempt assets to the legitimate creditors, and to object to any illegitimate claims. Under the current rule, any creditor that wants to receive a distribution from the debtor's assets in cases under chapter 7, chapter 12 or chapter 13 must file a proof of claim and attach any evidence to substantiate the claim. It is relatively easy for the trustee to make a cursory examination of the proofs of claim and the supporting documents filed in the case in order to determine whether or not to object to a claim. Moreover, it is a criminal offense for a creditor to file a false proof of claim. Accordingly, it is probably relatively rare that outright fraudulent claims are submitted or allowed to share in any distributions in most bankruptcy cases.
If the trustee were required to rely upon the debtor's schedules, however, it would be far more difficult for the trustee to determine which claims are legitimate and which ones are not. An individual debtor often has few records of his debts, has little incentive to substantiate the liabilities listed on his schedules, and is encouraged to schedule every conceivable liability to ensure that he receives as broad a discharge as possible. Accordingly, it is possible that the debtor will schedule far more creditors than actually hold legitimate claims against him as of the petition date. Since the trustee will not be able to verify the accuracy of those claims from the schedules alone, he has the choice of (i) independently investigating the scheduled claims in order to substantiate such claims, (ii) filing objections to any scheduled claim that could possibly be considered questionable, (iii) making distributions to illegitimate creditors, or (iv) all of the above. In either case, the estate's assets will be depleted through unnecessary administrative expenses or unwarranted distributions.
In sum, this proposal may sound good in theory but be bad in practice. It could easily drive up the cost of individual bankruptcies and deplete the estates' assets to the detriment of legitimate creditors. It will undoubtedly increase the administrative burdens on bankruptcy trustees. Furthermore, it may permit illegitimate creditors to share in the distribution of the debtors' estates to the detriment of the legitimate creditors.
It is the understanding of the Task Force that governmental taxing authorities do not suffer prejudice from application of the present rule. As a matter of routine, such creditors know to file proofs of claim outside of chapter 11. This change is not needed to protect taxing authorities from their own inadvertent errors.
Other Institutional Positions
A focus group of the
NOTICE TO GOVERNMENTAL UNITS
(COMMISSION TRACK NUMBERS 105, 106 AND 109)
Present Law
Governmental Agencies Required to Receive Notice: Bankruptcy Code
§ 521(a) and Bankruptcy Rule 1007(a) require a debtor to file a list
containing the name and address of each creditor, unless a schedule of
liabilities (which essentially includes this information) is filed. Unless the
court enters an order limiting notice, all notices are sent to these creditors,
including the notice of the commencement of a case under the Bankruptcy Code.
If the case is a chapter 11 case, then Bankruptcy Rule 2002(j) provides that
notices to the
Content of Notice: Bankruptcy Code § 342(a) provides that notice shall be given of the commencement of a case under the Bankruptcy Code. Bankruptcy Rule 9009 states that the "Official Forms prescribed by the Judicial Conference of the United States shall be observed and used with alterations as may be appropriate." The Official Forms include forms to be used to notify creditors of the commencement of the case, the meeting of creditors and certain deadlines set by the bankruptcy court. Bankruptcy Code § 342(c) provides that if notice is required to be given to a creditor under the Bankruptcy Code (this includes, but is not limited to, the notice of commencement of the case), the Bankruptcy Rules or an order of the Court, then the "notice shall contain the name, address and taxpayer identification number of the debtor, but the failure of such notice to contain such information shall not invalidate the legal effect of such notice."
Bar Date With Respect to Claims Filed By Governmental Agencies: Bankruptcy Code § 502(b)(9) and Bankruptcy Rules 3002(c)(1) and 3003(c)(3) provide that a proof of claim filed by a governmental unit is timely filed if it is filed not later than 180 days after the date of the order for relief.
Effect of Failure to Give Proper Notice: Bankruptcy Code § 523(a)(3) provides that an individual debtor is not discharged, under certain circumstances, from a debt that the debtor fails to list or schedule under the name of the creditor to whom such debt is owed, if known by the debtor.
Effect of Failure to Provide Sufficient Information: Although the Bankruptcy Code and the Bankruptcy Rules do not generally address a debtor's failure to provide sufficient information, from a practical standpoint, creditors and other parties in interest are not prevented from seeking such information. For example, within a reasonable time after a case is commenced under the Bankruptcy Code, the United States Trustee convenes and presides over a meeting of the debtor's creditors. At this meeting, the creditors have an opportunity to orally examine the debtor. Moreover, if a creditor is unable to obtain from the debtor information in the debtor's possession which the creditor needs in order to complete its proof of claim or to determine whether or not it even has a claim, then the creditor can seek relief from the bankruptcy court. Further, Bankruptcy Code § 523(a)(1) provides that an individual debtor will not be discharged with respect to tax claims or customs duties under certain circumstances related to filing required returns.
Proposals Before the Commission
Commission Track Number 105. Commissioner Shepard proposes that either the
Bankruptcy Code or the Bankruptcy Rules be amended to require a debtor to send
all notices sent to creditors to certain government agencies at locations to be
specified by the government agencies. In addition, he would amend either the
Bankruptcy Code or the Bankruptcy Rules to require that any such notices: (a)
contain meaningful and sufficient information to enable the government agency
to determine why the notice is being sent; (b) include identifying information
such as the employer identification number, taxpayer identification number,
social security number, and license numbers; (c) include the name of the
debtor, any predecessors in interest, merged corporations and all present and
former a/k/a's and d/b/a's. Further, he would amend either the Bankruptcy Code
or the Bankruptcy Rules to require that (a) any such notices related to claims
specify the debtor, successor in interest or other named predecessor who
incurred the obligation upon which the claim is based; (b) any such notices
related to environmental clean-up costs specify each particular property
involved; and (c) any such notices related to ad valorem property taxes specify
each particular property involved. Finally, he would amend Bankruptcy Code
§§ 342, 362 and 363 to include strong sanctions (such as allowing late
claims and denying the debtor's discharge on claims) for failure to satisfy the
above notice requirements. See
Commission Track Number 106. Commissioner Shepard proposes that Bankruptcy
Code § 727(c) be amended to provide that if a debtor fails to provide
notice to a creditor as required by the Bankruptcy Code and the Bankruptcy
Rules, then the time limit in which a creditor must object to discharge or file
a motion to revoke discharge will not begin to run until the affected creditor
receives proper notice. Further, he would amend section 727(c) to provide that
knowing or intentional failure to provide proper notice under the Bankruptcy
Code and the Bankruptcy Rules is grounds for barring discharge. See
Commission Track Number 109. Commissioner Shepard proposes that either the
Bankruptcy Code or the Bankruptcy Rules be amended to provide that a taxing
authority is entitled to an exception to the bar date or to a
nondischargeability determination if the debtor failed to provide the taxing
authority with sufficient information to determine the nature and extent of
potential claims. Further, he would amend either the Bankruptcy Code or the
Bankruptcy Rules to provide an exception to the bar date if the debtor failed
to timely file returns or provide required information. See
Task Force Position
Commission Track Number 105: The Task Force supports the proposal to amend either the Bankruptcy Code or the Bankruptcy Rules to require a debtor to send all notices sent to creditors to certain government agencies at locations to be specified by the government agencies, provided that the addresses are either incorporated into the Bankruptcy Rules, the local rules or are otherwise available from the bankruptcy court. With respect to the proposal to include additional information in the notice, the Task Force agrees that perhaps the notice should include some additional information; however, the Task Force does not support the sweeping requirements contained in the proposal.
Commission Track Number 106: The Task Force opposes this proposal.
Commission Track Number 109: The Task Force opposes this proposal.
See also our response to Commission Track Number 216, infra.
Reasons for Position
Commission Track Number 105: As noted above, the Task Force supports the proposal to amend either the Bankruptcy Code or the Bankruptcy Rules to require a debtor to send all notices sent to creditors to certain government agencies at locations to be specified by the government agencies, provided that the addresses are either incorporated into the Bankruptcy Rules, the local rules or are otherwise available from the bankruptcy court.
With respect to the proposal regarding information to be included in any notices, Bankruptcy Code § 342 already requires the debtor to include its taxpayer identification number in any notices. To the extent other information is readily available to the debtor, such as the debtor's employer identification number, social security number, license number, known present and former a/k/a's and d/b/a's and the location of real property subject to ad valorem taxes, then the Task Force supports expanding the requirement under § 342(c) to require that notices include this information. However, the Task Force believes that the provision in Bankruptcy Code § 342(c) that the failure to include this information in a notice "shall not invalidate the legal effect of the notice" should continue in effect. While a debtor should be required to provide this information if it is available, the debtor should not be penalized for failure to provide this information if it is not readily available. If the debtor deliberately excludes available information, then a creditor or other party in interest may request that the bankruptcy court sanction the debtor in a suitable manner. Such sanctions should be determined by the bankruptcy court in light of the applicable circumstances.
The Task Force does not support the proposal that (a) notices should contain meaningful and sufficient information to enable the government agency to determine why the notice is being sent; and (b) any notices related to claims specify the debtor, successor in interest or other named predecessor who incurred the obligation upon which the claim is based.(25) It is unclear what is intended by "meaningful and sufficient information". Moreover, this proposal appears to require a debtor to suggest potential areas of tax and environmental liability, regardless of whether the debtor believes such claims are valid. Further, the purpose of a notice is to allow a creditor to participate in the process. Debtors should not be required to determine the nature, extent, validity and amount of a governmental agency's claims. So long as the government agency has notice of the filing, basic information regarding the debtor (such as the debtor's taxpayer identification number and the location of its real property), then the government agency should be able to determine the nature, extent, validity and amount of its claim, if any.
Finally, the Task Force does not support the requested sanctions for failure to comply with notice requirements. Bankruptcy courts should have the discretion, as they do now, to sanction a debtor by allowing a late claim or disallowing the discharge of a claim under appropriate circumstances. This should not be mandated by the Bankruptcy Code.
Commission Track Number 106: The Task Force believes that this proposal raises several concerns. First, with respect to extending the time in which a creditor must object to discharge or file a motion to revoke a discharge, the proposal does not impose a time limit. Accordingly, a debtor will never achieve a fresh start. Conceptually, under this proposal, a creditor who was not noticed could come forward twenty years after a bankruptcy case has been closed and file a motion to revoke the discharge. As a result, following a bankruptcy filing, no one would be safe doing business with or loaning money to a debtor. Second, the proposal is overly broad with respect to amending Bankruptcy Code § 727(c). Essentially, the proposal contemplates turning the denial of discharge provision in Bankruptcy Code § 523(a)(3) with respect to specific claims into a blanket denial of discharge under Bankruptcy Code § 727(c). This expansion of the denial of discharge is simply unwarranted. Third, if a creditor has not received formal notice of a bankruptcy filing but has actual knowledge of the filing, then the creditor should be required to come forward and participate in the bankruptcy case. The proposal contemplates that a creditor without formal notice, but with actual knowledge, could wait until the bankruptcy case has been closed and then seek to revoke the debtor's discharge. This is patently unfair. A creditor should not be allowed to sit on its rights and then, perhaps even years later, seek revocation of the discharge.
Commission Track Number 109: This proposal is simply unjustified. If a debtor fails to provide a taxing authority with sufficient information to determine the nature and extent of potential claims, then the taxing authority should seek relief from the bankruptcy court in the form of a motion to compel the production of documents, a subpoena duces tecum or a 2004 examination. If the debtor continues to fail to provide the requisite information, then it is within the bankruptcy court's discretion to award sanctions. Further, Bankruptcy Code § 523(a)(1) provides that an individual debtor will not be discharged with respect to tax claims or customs duties under certain circumstances related to filing required returns.
With respect to contingent claims, such as a bankruptcy involving an individual responsible person who could be liable for unpaid employment taxes, the government agency is entitled to file a contingent claim in the individual's bankruptcy case. The proposal contemplates that the individual debtor must not only notify the government agency of the bankruptcy filing, but also of this contingent claim. It is impractical and unduly burdensome to require an individual debtor to review the tax laws and identify every conceivable tax claim, including contingent claims. While the Task Force does not support the proposal, the Task Force recognizes that perhaps governmental agencies need some additional information to enable them to identify these types of contingent claims. Accordingly, the Task Force proposes that the Official Forms be amended to require an individual debtor to state whether or not he is an officer, director or employee and identify the business entities for which he holds such positions.
Other Institutional Positions
The Association of the Bar of the City of
SCHEDULING THE TAX BASIS OF ASSETS
(COMMISSION TRACK NUMBERS 107 and 108)
Present Law
The Bankruptcy Code and the Internal Revenue Code contain no requirement for basis information to be provided when a debtor files a bankruptcy petition. See generally Bankruptcy Code § 521(1), Rule 1007 F. R. Bankr. P., and Forms 6 and 7, Official and Procedural Bankruptcy Forms (as amended to November 1, 1995).
Proposals Before The Commission
Commission Track Numbers 107 and 108. Commissioner Shepard proposes that the bankruptcy forms be amended to require debtors to include information to determine tax consequences of liquidation with specific requirements that:
- basis information, original and adjustments, be provided for all of the
debtor's assets;
- copies of tax returns, state and federal, are filed with the bankruptcy schedules;
and
- a statement be made by the debtor that no returns are required for those
time periods for which returns have not been filed.
See
The Advisory Committee has recommended that these proposals be withdrawn as unimportant.
Task Force Position
The Task Force opposes any amendment creating requirements for (i) basis information to be furnished as part of either the debtor's schedules or statement of affairs and (ii) copies of returns to be attached to the schedules.
The Task Force recommends that Official Form 7 be amended to add a title "Tax Matters" including only (i) a statement that all tax returns (state and federal) for the three years prior to the filing of the bankruptcy petition have been filed and whether the debtor has copies; and (ii) if all such returns have not been filed, identify the returns not filed.
Reasons for Position
In addressing any question in a bankruptcy context, the process must balance the debtor's right to a fresh start and every creditor's concomitant right to obtain its fair share of the assets. Nowhere does that balance become more difficult to conceptualize, much less implement, than in addressing taxation in a bankruptcy context.
The suggestion which would require the "furnishing of information necessary to compute the tax consequences of a liquidation" in the schedules could easily crush the ability of most consumers to obtain the fresh start afforded by filing for Chapter 7 relief. Requiring any potential debtor to state that tax returns have been filed imposes no additional burdens. Such a disclosure affords ample opportunity for trustees and creditors to make further inquiry. More importantly, every debtor, and particularly all debtors' counsel, should consider which returns have been filed and which have not.(26) A disclosure stating whether returns have been filed simply formalizes the due diligence that should occur without such a disclosure.
Currently, the schedules and statement of financial affairs required to be filed in a case under the Bankruptcy Code contain no "basis" data for the assets of the potential debtor. None of the specific questions in either set of documents contains any reference to the basis of any assets of the debtor.(27) The Internal Revenue Code establishes only one clear and direct basis consequence for bankruptcy matters: Section 108's adjustment to basis for debt discharged.(28)
What reason supports any requirement that a debtor submit basis information as a part of the initial filing requirements? We can think of none. Filing a bankruptcy petition does not occur with a wealth of well organized tax information at the fingertips of the petitioner. The need for immediate and instant relief under Title 11 greatly outweighs any need for basis information. Simply stated, imposing a basis information requirement as a condition for filing a bankruptcy petition enables tax information rarely needed in the bankruptcy context to act as an impediment to the fundamental policy of bankruptcy: a fresh start! No balance exits. The information necessary to determine liquidation consequences can be obtained by anyone that wants it at any time.(29)
In the overwhelming majority of consumer bankruptcy filings, the tax consequences of a liquidation of the debtor's assets does not and should not constitute even a minor "blip" on the radar screen of matters to consider before filing. Proceedings under Chapter 11, 12, or 13 simply do not present a basis problem; the debtor will continue to file returns and must report gain or loss in the ordinary course.(30) Even in the rare case where liquidation consequences should be addressed, in either business or consumer cases, the debtor or debtor's counsel should, and in most cases will, address the tax issues. Where not addressed prior to filing, the trustee and the taxing authorities can examine the debtor and obtain the information needed.(31)
Basis information must be obtained for one principal and not insignificant reason: a trustee's sale of assets. A bankruptcy trustee must file tax returns and report gain from the sale of assets.(32) Before any potential sale, a trustee should, if not must, determine the actual cash benefit to the estate on an after tax basis. If the tax on the gain from the sale eliminates any cash flow to the bankruptcy estate, the trustee needs to consider abandoning the asset.(33) That decision requires basis information. The trustee can determine if and when that information will be needed based on a review of the estate's assets after the petition has been filed. Again, in any significant bankruptcy estate, tax accountants and lawyers will certainly make the trustee aware of the need for basis information and will lead the search to obtain basis information.
Basis information must be made available to a trustee, when and as needed, not when the petition is filed. In most cases, the debtor will find the basis information, if available. If not available, should a debtor be precluded from bankruptcy relief? Only if fraud or destruction of information can be affirmatively established. Otherwise a motion to compel can address the failure of a debtor to supply basis information when requested.
Filing a bankruptcy necessarily mandates gathering and classifying significant amounts of information to identify creditors and transactions. The information currently required generally establishes the persons to whom notice must be given, the amounts of claims, the value of assets and the transactions that should be examined. Identifying tax returns filed and not filed imposes virtually no additional burden. Imposing an additional filing requirement for basis information on each and every debtor will create problems for all debtors without solving any. Whenever any party in interest needs information to determine the tax consequences of a liquidation, or basis information, the tools exist to obtain it. The Trustee has the only real need for that data and all trustees know (1) when they need that information and (2) how to obtain it.
Other Institutional Positions
The Association of the Bar of the City of
BURDEN OF PROOF
(COMMISSION TRACK NUMBER 211)
Present Law
The general bankruptcy rule is that a purported creditor adjudicating a claim against a debtor has the burden of proof with respect to the matters encompassed by the claim. Although the debtor may have some burden of going forward in initially contesting a claim and placing the issue before the court,(34) the burden of persuasion is on the party seeking to enforce the claim.(35)
Whether this allocation of the burden of proof applies to tax cases is in dispute. Although the taxpayer generally has the burden of proof outside of the bankruptcy court in any litigation with the Internal Revenue Service(36) at least three circuits of the United States Court of Appeals have held that the general bankruptcy rule applies in the bankruptcy court,(37) and a governmental taxing authority asserting the claim has the burden of proof. Three circuits apply the general tax rule and place the burden of proof on the taxpayer.(38) The rule in one circuit that seems to have addressed the issue is unclear.(39)
Proposals Before the Commission
Commission Track Number 211. The Government Working Group proposes to conform the bankruptcy rule to the tax rule outside of bankruptcy. See Government Working Group Proposal number 8; see also Santa Fe Discussion Issues, p. 25, Item IVD; Justice Proposal p. 85; IRS Proposal, p. 1.
Task Force Position
The Task Force generally agrees with the proposal that the burden of proof in the Bankruptcy Court should not differ from the burden of proof in other forums. However, there may sometimes be competing considerations in bankruptcy cases and the bankruptcy judge should be given limited authority to place the burden of proof on the Government in cases where the interests of justice would be served.
Reasons for Position
In its submission to the Commission, the Department of Justice argues in part that allocating the burden of proof to the taxpayer "is appropriate because the taxpayer has or should have information underlying entries on the tax return including information relating to the income and deductions . . . . A taxing authority would be at a serious disadvantage if all of a taxpayer's unsubstantiated deductions had to be allowed, absent proof that such deductions were inappropriate . . . . Except in the rarest of circumstances, the Government is a stranger to the transactions that are the subject of a tax dispute . . . ."(40)
The Task Force is persuaded by the arguments made by the Department of Justice. A taxing authority generally does not have at its disposal records that would enable it to contest a taxpayer position, and a taxpayer is under a legal obligation to maintain records to substantiate the items on its income tax return. Placing the burden of proof on the Government in a tax dispute in the Bankruptcy Court allows a taxpayer to go into bankruptcy to obtain an advantage that tax laws would not afford. This is bad public policy, regardless of our general view that there are places where the strictures of the tax law must give way in order to accommodate the objectives of the bankruptcy law. For these very reasons, however, the Task Force believes that there may be times at which an exception is warranted. The most obvious situation is the case in which a trustee has been appointed, particularly in the case of an individual chapter 7 case. Here, the parties may be faced with an uncooperative debtor. Placing the burden of proof on the trustee may give the Government a windfall vis-a vis other creditors.(41) By simply disallowing deductions, for example, and putting the trustee to proof which the trustee may not have, the Government may end up collecting a tax which is not owed, and depriving unsecured creditors of money to which they may be entitled. While placement of the burden of proof in some such cases may deprive the fisc of revenue, a balancing of interests seems required. Since all of these cases may be fact driven, it would be impossible to set forth hard and fast rules. The Task Force believes that such an appropriate balancing can be achieved if the statute is drafted so as to place the burden of proof on the debtor in the ordinary case, subject to generally applicable nonbankruptcy exceptions. The bankruptcy judge would have the power to vary the rule in the interests of justice. Appropriate legislative history should set forth that it is expected that the bankruptcy judge would use such authority only in cases where the assumption underlying the general rule, i.e., disparity in factual information between the debtor and the Government, is not present. The Task Force believes that such a resolution would lead to a proper result in every case.
Other Institutional Positions
The Association of the Bar of the City of
BRINGING TAX RETURNS AND PAYMENTS OF CURRENT
(COMMISSION TRACK NUMBER 212)
Present Law
A. Tax Return Filing Requirements.
The Internal Revenue Code generally requires any person liable for any tax imposed by Title 26 of the United States Code to file a tax return.(42) A willful failure to file a federal tax return constitutes a misdemeanor and is punishable by imprisonment for a term not exceeding one year, a fine not exceeding $25,000, or both.(43)
If a taxpayer fails to file a tax return required to be filed under federal or state law, the taxes with respect to such return are not dischargeable in bankruptcy.(44)
If an individual files a chapter 7 or chapter 11 petition, a bankruptcy estate is created and is treated as a separate taxpayer.(45) In a chapter 7 case involving an individual, the bankruptcy trustee is responsible for filing the estate's federal income tax return.(46) If a trustee is appointed in an individual's chapter 11 case, such trustee is responsible for filing the estate's federal income tax return.(47) If the individual debtor is a debtor in possession, the individual debtor is responsible for filing the estate's federal income tax return.(48)
An individual debtor in a chapter 7 or chapter 11 case is responsible for filing a federal income tax return with respect to the debtor's (as distinguished from the estate's) postpetition income.(49)
No separate taxable entity is created for federal income tax purposes when an individual files a petition under chapter 12 or chapter 13.(50) In such cases, the debtor and the estate are one and the same, and the debtor is responsible for filing a federal income tax return.(51)
With respect to corporations, no separate taxable entity is created when a chapter 7 or chapter 11 petition is filed.(52) The bankruptcy trustee is responsible for filing the corporation's federal income tax return in a chapter 7 case and a chapter 11 case (assuming a trustee is appointed).(53) A debtor in possession in a corporate chapter 11 case is responsible for filing the corporation's federal income tax return.(54)
B. Tax Payment Requirements.
A willful failure to pay federal taxes is a misdemeanor, punishable by imprisonment for a term not exceeding one year, a fine not exceeding $25,000 or both.(55)
A chapter 11 plan cannot be confirmed unless it provides for the payment of allowed administrative tax claims (i.e., postpetition taxes) in cash in full on the effective date of the reorganization (unless the claim holder agrees to different treatment of such claim).(56) Neither a chapter 12 nor a chapter 13 plan can be confirmed unless it provides for the full payment, in deferred cash payments, of all allowed tax claims entitled to priority under Bankruptcy Code § 507 (including, but not limited to, administrative tax claims), unless the claim holder agrees to different treatment.(57)
An individual debtor in a chapter 7 case is not barred from receiving a discharge merely because the bankruptcy estate is administratively insolvent and cannot pay all administrative tax claims.
Proposals Before the Commission
Commission Track Number 212. The Government Working Group proposes the following:
1. Bankruptcy Code §§ 707(a), 727(a), 1121(b), 1121(c), 1222(a) and 1322(a) should be amended to require a debtor, as a precondition to plan confirmation, discharge or an order extending exclusivity, to file verified proof that the debtor has (i) timely paid all postpetition taxes then due, (ii) timely filed all postpetition tax returns then due, and (iii) filed all theretofore unfiled prepetition tax returns by the conclusion of the section 341 first meeting of creditors for the last six taxable years preceding the commencement of a bankruptcy case.
2. Bankruptcy Code §§ 1112(b), 1208(c) and 1307(c) should be amended to provide that failure to file tax returns or timely pay postpetition taxes shall be grounds for dismissal or conversion upon motion by the United States Trustee or any aggrieved governmental unit or, possibly, other parties in interest. Government Working Group Proposal No. 10. See also Santa Fe Discussion Issues, p. 15, Item II D7; Justice Proposal, p. 83; IRS Proposal, p.2.
It should be noted that under this proposal a late filing of a tax return for a postpetition taxable period will preclude a discharge or confirmation of a plan of reorganization. If a tax return is filed late, it will be impossible to provide verified proof of timely filing, thereby making it impossible to satisfy a condition precedent for discharge or plan confirmation.
Task Force Position
The Task Force generally opposes the proposal, particularly as it relates to individual debtors (as distinguished from corporations or partnerships), chapter 7 cases and the payment of taxes (as distinguished from the filing of tax returns). However, the Task Force agrees with the following aspects of the proposal:
1. Bankruptcy Code §§ 1121(b) and 1129(a) should be amended to provide that in a case where the debtor is a corporation or partnership, a debtor in possession or a chapter 11 trustee is required, as a condition to plan confirmation, discharge and an order extending exclusivity, to file verified proof that the debtor has filed (but not necessarily timely filed) (a) all postpetition returns then due and (b) all theretofore unfiled prepetition tax returns for the last three taxable years preceding the commencement of a bankruptcy case. The same rule should apply to an individual debtor who is a debtor in possession.
2. Bankruptcy Code § 1112(b) should be amended to provide that in a case in which the debtor is a corporation or partnership, a failure to file postpetition tax returns shall be grounds for dismissal or conversion upon motion by the United States Trustee or an aggrieved governmental unit. The same rule should apply to an individual debtor who is a debtor in possession, but the rule should be limited to tax returns of the estate and should not extend to tax returns of the debtor.
3. Bankruptcy Code §§ 1222(a) and 1322(a) should be amended to provide that an individual debtor is required, as a condition to plan confirmation and discharge, to file verified proof that the debtor has filed (but not necessarily timely filed) (a) all postpetition tax returns then due, and (b) all theretofore unfiled prepetition tax returns for the last three taxable years preceding the commencement of a bankruptcy case.
4. Bankruptcy Code §§ 1208(c) and 1307(c) should be amended to provide that a failure to file postpetition tax returns shall be grounds for conversion or dismissal on motion by the United States Trustee or an aggrieved governmental unit.
Reasons for Position
The proposal before the Commission is complex and multifaceted, involving chapters 7, 11, 12 and 13 and applying to individual debtors as well as corporation and partnership debtors. This broad-based approach is unwarranted and inappropriate in view of substantive tax rules (namely, Internal Revenue Code sections 1398 and 1399) that create important distinctions between chapter 7 and chapter 11 cases involving individual debtors and other kinds of chapter proceedings and debtors. In addition, "timely payment" requirements embedded in the Commission's proposal run counter to existing provisions of the Bankruptcy Code regarding the payment of administrative and prepetition tax claims in chapters 11, 12 and 13. Finally, the proposed requirement that tax returns be "timely" filed and taxes be "timely" paid creates the potential for imposing drastic penalties for minor footfaults.
A. Filing Requirements.
1. Chapter 7 Cases; Individual Debtors.
As discussed above,(58) the federal income tax return for the bankruptcy estate is prepared by the bankruptcy trustee, not the debtor. The debtor and the estate are separate taxpayers. To deny the debtor a discharge because his or her bankruptcy trustee fails to file a tax return with respect to a postpetition tax period of the estate (or files such return late) is manifestly inappropriate and wrong. It amounts to severely penalizing the debtor for a matter over which he or she has no control.
The Commission's proposal is also flawed to the extent it envisions denying the debtor a discharge in the event the debtor fails to file a tax return with respect to a debtor's postpetition tax period. A debtor's tax liability for a postpetition tax period is not a claim against the estate nor in any way involved in the debtor's chapter 7 case. The liability remains outstanding notwithstanding the discharge the debtor may receive in the chapter 7 case.
Under these circumstances, denying a discharge because a debtor fails to file a return for a postpetition period would be a purely punitive measure. The Task Force believes sufficient penalties already exist to punish a willful failure to file a tax return, namely, potential imprisonment, fines and civil penalties. There is no need to add the denial of a discharge in bankruptcy to this already formidable array of penalties.
Finally, many chapter 7 cases involving individual debtors are "no asset" cases in which the estate's resources are insufficient to pay for the preparation of postpetition tax returns. Although a bankruptcy trustee conceivably could be required to pay for return preparation, this would increase the cost of administering such cases and ultimately require the government to pay additional compensation to trustees, possibly resulting in no net increase (or perhaps even a net decrease) in government revenues.
2. Chapter 7 Cases; Corporate and Partnership Debtors.
A corporate or partnership debtor in a chapter 7 case does not receive a discharge.(59) Consequently, the Commission's Proposal is superfluous to the extent it provides for denying a discharge to a corporate or partnership debtor in a chapter 7 case.
3. Chapter 11 Cases; Individual Debtors.
If a trustee is appointed in an individual debtor's chapter 11 case, the trustee is responsible for filing the estate's federal income tax return.(60) Denying a discharge to a debtor because his or her trustee fails to file a postpetition tax return for the estate is unwarranted and inappropriate. If, notwithstanding this consideration, the Commission believes a debtor should be denied a discharge under these circumstances, the debtor should have a private right of action against the trustee for monetary damages for the trustee's failure to file an estate tax return.
If an individual debtor is a debtor in possession, it is reasonable to require that prepetition tax returns for the preceding three years as well as all postpetition returns be filed as a condition to the entry of an order extending exclusivity, confirming a plan of reorganization or granting a discharge. If an individual debtor's chapter 11 estate possesses adequate resources to confirm a chapter 11 plan, it is likely to possess sufficient resources to pay for the preparation of prepetition and postpetition tax returns.
Similarly, the Task Force believes Bankruptcy Code § 1112(b) should be amended to provide that an individual debtor in possession's failure to file postpetition tax returns for the estate (but not the debtor) shall be grounds for dismissal or conversion upon motion of the United States Trustee or an aggrieved governmental unit.
4. Chapter 11 Cases; Corporate and Partnership Debtors.
The Task Force believes it is reasonable to require a corporate or partnership debtor in a chapter 11 case to file all postpetition tax returns and prepetition tax returns for the three years preceding the filing of the petition as a condition to the entry of an order extending exclusivity, confirming a plan of reorganization or granting a discharge. The confirmation of a chapter 11 reorganization plan presupposes that the debtor possesses sufficient resources to render the plan "feasible."(61) Thus, a chapter 11 debtor who can confirm a plan is likely to possess sufficient resources to pay for the preparation of prepetition and postpetition tax returns.
Requiring that prepetition returns be filed for the preceding six years seems excessive. A three year filing requirement would be in harmony with the three year period generally applicable with respect to eighth priority taxes(62) and seems more reasonable than a six year requirement.
For similar reasons, the Task Force believes that Bankruptcy Code section 1112(b) should be amended to provide that a failure to file postpetition tax returns shall be grounds for dismissal or conversion upon motion by the United States Trustee or an aggrieved governmental unit.
5. Chapter 12 and 13 Cases; Individual Debtors.
If adequate resources exist to permit confirmation of a chapter 12 or 13 plan, it is likely that adequate resources exist to pay for the preparation of prepetition and postpetition tax returns. The Task Force supports the Government Working Group's proposal insofar as it requires the filing of all postpetition tax returns and prepetition tax returns for the three years preceding the filing of the petition as a condition to plan confirmation and, upon successful completion of the plan, the granting of a discharge to the debtor.
The Task Force also supports the Government Working Group's proposal that Bankruptcy Code sections 1208(c) and 1307(c) be amended to provide that failure to timely file postpetition tax returns shall be grounds for dismissal or conversion upon motion by the United States Trustee or an aggrieved governmental unit.
B. Payment Requirements.
1. Chapter 7 Cases.
A bankruptcy trustee's failure or inability to pay the estate's postpetition taxes should have no effect on the debtor's entitlement to a discharge. This is a matter over which the debtor has no control, and it would be patently unfair to severely penalize the debtor for a trustee's omissions or mistakes or the estate's administrative insolvency.
As discussed above,(63) no discharge is available in a chapter 7 case involving a corporate or partnership debtor, so the entire issue is moot.
2. Chapter 11 Cases.
Chapter 11 already provides for the payment of postpetition taxes under a confirmed plan of reorganization. Such taxes must be paid in cash in full on the plan's effective date unless the taxing authority holding the claim agrees to different treatment.(64)
This provision is in the nature of a fail-safe mechanism designed to backstop any administrative claims not paid in the ordinary course of business. A creditor (including a taxing authority) holding an administrative claim generally is assured that its claim, if not earlier paid, will be paid when a plan of reorganization becomes effective.
See our response to Commission Track Numbers 421-4, infra.
3. Chapter 12 and Chapter 13 Cases.
Chapters 12 and 13 each provides for the payment of postpetition taxes pursuant to a confirmed plan: there must be full payment, in deferred cash payments, of all administrative tax claims unless the claim holder agrees to different treatment.(65) Moreover, Bankruptcy Code sections 1226(b)(1) and 1326(b)(1) provide that administrative tax claims must be paid before or at the time of payments under the plan to other creditors.(66) This gives administrative tax claims a priority over (or, at the very least, makes them pari passu with) all claims other than other administrative claims.
There is no valid reason why the payment of administrative tax claims should be accelerated any more than they already are under Bankruptcy Code sections 1226(b)(1) and 1326(b)(1). A taxing authority holding a postpetition tax claim should be subject to the same rules regarding payment as other administrative claim holders; no special exception should be made. But see our response to Commission Track Numbers 421-4, infra.
C. "Timely" Filing of a Return or Payment of Taxes.
Under the Commission's proposal, a debtor could be denied a discharge if he or she was even one day late in filing a tax return or paying taxes. A chapter 11, 12 or 13 plan could not be confirmed if a debtor was even one day late in filing a tax return or paying taxes.
These are truly draconian penalties for minor (and probably harmless) mistakes.
Unfortunately, this is not the type of problem that can be solved by giving a debtor an additional period of time in which to file a postpetition tax return. If a debtor is given an additional period of time (say, 90 days) in which to file a return, there will be some debtors who will file on the 91st or 92nd day, creating the same problem of a disproportionate penalty for a minor footfault (filing one or two days beyond the deadline).
A better approach is to require that all postpetition tax returns be filed before a plan can be confirmed, but not to require that such returns be filed on time. A corollary rule would give a taxing authority an additional period of time in which to file a claim in the event that a tax return for a postpetition period is tardily filed.
Other Institutional Positions
The Association of the Bar of the City of
THE CHAPTER 13 "SUPERDISCHARGE"
(COMMISSION TRACK NUMBER 213)
Present Law
In order for income taxes to be dischargeable in a Chapter 7 case a debtor must have filed her tax returns for the years in question at least more than two years prior to filing the bankruptcy petition.(67) In a Chapter 7 case a debtor who has not filed his returns at all, or has filed them within two years prior to the bankruptcy, cannot discharge those taxes even though the tax has been assessed more than 240 days. In a Chapter 13, however, if a tax meets all the other criteria for dischargeability, it may be wiped out or reduced in a Chapter 13 plan.(68) That a return need not be filed in order to make a tax dischargeable under Chapter 13 is apparent from a careful reading of the priority language of the Bankruptcy Code. A taxpayer's failure to file a return, or if she filed it less than two years prior to the bankruptcy, renders the tax nondischargeable under Chapter 7 pursuant to section 523(a)(1), but this code section does not apply in Chapter 13.(69) Bankruptcy Code §1322(a)(2) requires only that the Chapter 13 plan provide for full payment of priority taxes under section 507(a)(8). Referring to section 507(a)(8), nowhere does the language include within the category of priority tax one for which a tax return was filed late or not filed. Hence, the failure to file a return does not render that tax a priority tax. Compare section 1322 with section 523 (exceptions to discharge) which renders tax for which no return was filed or which was filed less than two years prior, nondischargeable under Chapter 7 (section 727).(70)
Where the taxpayer filed a fraudulent return and engaged in activity which is deemed to be willful evasion of a tax obligation, any tax arising in connection with such return or evasion is ordinarily not dischargeable in Chapter 7.(71) The discharge available in Chapter 13 does not exclude the claims in this category (fraud or evasion), and therefore they are dischargeable to the extent any other secured or unsecured claim may be discharged, depending on the particular plan. As long as the Chapter 13 plan provides for full payment of priority claims provided by section 507, the discharge is allowable as to tax claims.(72) Section 507 does not include tax claims based on fraud or evasion; therefore, the plan need not provide for full payment of them, unless the tax claims fall within some other category provided in section 507.(73)
Regardless of whether a tax obligation is found to be based on fraudulent returns, the debtor's dishonest prepetition conduct in regard to his tax obligations may be taken into consideration on the issue of bad faith.(74)
Proposals Before the Commission
Commission Track Number 213. Commissioner Shepard proposes to close the perceived loophole which allows for a discharge of fraudulent and/or unfiled or late returns in Chapter 13. He believes that taxes which are otherwise entitled to priority should not be denied priority status simply because the taxpayer filed under Chapter 13, not Chapter 11 or 7. The taxes resulting from debtor's misconduct because of fraud, failure to file or late filing should not be dischargeable in Chapter 13. See Santa Fe Discussion Issues p. 12, Item IIC1; See also Justice Proposal, p. 91; IRS Proposal, p.8 (each proposing repeal of the Chapter 13 superdischarge altogether.)
Task Force Position
The Task Force does not support these proposals, but instead supports maintenance of the status quo.
Reasons for Position
Present law allows taxpayers who may have engaged in prior tax misconduct by not filing a return or by having filed a fraudulent return to gain a fresh start. Courts are currently authorized to review each plan based upon a bad faith standard. The bad faith standard can be determined by the bankruptcy bench. There are valid reasons why a taxpayer should be allowed rehabilitation under a Chapter 13 plan. A taxpayer faced with an overwhelming tax debt as a result of prior tax misconduct would have greater incentive to be productive if she could satisfy her tax obligation by paying a portion over a period of years. The IRS Collection Division is inflexible and imposes draconian allowable expense standards. The current law allows a bankruptcy judge to protect a Chapter 13 debtor from the harsh collection approach of the IRS.
The Task Force would agree that in no event should someone who has failed to file a return, or who has filed a fraudulent return, be allowed a zero percent plan. A better solution to the problem would be to require a minimum percentage payment. It should also be noted that by law Chapter 13 only is available to someone with unsecured debts less than $250,000, thereby preventing its use by the most unworthy taxpayers.
Other Institutional Positions
A focus group of the
DEFERRED PAYMENTS OF PRIORITY TAXES UNDER
SECTION 1129(a)(9)(C) OF THE BANKRUPTCY CODE
(COMMISSION TRACK NUMBER 214)
Present Law
Section 1129(a)(9)(C) of the Bankruptcy Code provides that, unless the holder of a priority tax claim otherwise agrees, such a tax authority must receive deferred cash payments, over a period not exceeding six years from the date of assessment, of a value, as of the effective date of the plan, equal to the allowed amount of the claim.
No specific interest rate is prescribed by the statute with respect deferred payments. Similarly, the statute does not require that payments be made in a specific amount (i.e. level payments) or on a specific schedule (e.g., quarterly or annually).
Proposals Before the Commission
Commission Track Number 214. Commissioner Shepard has proposed that the
statute be amended to provide for a specific interest rate. Because the federal
and state tax laws often impose different interest rates on delinquent
taxpayers, Commissioner Shepard suggested adoption of either the federal tax
deficiency rate for all priority taxes or would simply adopt the non-bankruptcy
Federal Judgment Collection rate. See
Commissioner Shepard also suggests amending the statute to require level
monthly payments over the six year period. See
The Commission is not considering any changes other than as herein proposed
in determining the date from which the six year deferral period should be
measured.
Task Force Position
(a) Interest Rate
The Task Force recommends that the statute be amended to provide that the interest rate used to value deferred payments of priority taxes shall be equal to the applicable rate for underpayments as determined under section 6621(a)(2) of the Internal Revenue Code on the date of confirmation of the plan.
There has been a significant amount of litigation between debtors and tax authorities in determining the appropriate interest rate which should be charged on deferred payments under section 1129, and the courts have not been consistent in determining such rates. Although both federal and state tax laws set specific interest rates (or formulae for calculating such rates) applicable to taxpayers not in bankruptcy with unpaid tax liability, bankruptcy courts generally have interpreted section 1129 to require the court to engage in a present value calculation, based on the credit markets and an analysis of the credit risk of the debtor,(75)
prior to setting an interest rate on the deferred payments. Often the interest rates set by the bankruptcy courts are less than the statutory tax interest rates, and the uncertainty now inherent in the existing statute affords the debtor unintended leverage in its negotiations with a tax authority holding priority claims. Also, current law arguably unfairly prefers Chapter 11 debtors by giving them an opportunity to obtain lower interest rates on their unpaid tax liability than would be available to non-debtor taxpayers. The disparity appears even more unfair because a Chapter 11 debtor, unlike a non-debtor taxpayer, is permitted a six year period over which to pay its tax liability. A tax authority typically will seek immediate payment of the entire liability from a non-debtor taxpayer; if a non-debtor taxpayer is unable to satisfy the entire liability, the authority usually imposes heavy penalties or severe restrictions on the delinquent taxpayer.
It can be contended that the tax authority is entitled only to the "true" present value of its claim and that, by sanctioning what may be an above market interest rate, the Bankruptcy Code will prefer the claims of tax authorities to other creditors. Also, it will be argued that if the Bankruptcy Code requires the debtor to pay high interest rates on its priority tax claims, the reorganized debtor's chances for a successful reorganization may be adversely affected. Neither of these reasons is sufficient to justify the current provisions. Where Congress or the states have provided for specific tax interest rates (or formulae to set such rates), there is no overriding policy which justifies the Bankruptcy Court setting an entirely different interest rate, particularly when the tax authorities have been forced to wait (without interest) during the pendency of the Chapter 11 proceeding before collecting the delinquent tax liability.
On the other hand, the Task Force agrees that a debtor's future obligations for priority tax payments should be clearly known at the time of confirmation, and that the applicable interest rate should be easily determinable and generally related to current market rates.
For these reasons, the Task Force believes that the interest rate on allowed deferred priority tax claims should be fixed at the time of confirmation, and should not be subject to change over the deferral period. Also, the Task Force suggests that a single rate be applied to all priority tax payments, federal, state and local. In our view, the rate determined under section 6621(a)(2) of the Internal Revenue Code should be adopted for bankruptcy purposes. The section 6621(a)(2) rate not only reflects federal tax policy, but is reset every calendar quarter to reflect changes in market interest rates.(76)
The Task Force recommends that the additional interest rate imposed on corporations for underpayments in excess of $100,000 (5 percent above the short-term federal rate) not apply to the priority tax claims of Chapter 11 corporate debtors.(77) The additional 2 percent reflects the fact that a C corporation may deduct such interest (as compared with individuals who are not entitled to a similar deduction), which is not relevant to the Bankruptcy Code.
(b) Deferred Payments
In numerous cases, debtors have proposed repayment schedules providing for no or nominal payments of priority tax claims in the initial years following the effective date, with much larger payments (or perhaps a balloon payment) in the later years. Tax authorities often contest such repayment schedules, typically arguing for level principal payments over the six year deferral term. In interpreting the six year deferral provision, the courts have permitted debtors flexibility in crafting repayment schedules, where the courts found that a debtor required some breathing room initially following confirmation.(78)
It has been proposed to the Commission that the Bankruptcy Code be amended to require level payments of priority taxes during the six year deferral period. First, we believe that such level payments should be calculated as if the priority tax debt were a self-amortizing mortgage, so that the scheduled payments of principal and interest will be in equal amounts during the entire six year period. (Such level payments should be made at least annually, or more frequently as ordered by the bankruptcy court.) If the Bankruptcy Code is amended to require equal principal payments over a six year period, the burden imposed on the debtor to meet its priority tax claim obligations immediately following the effective date of reorganization will be significantly larger than in the later years because the interest payable on the unpaid balance will be larger in the earlier years. This additional burden is inconsistent with the goal of an effective reorganization.
Second, and more important, we believe that the level payment rule should not be mandatory; the debtor should be allowed to adopt a different payment schedule if it demonstrates that such a schedule will facilitate the successful reorganization of the debtor.(79)
At the same time, we recognize that the Bankruptcy Code affords priority to the tax collector, who should not lose his priority as a result of the deferral of priority tax payments. For these reasons, we suggest that, if the priority tax claims are not paid on a level payment basis (calculated similar to a self-amortizing mortgage), the debtor's payment schedule for such claims must provide recoveries on at least as rapid a basis as the most favored nonpriority unsecured claims. In other words, if the holders of unsecured claims are receiving 25 percent recoveries in quarterly installments over the first two years, then the priority tax claims must receive at least a 25 percent recovery in quarterly installments over the first two years; the 75 percent balance then will be paid over the next four years in accordance with the plan. In this way, a tax authority which is not receiving level payments will not be in the position of obtaining its recovery at a slower pace than unsecured creditors.(80) Of course, the debtor may decide to pay the priority tax claims on a level payment basis over the six year period following the effective date, which will enable the debtor to pay its unsecured creditors on a faster basis.
(c) Commencement of Deferral Period
The Task Force recommends that the deferral period for priority tax claims commence on the effective date of reorganization and not relate back to an earlier assessment date.
The six year deferral period is now measured from the date of assessment, not the effective date.(81) In some cases, the tax authority may have assessed the priority tax before the Chapter 11 petition was filed. If the Chapter 11 proceeding takes two years, such a tax authority will be entitled to collect its priority tax claim in only four years following the effective date, while other tax claimants will be subject to a six year deferral period. Also, recent changes in the Bankruptcy Code permit tax authorities to make assessments during the Chapter 11 proceeding. We do not believe that in amending section 362(a)(9) Congress intended this result.
Priority taxes, whether or not assessed prior to the filing of, during, or at the close of the Chapter 11 proceeding should be subject to the same deferral period. We believe that the six year deferral period should be measured from the effective date of the plan of reorganization. This will place all priority tax claims in the same position.
Other Institutional Positions
The Association of the Bar of the City of
SETOFFS
(COMMISSION TRACK NUMBER 215)
Present Law
Bankruptcy Code § 553 generally preserves a creditor's right to setoff a prepetition obligation of that creditor against such a creditor's prepetition claim against the debtor. However, section 362 imposes an automatic stay of the setoff of any prepetition debt owing to the debtor against any claim against the debtor.(82) The creditor must seek relief from stay to make the setoff. These provisions apply to governmental and nongovernmental creditors alike. Although section 362(b) contains exceptions to the automatic stay, none of the exceptions permits setoffs of prepetition tax liabilities against prepetition tax refunds.(83) In other words, if a debtor files a bankruptcy petition at a time when he or she owes taxes for a prepetition year but is entitled to a refund for another prepetition year, the IRS cannot, in most jurisdictions, presently apply that refund against the liability (without seeking relief from stay).
Proposals Before the Commission
Commission Track Number 215. The IRS has requested the Commission to propose permitting such setoff by adding a new subsection (b) (19) to section 362 as follows:
(19) under subsection (a) of this section, of the setoff by a governmental
unit of a tax refund that arose before the commencement of the case against a
tax liability that arose before the commencement of the case.
Government Working Group Proposal No. 13 would adopt this rule.
The IRS estimates that it could obtain approximately $24 million in potential setoffs annually pursuant to this change. See IRS Proposal, p. 14. The Department of Justice makes a similar recommendation. See Report of the Justice Proposal, p. 100.
The IRS makes a separate proposal to extend the right of setoff to post-petition refunds. See IRS Proposal, p. 15.
Task Force Position
The Task Force opposes these proposals and recommends that no change be made to present law.
Reasons for Position
The IRS already has adequate means to ensure that it will receive the tax refund. The debtor is required to disclose the tax refund (or potential tax refund) on Schedule B of the petition as it is "property" of the debtor. If the IRS has a valid prepetition claim and is entitled to the setoff, it will ultimately keep the refund.
The IRS is not without remedy. Section 362(d) permits a creditor to request relief from the stay and upon notice and a hearing the relief shall be granted for cause or if the debtor does not have an equity in the property and the property is not necessary to an effective reorganization. Thus, the IRS may choose to request relief from the stay to setoff the prepetition refund against the prepetition liability. The notice and hearing requirements are essential to protect the rights of the other creditors that may be entitled to the funds under the priority rules contained in section 507. If the IRS is permitted to automatically setoff a refund against a tax liability, the other creditors will not be aware of the setoff and will not have a forum to protest the setoff. Also, the tax refund may be an asset of the debtor that is exempt from creditors. By permitting an automatic setoff, the debtor may be deprived of the ability to retain the exempt asset. There is no policy justification for depriving the debtor of an exempt asset merely because the asset happens to be a tax refund.
Finally, the rules as to setoffs apply to all creditors. With respect to this procedural matter, there is no justification for giving the IRS rights that are not enjoyed by other creditors. If the setoff rules are faulty, the Commission ought to deal with them generally.
Other Institutional Positions
The Association of the Bar of the City of
NOTICE REQUIREMENTS UNDER
SECTION 505(b) OF THE BANKRUPTCY CODE
(COMMISSION TRACK NUMBER 216)
Present Law
Bankruptcy Code § 505(b) provides a method to invoke the Bankruptcy Court's jurisdiction to determine the amount of tax due by, or refund due to, a debtor. In a title 11 case, the trustee or debtor may file a tax return, pay the tax set forth and request the Internal Revenue Service or other taxing authority to determine the proper tax liability. The Internal Revenue Service or other taxing authority has 60 days to notify the trustee or debtor the return has been selected for examination and 180 days (subject to extensions granted by the Bankruptcy Court) to complete the audit. Absent fraud or material misrepresentation, the passing of the 60 days or 180 days will discharge the debtor from any further tax liability.(84)
To invoke Bankruptcy Code § 505(b), the request for a determination
must be to the governmental authority. In at least two cases, the question of
what constitutes appropriate notice to the Internal Revenue Service has been
raised and resolved in a conflicting manner. Compare, In re Carie
Corp., 128 B.R. 266 (D.
Proposals Before the Commission
Commission Track Number 216. The Government Working Group proposes to amend the Bankruptcy Rules notices demanding the benefits of rapid examination under section 505(b) be sent to the office specifically designated by the applicable taxing authority for such purpose, in any reasonable manner prescribed by such taxing authority. See Government Working Group Proposal No. 17; See also Santa Fe Discussion Issues, p. 24, Item IVC5; IRS Proposal, p. 38.
Task Force Position
The Task Force supports the Government Working Group Proposal, provided the notification procedure has been filed by the taxing authority with the Bankruptcy Court in a manner that will provide the debtor sufficient notice of the procedural requirements.
Reasons for Position
We believe the proposal raises legitimate concern. The taxing authority should be entitled to "real" notification of the request for expedited audit procedure. But, we are also mindful of the difficulty in obtaining reliable directions as to where and how requests for expedited audit tax claims should be filed, particularly with state and local taxing authorities. The rules for those filings, to the extent they exist, are not easily located in the available tax services or through other means readily available to debtors, trustees and their legal advisers. Thus, to accomplish the legitimate goals of the taxing authority and the legitimate needs of the tax paying debtors and their successors, we recommend the rules provide for notice to the taxing authority in the manner set forth in procedures on file with the Bankruptcy Court in which the proceeding is proceeding. Applicable procedures for expedited filings with federal, state and local taxing authorities would be accepted for filing by the Bankruptcy Courts of the United States unless the Bankruptcy Court Chief Judge for each district who receives a proposed notice requirement from a taxing jurisdiction determines the notice requirement is inappropriate (for whatever reason the Chief Judge determines) within 60 days after the submission of the notice procedures to the respective Bankruptcy Court. In the absence of any filing, any notice request to the affected governmental taxing authority would suffice.
Alternatively, the filings could be accomplished by requiring each taxing jurisdiction to file its notice procedures with the clerk of each United States Court of Appeals or some appropriate national registry to be created. The Circuit Court Clerks would provide copies to all Bankruptcy Courts in the circuit for dissemination to affected debtors.
We would anticipate that each taxing jurisdiction would file its procedures with all of the Bankruptcy Courts and that, in general, those procedures would be accepted as filed, particularly if they provide rules similar to those published in Rev. Proc. 81-17, 1981-1 C.B. 688. We further anticipate the Bankruptcy Courts would incorporate these tax authority filing notices as appendices to the local Bankruptcy Court rules and would thus make the filing requirements readily available and knowable to all debtors and their counsel.
See also our response to Commission Track Numbers 105, 106 and 109, supra.
THE ESTATE OF AN INDIVIDUAL FAMILY FARMER
AS A TAXABLE ENTITY:
SECTION 1231(b) OF THE BANKRUPTCY CODE
(COMMISSION TRACK NUMBER 217)
Present Law
Section 1398 of the Internal Revenue Code provides certain rules for the taxation of estates of individuals in cases arising under chapter 7 or chapter 11 of the Bankruptcy Code.(85) The estate is required to compute its taxable income in the same manner as an individual, and the tax liability computed with respect to such taxable income is to be paid by the trustee.(86) Section 1398 provides detailed rules dealing with the taxable years of individual debtors who file bankruptcy petitions, rules dealing with the income, deductions and credits of the bankruptcy estate, and the transfer of tax attributes between a debtor and an estate. Significantly, section 1399 of the Internal Revenue Code provides that "[e]xcept in any case to which section 1398 applies, no separate taxable entity shall result from the commencement of a case under title 11 of the United States Code."
The effect of these rules, as they relate to individuals, is that when an individual files a chapter 7 or a chapter 11 case, a new taxable entity springs into existence for federal income tax purposes, as to which the trustee must file returns and pay tax. However, when such an individual files a case under chapter 12 or 13 of the Bankruptcy Code, no separate taxable entity is created for federal income tax purposes. The individual's return filing requirements are unaffected, and all items of income and deduction realized by the bankruptcy estate are reported on the returns of the individual debtor.
Various sections of the Bankruptcy Code provide rules for a bankruptcy estate's liability for state or local income taxes. With the exception of the treatment of chapter 12 estates, dealing with bankruptcies of family farmers, these largely parallel the federal rules, although the wording is not identical. For example, section 346(b)(1) of the Bankruptcy Code provides in part, "in a case under chapter 7, 12 or 11 of this title concerning an individual, any income of the estate may be taxed under a state or local law imposing a tax on or measured by income only to the estate, and may not be taxed to such individual."(87) Income in a chapter 13 case may be taxed only to the individual and not to the estate.(88) The liability of such an estate for taxes in a chapter 7 case is buttressed by a provision which requires filing of state or local income tax returns by a trustee, but only if such estate "has net taxable income for the entire period after the order for relief under this chapter during which the case is pending."(89) Section 1231(b) of the Bankruptcy Code specifically provides that "the trustee shall make a state or local tax return of income for the estate of an individual debtor in a case under this chapter for each taxable period after the order for relief under this chapter during which the case is pending."(90)
Proposals Before the Commission
Commission Track Number 217. The Government Working Group proposes that section 1231(b) of the Bankruptcy Code be repealed. Government Working Group Proposal No. 9. See also Santa Fe Discussion Issues, p. 27, Item IVE7.
Task Force Position
The Task Force supports the Government Working Group's proposal.
Reasons for Position
Under both the Internal Revenue Code and the Bankruptcy Code, a separate taxable entity is created in a case concerning an individual debtor under chapter 7 or chapter 11. The same is not true in a case under chapter 13, presumably because of the fact that an individual's post-bankruptcy income is committed to the satisfaction of chapter 13 debts. Therefore, the income during the period of bankruptcy administration is reported on an estate income tax return in individual chapter 7 and chapter 11 cases, but on the individual debtor's personal income tax return in chapter 13 cases. There is no proposal pending before the Commission to change these entity and return filing rules with respect to chapters 7, 11 and 13, and the Task Force does not itself propose any changes. Regardless of the merits, the current law has the advantage of symmetry between the federal and state/local tax treatment of bankruptcy estates.
The treatment of family farmer cases under chapter 12 is anomalous, and has no basis in logic. It probably results from oversight. Chapter 12 was not a part of the original Bankruptcy Code in 1978, and did not exist when the Bankruptcy Tax Act of 1980 was enacted. In 1986, chapter 12 was added to the Bankruptcy Code, setting up special rules for the administration of cases involving family farmers. Chapter 12 contains its own special state and local tax provisions, including section 1231(b). When chapter 12 was enacted, however, no effort was made to amend section 1398 of the Internal Revenue Code to include chapter 12 cases as situations in which separate taxable entities would be created. The Task Force does not know what the actual practice has been. However, if debtors in fact comply with the law as it stands, income of the estate is taxed to the individual family farmer for federal income tax purposes but to the trustee for state and local tax purposes. The Task Force cannot think of any argument supporting these inconsistent rules, and it is clear that one of them should be changed.
The Government Working Group proposes to abolish the requirement for filing state and local tax returns. If this is done, the rules for state and local income taxes would parallel those applicable to federal returns under section 1398 of the Internal Revenue Code. The choice of adopting the current federal rule rather than the current state rule appears to be the better one, based upon the fact that overall, the substantive provisions of chapter 12 are closer to those of chapter 13 than to chapters 7 and 11.
There are two other collateral technical amendments that are necessary. First, the reference to chapter 12 in sections 346(b)(1), 346(g)(1)(C) and 346(i)(1) should be deleted.(91) Second, section 1231(a) should also be repealed.(92)
Other Institutional Positions
The National Bankruptcy Conference is on record as supporting repeal of
section 1231(b). A focus group of the
PROPOSAL TO CREATE AN ELECTIVE SHORT TAXABLE YEAR
FOR STATE AND LOCAL TAX PURPOSES
(COMMISSION TRACK NUMBER 217A)
Present Law
Section 1398 of the Internal Revenue Code creates a separate taxable estate when an individual files a petition in a chapter 7 or chapter 11 case.(93) Section 1398(d) provides that as a general rule, an individual's taxable year does not terminate when such a petition is filed.(94) However, section 1398(d)(2) provides that an individual may elect to terminate his taxable year as of the date prior to the filing of the bankruptcy case, thus starting a new taxable year on the day the petition is filed.(95) This election is important, principally because it enables a debtor going into a chapter 7 or 11 bankruptcy to terminate his taxable year, thus creating a "prepetition" tax liability which, although nondischargeable, can be paid as a priority tax out of the assets of his bankruptcy estate.(96) The draftsmen of the Bankruptcy Code were cognizant of the issues surrounding this provision, but addressed it in their own way. Section 728 of the Bankruptcy Code provides in part, "for purposes of any State or local law imposing a tax on or measured by income, the taxable period of a debtor that is an individual shall terminate on the date of the order for relief under this chapter [i.e., chapter 7], unless the case was converted under section 1112 or 1208 of this title."(97)
Proposals Before the Commission
Commission Track Number 217A. This proposal.
Task Force Position
The Task Force proposes that the Commission recommend amending sections 728(a), 1146(a) and 1231(a) of the Bankruptcy Code to conform with the Internal Revenue Code. Sections 728, 1146 and, if it is not otherwise repealed, section 1231 of the Bankruptcy Code, should be amended to provide that if the Internal Revenue Code gives a debtor an election to terminate his taxable year for federal income tax purposes, and the debtor, or the debtor's spouse in the case of a joint return, makes such an election, then the debtor's taxable year for state and local tax purposes shall terminate on the date of termination for federal income tax purposes.
Reasons for Position
There is no policy justification for having a different taxable year for federal purposes on the one hand, and for state and local purposes on the other hand. Most states use federal taxable income as a base for computing a state or local income tax liability, if any. This policy decision cannot be implemented if the taxable periods are different for federal, state and local income tax purposes. Yet, as the two statutes currently coexist, there will always be a different taxable year for federal income tax purposes and for state and local income tax purposes for the year in which an individual debtor files a bankruptcy case. If the debtor does not make the federal election under section 1398(d)(2) of the Internal Revenue Code, then he will have a full taxable period of twelve months for federal income tax purposes, but will have two taxable years for state and local income tax purposes as a result of the special tax provisions now contained in chapters 7, 11 and 12. Moreover, because of differences in drafting, there will be a variance of a single day in such taxable periods even if the debtor does make the federal election. Under section 1398 of the Internal Revenue Code, the debtor's first short taxable year would end on the day before the petition is filed, whereas under the special tax provisions of the Bankruptcy Code, the first short taxable year ends on the date of filing the petition. The interest in uniformity clearly outweighs any argument that can be made for retention of present law, although the Task Force does not know of any such argument.
Other Institutional Positions
The National Bankruptcy Conference is on record in supporting this amendment.
DEBTOR'S DUTY TO GIVE NOTICE OF
PENDING FEDERAL TAX AUDITS
(COMMISSION TRACK NUMBER 218)
Present Law
Government Working Group Proposal No. 14 addresses the state taxing authorities' concerns regarding the debtor's obligation to disclose and report information to the state when there is a federal audit or assessment altering the debtor's income tax liability as originally reported on his or her income tax return. State income tax liabilities are often calculated based upon the adjusted gross or taxable income properly reportable for federal income tax purposes. When a taxpayer's federal income is changed due to an audit, state statutes generally require the debtor to inform the state of such changes. The Internal Revenue Service ("IRS") also provides copies of the revenue agent's report ("RAR") of the audit results to the state. Upon receiving either the RAR from the IRS or the information from the taxpayer, the state assesses the additional tax owed based upon the change in income. Government Working Group Proposal No. 14 is concerned with the state not receiving notice or receiving notice late of a debtor taxpayer's adjusted tax liability. In such case, the state is concerned that its claim may be barred because the discharge occurs before the audit is completed and after any applicable bar date.
Proposals Before the Commission
Commission Track Number 218. The Government Working Group proposes that the Commission should submit to the Advisory Committee on Bankruptcy Rules of the Judicial Conference ("Rules Committee") a recommendation that Federal Rule of Bankruptcy ("Bankruptcy Rule") 1007 require a debtor to disclose on schedules when initially filed whether or not any tax audits are pending, and to file amended schedules and statements as necessary, with written notice thereof to state and local taxing authorities, to provide adequate notice to state taxing authorities and other creditors of a federal tax audit. Additionally, Government Working Group Proposal No. 14 recommends that Bankruptcy Code § 523(a) be amended to provide that failure to substantially comply with Bankruptcy Rule 1007 renders nondischargeable a state or local government claim associated with a debtor's noncompliance.
Task Force Position
The Task Force agrees with the proposed amendment to Bankruptcy Rule 1007. However, the Task Force opposes the proposed amendment to Bankruptcy Code §523(a) excepting from discharge a state or local government claim associated with a debtor's noncompliance with Bankruptcy Rule 1007. This amendment is unnecessary, given that these claims are already nondischargeable under section 523(a)(1)(A) as a priority tax falling under section 507(a)(8)(A)(iii) which covers taxes that are not assessed as of the date of the petition but are still assessable. If the states are concerned about the tax being discharged in a Chapter 13 case where the state fails to file a timely claim, then the appropriate remedy is to amend section 1328.
Although Proposal No. 14 only encompasses state taxes arising from federal audits in progress at the time the bankruptcy petition is filed, the Commission should also consider the broader issue of the dischargeability of state taxes arising out of prepetition federal audits where the federal tax has already been assessed prior to the filing of the petition. As discussed above, once the federal audit becomes final, the states require that the taxpayer report the changes in income. Some states require that the taxpayer file an amended return, while others merely require that the taxpayer provide the state with a copy of the RAR. Most states require the change in income be reported within 30 to 90 days. If the taxpayer either fails to provide the report or provides it late, it is unclear as to whether the tax is dischargeable. There have been several conflicting cases on this issue.
A state tax resulting from a federal audit should be dischargeable even if the taxpayer failed to provide the state with a copy of the RAR or amended return. Because the IRS furnishes the state with the information necessary for the state to determine the additional tax due, the state should be required to assess the tax within a reasonable period of the federal assessment, such as 180 days. Thus, a state tax resulting from a federal audit would be dischargeable 420 days (180 days plus the 240 days provided in section 507(a)(8)(A)(ii)) after the federal assessment.
In order to encourage the debtor to comply with the reporting requirements, the debtor should be able to shorten this period by filing an amended return or providing the report. Often, even when the debtor timely files the report, the state does not promptly assess the tax. Once a debtor provides the state with the report or amended return, 30 days is a reasonable time for the state to assess the tax. Thus, if the debtor complies with the state law and provides the state with a report or an amended return, the state tax resulting from the audit would be dischargeable 270 days from the date the return is filed (30 days plus the 240 days provided in section 507(a)(8)(A)(ii)).
The Task Force recommends that section 523(a)(1)(B) be amended to clarify that neither an amended return nor a report is a "return" for purposes of that provision (as well as for purposes of section 507(a)(8)(A)(i)). Section 507(a)(8)(A) should be amended by adding the following subparagraph:
(iv) a state or local income tax assessable due to an increase in income as
a result of an Internal Revenue Service audit of the debtor's income as
reported on the federal tax return filed by the debtor shall be deemed assessed
for purposes of subparagraph (ii) of this paragraph on the earlier of (1) 30
days after the date on which an amended return or report was filed with the
state, or (2) 180 days after the date on which the federal tax was assessed.
Reasons for Position
The information requested regarding pending audits is reasonable and necessary for the state to protect its potential claim in the bankruptcy. Although the additional information will require paperwork by the debtor, this burden is not unreasonable when compared to the prejudice to the state if it does not receive notice of the audit.
Government Working Group Proposal No. 14 includes an amendment to section 523(a) providing that failure to comply with Bankruptcy Rule 1007 will result in the state's claim being nondischargeable. This amendment is unnecessary because such claims are already denied a discharge under section 523(a)(1)(A), which exempts from discharge any tax specified in section 507(a)(8). Under section 507(a)(8)(A)(iii) a tax that is not assessed but is still assessable at the time the petition is filed is a priority nondischargeable tax. If the state is able under state law to assess the tax once the audit is final, the additional state tax resulting from the audit falls under section 507(a)(8)(A)(iii) and is thus nondischargeable under section 523(a)(1)(A).
The state may be concerned that if it is unaware of the claim, the tax may be discharged in a Chapter 13 case. Although priority taxes must be paid in full in a Chapter 13, section 1328 provides that a debtor is discharged of all claims provided for in the plan. If the state is unaware of its claim and fails to file a proof of claim, even a priority tax may be discharged. The remedy to protect the state is to amend section 1328, not section 523(a).
As discussed above, all states that have an income tax require the taxpayer
to report a change in federal income to the state. The method and time to
report the change vary from state to state. Twenty five states require a
taxpayer to file an amended return and a copy of the RAR to report the change
in income.(98) The remaining states that impose
an income tax either permit the taxpayer to choose to amend its return or to
merely provide a copy of the RAR, or they use a form to disclose the change.
One state,
Because the states use a wide variety of reporting methods, there are conflicting cases regarding whether a tax assessed by the state more than 240 days prior to the date the petition was filed was dischargeable where the debtor either did not file an amended return or filed late. Several courts in states where an amended return was required held that the amended return was a required return for purposes of section 523(a)(1)(B) and thus the tax was nondischargeable if the debtor failed to file a return or filed late and the petition was filed within two years of the date the late return was filed.(99) These cases generally state that an amended return is a "return" without any analysis.
There are many cases finding that an amended return is not a "return". At least one bankruptcy case, In re Arenson,(100) has held that where a taxpayer files an amended return in response to a substitute return filed by the IRS for the taxpayer, the amended return does not constitute a return within the meaning of section 523(a)(1)(B)(i). Arenson relied upon Supreme Court decisions holding that an amended return is not a new "return," but merely a change in the original return, for purposes of the statute of limitations.(101) By holding that the amended return was not a return, the court denied the debtor a discharge for the federal tax claim.
Another bankruptcy decision, In re Lamborn,(102) held that an amended return is a return for purposes of section 507(a)(8)(A)(i) and thus a tax resulting from the amended return is not dischargeable for three years. The court distinguished In re Greenstein and all of the Supreme Court cases holding an amended return is not a return. In finding that the amended return is a return, again the court denied the debtor a discharge.
Where the state merely requires a report, and not an amended return, courts have generally found that a report is not a required return.(103) These cases generally state that section 523(a)(1)(B) must be interpreted liberally in favor of the debtor. Additionally, the purpose of section 523(a)(1)(B) is to deny a discharge to a debtor who has engaged in a "wrongful act" by not filing any return and has thwarted the government's attempt to determine the liability owed. These cases concluded that the state, by requiring successive returns, should not be able to deny the debtor a discharge. Further, the courts stated that based upon the plain meaning of the statute, a return is not "required" if the debtor may choose to file a copy of the RAR instead of amending the return. Thus, not every requirement to provide information to a taxing authority rises to the level of a required return. Last, the courts found that where the IRS already provides the information to the state necessary for the state to determine the tax owed, the information required from the debtor is not necessary. In consequence, the state does not need the protection of section 523(a)(1). Only one case, In re Blutter,(104) has held that a "report" is a required return.
Because there are so many conflicting cases regarding whether an amended return is a "return" and whether a report is a "return," Congress should resolve the issue. The better rule is that an amended return and a report should not be considered a "return" for purposes of either section 507(a)(8)(A)(i) or section 523(a)(1)(B). An amended return is not a new return but a change in a previously filed return. Section 523(a)(1)(B) is meant to deny a discharge where the debtor has committed a "wrongful act;" it should not be construed to prevent a discharge where a debtor is innocently mistaken in reporting his or her income. If the debtor is not innocently mistaken as to the appropriate income, the courts could use section 523(a)(1)(B)(iii) to deny a discharge if the taxpayer has willfully attempted to evade the tax or has committed fraud.
The case is more compelling regarding states requiring amended returns or reports. First, the state receives the information from the IRS and the amended return does not provide any different information. Thus, the state has the relevant information to make an assessment. Many debtors can not afford to pay an accountant to provide them with tax advice. In consequence, they will frequently not comply with the requirement to file the return, not out of a desire to willfully fail to comply with the state law, but because they are unaware of the requirement or the time in which to comply. They also may be misled by the fact that the IRS informs them that it will notify the state. Ironically, the federal tax resulting from the audit will be dischargeable 240 days after the federal assessment while the state tax that "piggybacks" off the federal tax will be nondischargeable. Thus, the state will frequently get a windfall because of its requirement to file an amended return.
Additionally, states that require an amended return will receive more preferential treatment than those states that make it easier for the taxpayer to comply by simply providing a copy of the RAR to the state. Some states may change their state statute to require an amended return. One of the major complaints about the state and federal tax systems is that compliance is often difficult. Thus, the bankruptcy law should not encourage states to adopt more difficult compliance procedures by rewarding the states that require the most returns and punishing the states that make the process easier for the taxpayer.
In light of the above discussed concerns, the Task force recommends that all state taxes that piggyback off of federal audits should be treated uniformly under the Bankruptcy Code regardless of the state reporting requirements. The rule adopted should allow the state ample time to assess the tax, but should essentially place the state tax on an equal basis with the federal tax. The Task Force proposal accomplishes these goals.
Other Institutional Positions
The Association of the Bar of the City of
SANCTIONS OR CONTEMPT AGAINST A GOVERNMENTAL
AUTHORITY FOR VIOLATION OF THE AUTOMATIC STAY
(COMMISSION TRACK NUMBER 219)
Present Law
Section 362(a) of the Bankruptcy Code provides for an automatic stay against certain actions by creditors once a bankruptcy petition is filed. The purpose of the automatic stay is to bring all enforcement and collection activities before the bankruptcy court and make them subject to the processes of the Bankruptcy Code. Section 362(b) contains an enumeration of actions by creditors that will not constitute a violation of the automatic stay. Section 362(d) of the Bankruptcy Code permits a creditor to make a motion in the Bankruptcy Court to lift the automatic stay. After notice and a hearing, the court may grant such a motion if certain conditions are met. Section 362(h) of the Bankruptcy Code provides that "[a]n individual injured by any willful violation of a stay provided by this section shall recover actual damages, including costs and attorneys' fees, and, in appropriate circumstances, may recover punitive damages." In addition, the district court (but not the bankruptcy court) may use its contempt powers to sanction parties who violate the automatic stay. Taxing authorities, like other creditors, are subject to the 362(h) damage awards and the contempt powers of the court in cases of a willful violation.
Proposals Before the Commission
Commission Track Number 219. Commissioner Shepard recommends that the law be amended to "statutorily provide that as a condition of an application for sanctions or contempt against a governmental authority for a violation of the stay that the debtor and/or counsel must have made a meaningful attempt to resolve the problem in a nonlitigious manner before filing such action and that the debtor shall bear the burden of proof of such attempt." See Santa Fe Discussion Issues, p. 18, item IIG1. See also Government Working Group Proposal Number 15, considering a rules change to the same effect. The Advisory Committee has recommended that this proposal be withdrawn as unimportant.
Task Force Position
The Task Force opposes a statutory amendment to deal with this issue. If there is a problem, it should be taken up by the Rules Committee, without a recommendation by the Commission.
Reasons for Position
A party engaging in a willful violation of the automatic stay is subject to the damages provisions of section 362(h) of the Bankruptcy Code as well the general contempt powers of the court. This can apply to a governmental authority, including a taxing authority, as well as to a private party.
In our view, the case that any statutory amendment is required has not been made. In fact, the cases cited by Commissioner Shepard do not suggest that any statutory relief is needed. Price v. Pediatric Academic Assn, Inc., 175 B.R. 219 (S.D. Ohio 1994) did not involve a taxing authority at all and involved a situation in which the court found a willful violation of the automatic stay, for which it imposed sanctions. The court stated by way of dictum that it would not have imposed sanctions if the violation was merely technical and was not willful. In re Jove Engineering, Inc., 171 B.R. 387 (D.C. N.D. Ala. 1994) did involve a situation in which the IRS was handed a small monetary sanction for a technical violation. However, a reading of the opinion indicates that the court did not impose that sanction lightly and did so only after an extensive review of the facts in which it attempted to evaluate the seriousness of the IRS's violation. The Task Force is not aware that bankruptcy judges are lightly imposing sanctions on the IRS or other taxing authorities. There is no empirical evidence that this is a real problem. Based on experience, if there is any problem, it may be the opposite one. Tax laws generally give taxing authorities far-reaching enforcement powers that are not enjoyed by private creditors. Such taxing authorities do not often do a good job of educating their agents that an automatic stay against collection activities arises when a petition is filed. Counsel often has a difficult time communicating with the tax bureaucracy to slow down the collection engine. See the description of counsel's efforts in In re Jove Engineering, supra. Counsel in that case surely made good faith efforts to deal with the IRS.
Amending the statute does not seem like an appropriate cure for any practical problem, if such a practical problem exists. On the contrary, taxing authorities are likely to seize on such statutory amendments, including the gratuitous assignment of the burden of proof, to defend themselves against contempt or section 382(h) applications when there are real grievances that should be redressed.
SUSPENSION OF TIME UNDER SECTION 507(a)(8) OF THE
BANKRUPTCY CODE DURING PERIOD OF PREVIOUS BANKRUPTCY CASES
(COMMISSION TRACK NUMBER 311)
Present Law
The Bankruptcy Code affords priority status to "recent" taxes, i.e., those which arose within certain specified periods of time prior to the commencement of the bankruptcy case (the "Priority Time Period"), most commonly approximately three years.(105) The Code further provides that taxes entitled to priority are not dischargeable.(106)
Taxpayers have attempted to prevent collection during the Priority Time Period and then to discharge the tax debt immediately after the conclusion of the Priority Time Period. Where taxpayers avail themselves of the suspension of collection efforts associated with the filing of an Offer in Compromise, the Bankruptcy Code calls a "time out" on the shortest Priority Time Period: the "240 days after assessment" Priority Time Period is extended by the time that an Offer in Compromise is under consideration, plus 30 days. See our reponse to Commission Track Number 313, infra.
No similar provision exists with respect to prior bankruptcy cases. Thus, taxpayers have filed cases, commonly under Chapter 13 or Chapter 11, availed themselves of the automatic stay to prevent collection efforts during some substantial portion of the Priority Tax Period, then obtained dismissal of the case and re-filed as a Chapter 7 case immediately upon the conclusion of the Priority Tax Period in an attempt to discharge the tax obligation. Under current law this device is generally unsuccessful,(107) but there is no clear statutory "time out" for prior bankruptcy cases.
Proposals Before the Commission
Commission Track Number 311. Several proposals before the Commission would provide for a statutory suspension of the running of the Priority Tax Periods during prior bankruptcy cases. The Department of Justice and the IRS would add six months to this time period. See Santa Fe Discussion Issues, p. 7, Item IIA3; Report of Department of Justice Bankruptcy Working Group, p. 82; IRS Proposal, p. 41, see also unnumbered Government Working Group Proposal.
Task Force Position
The Task Force generally supports these proposals, but would limit the add-on to 30 days.
Reasons for Position
The impetus for the pending proposals is an attempt to prevent taxpayers from manipulating the automatic stay so as to obtain a discharge of a tax debt that would not be available in the first instance.
On balance, we agree with the proposals, although we note that this is not a black and white case. Priority provisions govern the rights of creditors inter sese. The existence of a priority tax ordinarily results in a substantial diminution, if not a complete elimination, of the distribution available to general unsecured creditors. As the law currently exists, the rights of general unsecured creditors are subordinated to the rights of the taxing authorities (by means of the priority provisions) only with respect to recent taxes. It may be argued that there is no reason to further reduce the recovery to general unsecured creditors by extending priority status to old claims on account of the debtor's misconduct. Compare section 523(a)(1)(B), which limits the dischargeability of taxes as to which a timely return was not filed, but does not afford those taxes a priority. Therefore, the proposals may be overbroad, since they would expand the scope of taxes entitled to priority, rather than expanding the scope of taxes which cannot be discharged.
Nevertheless, since the tax claim would take priority over unsecured claims in the first case, it seems the better result to afford the government the same priority in the second case rather then divest the priority as a result of tying the government's hands in the first case.
In the cognate case where a debtor avails himself of the cessation of collection efforts associated with the pendency of an offer in compromise, the statutory time out is limited to the Offer in Compromise period plus 30 days. Bankruptcy Code § 507(a)(8)(A)(ii). Here, the Department of Justice proposes a time out for the term of the prior bankruptcy case plus 6 months. The Task Force can see no reason for this disparity. If the Commission's Proposal is to be adopted, the "extra time" should be limited to 30 days, consistent with the existing rule for offers in compromise.
REMEDIES UPON DEFAULT OR
DISMISSAL OF CONFIRMED PLAN
(COMMISSION TRACK NUMBER 312)
Present Law
Section 1141 of the Bankruptcy Code provides that upon confirmation of a plan of reorganization, pre-bankruptcy debts are discharged and creditors are entitled to receive only what the plan provides. Some plans specify the consequences which arise upon a plan default either with respect to specific class of creditors, e.g., priority tax claims, or with respect to creditors generally. Other plans do not have specific default provisions, or have default provisions which prove inadequate to address the issues which arise.
In addition, section 1112 of the Bankruptcy Code permits conversion(108) or dismissal for, inter alia, inability to effectuate a plan, inability to effectuate substantial consummation of a confirmed plan, or a material default under a confirmed plan. Thus, issues arise with respect to the treatment of claims under a confirmed plan where (a) there has been a default, but neither conversion nor dismissal (a "Plan Default"); (b) the case has been dismissed; or (c) the case has been converted.
In each of these circumstances, there are two key questions: first, may a creditor take individual and unilateral action, or must he avail himself of the collective bankruptcy process. For example, upon a Plan Default, may an individual creditor file suit or, in the case of the IRS, pursue administrative collection procedures, or must that creditor first seek conversion or dismissal of the bankruptcy case? Existing law on this subject is unclear in the case of a Plan Default. By contrast, where the case is dismissed, it is clear that the creditor may act unilaterally "as though the bankruptcy had never occurred,"(109) and in the case of a conversion, the creditor is limited to the collective bankruptcy process, except to the extent that the claim is non-dischargeable.(110)
The second question is: may the creditor assert its pre-confirmation claim, or is it limited to the rights afforded under a plan of reorganization. Thus, for example, if a plan of reorganization proposes payment of 25% over time in full satisfaction of unsecured creditor claims and there is a subsequent material default, may unsecured creditors assert claims at the pre-confirmation amount (100%) or only at the post-confirmation amount (25%). Similarly, if a priority tax claim is treated under a plan of reorganization and there is a subsequent conversion, does that claim remain entitled to priority tax treatment? Following a Plan Default, may it be enforced as a tax claim instead of a contract claim? If any administrative or non-tax priority claim is to be paid over time under a plan and there is a material default before payment has been completed, does the claim preserve its administrative or priority character in a subsequent Chapter 7 case?
Existing law on this question is relatively clear in the case of a dismissal: claims are restored to their nature, extent and priority pre-confirmation. There is far less clarity in the case of a Plan Default or conversion, with some courts relying on a strict construction of section 1141 to limit all creditors to contract rights under the plan while other courts rebel against this type of "the last shall be first" approach, in the absence of policy rationale.
Proposals Before the Commission
Commission Track Number 312. A proposal before the Commission would provide that upon dismissal of or default in the plan, the administrative powers and rights of a governmental unit to collect taxes as they existed prior to the filing of the petition are reinstated, including but not limited to, the assessment of taxes, the filing of a notice of lien, and the powers of levy, seizure and sale.
See Unnumbered Government Working Group Proposal; Santa Fe Discussion Issues, p. 11, Item IIB9; IRS Proposal, p. 42; Justice Proposal, p. 83.
Task Force Position
The Task Force opposes this draft proposal as inadequate and recommends an alternative proposal under which the issues of postconfirmation Plan Default, conversion and dismissal would be resolved with respect to all creditor claims in a fashion consistent with the principles of the Bankruptcy Code. The Task Force recommends the following amendments to the Bankruptcy Code:
Insert as new Section 1141(e):
(e) The rights and remedies of creditors and classes of creditors in the
event of a default under a confirmed Plan of Reorganization shall be as
specified in the Plan of Reorganization. To the extent that those rights and
remedies are not so specified, no creditor may take unilateral action to
enforce its claim except by filing a motion under section 1112.
Insert as new Section 1112(g) and (h):
(h) In the event that the Court shall dismiss a case after confirmation of a
Plan of Reorganization, all claims shall be restored to the nature, extent and
enforceability those claims enjoyed prior to the commencement of the case or
the confirmation of the Plan, as the case may be, and holders of claims may
enforce their rights, including the rights of holders of tax claims to lien,
levy and seize property, without regard to the case.
(g) In the event that the Court shall convert a case after confirmation of a
Plan of Reorganization, all claims subject to treatment under the Plan shall
allowed with the same nature, extent, enforceability and priority as those
claims enjoyed prior to the commencement of the case or the confirmation of the
Plan, as the case may be. Notwithstanding the foregoing, an unpaid claim under
section 503(b) which arose prior to confirmation of the Plan shall be
subordinate in priority to a claim under section 503(b) which arose subsequent
to conversion.
Insert as final sentence to Section 301:
In the event that a voluntary petition shall be filed prior to the
completion of performance under a Plan which has been confirmed under 1129,
1225 or 1325, the provisions of section 1112(g) shall apply to claims treated
under the prior Plan, to the extent that such claims have not previously been
paid.
Reasons for Position
The Task Force concludes that the draft proposal is inadequate for two reasons. First, with respect to tax claims, the draft proposal is undesirable, inasmuch as it purports to prevent plans of reorganization from prescribing the consequences of a default with respect to tax claims; this limitation is not desirable as a matter of practice or policy. Second, the draft proposal is inadequate because it does not provide guidance on the treatment of the comparable issue in a non-tax context. (The Task Force does not oppose the draft proposal with respect to dismissal of the case, but notes that in that limited circumstance the proposal is merely reflective of existing law.)
Under the draft proposal, any default under a plan would permit the taxing authorities immediately to enforce its non-bankruptcy right. As drafted, a non-monetary default or a default in the treatment of the third party would trigger this enforcement mechanism. As drafted, the provision would not require an opportunity to cure or even notice, such that even if the party suffering the default consented to the default the taxing authority would be free to exercise its remedies.
More fundamentally, well-drafted plans of reorganization include default provisions. Creditors, for example, may negotiate for a mechanism through which the business is sold or liquidated in an orderly fashion upon the occurrence of a default. A debtor may engage in a post-confirmation loan work-out under which certain creditors agree to defer or forgive a portion of the plan payments so that the debtor may continue to fund, e.g., required payments to taxing authorities under the plan. All of this is consistent with the primary policy objective of the Bankruptcy Code -- maximization of value for creditors through a collective proceeding. Where a plan contains default provisions which have been confirmed by the court, there is no policy justification for overriding those provisions to permit the taxing authorities to exercise administrative remedies which, ordinarily, will prevent the realization of maximum value from the reorganized debtor's business, and will sacrifice the collective benefit for the taxing authority's forced sale.
There is no reason to alter the rule based on the prospect that some plans will be confirmed which do not include default provisions. A collective proceeding having been begun, it is not an unreasonable burden to require that creditors either demand reasonable default provisions as part of the plan confirmation process or move the Court to convert or dismiss, whichever shall appear to be in their individual best interests, in the event of a future Plan Default.
The draft proposal is inadequate inasmuch as it does not address the treatment of the claims of creditors other than taxing authorities in the event of a Plan Default. The Task Force proposal treats all creditors in a similar fashion, which is also consistent with bankruptcy principles:
1. Plan provisions which have been negotiated or disclosed as part of the disclosure process and approved by the Court govern; otherwise
2. The collective proceeding must collectively be resolved through a motion to convert or dismiss before creditors can take unilateral action; and
3. Ordinarily, the rights of creditors after conversion and dismissal will be the same as the rights prior to confirmation.
It is submitted that the foregoing provisions are consistent with a few basic principles. First, if creditors negotiate plan default provisions, those negotiated provisions should stand. One of the core policies behind Chapter 11 of the Bankruptcy Code was to foster negotiated resolutions.
Second, creditors engaged in a collective proceeding accept burdens and negotiate rights based on the existence of a collective proceeding. Often, after a plan of reorganization has been confirmed, the collective nature of the proceeding continues to dominate the views of the participants. Where a collective proceeding has been commenced and proceeds on the basis of a prohibition against unilateral action, it is inappropriate to permit unilateral action without some variety of notice to potentially affected other parties. By requiring the issue of a collective proceeding to come to rest in the form of conversion or dismissal, creditors enjoy notice and an opportunity to urge either continuation of the collective proceeding (conversion) or an end to the collective proceeding (dismissal).
Finally, the expectation of creditors in the plan of reorganization process is that they are trading promises for performance, e.g., an unfulfillable promise of immediate payment in full in return for payment of 25% over time, which payment a court has independently concluded to be feasible. Section 1129(a)(11). If, in fact, the plan does not prove to be feasible, creditors do not expect that they have traded a 100% claim for a 25% claim solely in order to enjoy an initial unsuccessful "roll of the dice."
It should be noted that applying this rule will result in two chronologically disparate "priority periods": to the extent that a plan permits the payment of priority taxes over time, and to the extent non-tax priority creditors consent to payments over time, they will preserve their priority in a subsequent Chapter 7 case, even though they would not otherwise enjoy that priority due to the date that the claims were originally incurred. This is appropriate, since absent such a priority reasonable administrative and priority creditors would not accept the payment deferrals and would instead insist upon their statutory right to immediate payment in full.
The only proposed exception to the "preservation of priority" approach is with respect to unpaid Chapter 11 administrative claims to be paid under the defaulted plan. While a type of administrative claim status is preserved, it is proposed that "old" Chapter 11 administrative claims be junior to "new" Chapter 11 administrative claims and Chapter 7 administrative claims. This approach is consistent with the general policy of affording first priority to the undertaker so as to assure that subsequent administration and burial will be possible, see, section 726(b).
EFFECT OF OFFERS IN COMPROMISE ON THE 240-DAY PERIOD
OF SECTION 507(a)(8)(A)(ii) OF THE BANKRUPTCY CODE
(COMMISSION TRACK NUMBER 313)
Present Law
Any income tax assessed within 240 days of the debtor's bankruptcy petition is excepted from discharge. Bankruptcy Code § 507(a)(8)(A)(ii). If an offer in compromise is made during the 240-day period, the 240-day period is expanded by thirty days plus the time the offer is pending.
In Chapter 7, this section applies primarily to contested issues that have been recently resolved. For example, assume the I.R.S. chooses a 1992 tax return for audit in 1994. The case is docketed in the Tax Court in 1995 and decided in May 1996. Despite the tax being more than three years old, this section gives the government eight months to collect the new assessment before the tax can be discharged in bankruptcy.
In Chapter 13, this section can trap an unwary debtor. A general requirement of most judges is that all tax returns must be filed before a Chapter 13 plan will be confirmed. With regard to tax years that are more than three years old, if the nonfiler complies by filing tax returns before filing the bankruptcy petition, this section may give the tax priority status. This happens if the tax on the returns is assessed prepetition by the I.R.S. Such a tax would be payable in full in Chapter 13. If the nonfiler complies by filing tax returns post-petition, this section has no application. The tax would be payable only with best efforts.
Several ancillary holdings should be noted. If a bankruptcy filing is made
within the 240-day period, the 240-day period does not run while the automatic
stay is in effect.
When two offers in compromise were made within the 240-day period, one court
held that only the first offer in compromise should be used to expand the
nondischargeability period. Callahan v.
Offers in compromise made prior to assessment do not affect the 240-day
period.
The 240-day period stops running when an offer is accepted for processing. Romagnolo
v.
Proposals Before the Commission
Commission Track Number 313. Commissioner Shepard proposes that (a) the
240-day period be expanded to include preassessment offers; and (b) the
240-day period be expanded by any outstanding offer and not just the first
offer.
The Justice Department proposes that (a) the 240-day period be expanded to one year; and (b) § 507(a)(8)(A) be expanded to include employment and excise taxes in addition to income taxes See our response to Commission Track Number 335. Justice Proposal, p. 92-93.
The Internal Revenue Service proposes that (a) the 240-day period be expanded to include preassessment offers; and (b) the 240-day period by stayed by installment agreements (in addition to offers in compromise). IRS Proposal, p. 43. See also Unnumbered Government Working Group proposal.
Task Force Position
Provided Bankruptcy Code § 523(a)(1)(C) is not given an expansive reading by the courts and Chapter 13 remains available to pay nonpriority/nondischargeable obligations with best efforts, the Task Force proposes that (a) the 240-day period be expanded to one year; and (b) the one-year period be stayed by any pending offer. Such period should not be affected by installment payment agreements.
Reasons for Position
The Task Force agrees with the concept that the I.R.S. ought to have a reasonable amount of time to collect an assessed tax before it becomes dischargeable. Aberl and Callahan highlight fact patterns where the government did not receive the full 240-day period. Amending the statute to provide that any pending offer stays the 240-day period should cure these anomalies.
The Justice Proposal to enlarge the 240-day period to one year must be read in conjunction with other Bankruptcy Code sections. Current case law makes it uncertain whether tax relief can be obtained in Chapter 7. The willful attempt to evade or defeat standard of Bankruptcy Code § 523(a)(1)(C) has been interpreted to mean that any nonpayment of tax results in the underlying obligation being nondischargeable. See, Toti v. United States (In re Toti), 24 F.3d 806 (6th Cir. 1994) (taxpayer had wherewithal to file his return and pay his taxes, but he did not fulfill his obligation; held, tax liability nondischargeable), cert. denied, 115 S.Ct. 482 (1994); Bruner v. United States (In re Bruner), 55 F.3d 195 (5th Cir. 1995) (agreed with analysis in Toti); and see our response to Commission Track Number 602, infra. In Track Commission Track Number 213, the government proposes expanding the denial of the superdischarge in section 1328(a) to all nondischargeable taxes in Chapter 7. If the government is willing to recognize relief for tax debtors under willful intent and allow relief in Chapter 13, then expanding the nondischargeability period to one year seems reasonable.
The Internal Revenue Service recommendation to stay the 240-day period for installment agreements should be rejected unequivocally. Given the frequency with which installment agreements are entered, this rule could make the nondischarge period for a tax unlimited. In turn, this rule would harm compliant taxpayers who are trying to pay off their tax while benefitting those taxpayers who thumb their noses at the government and say no to an installment agreement.
The proposal for expanding section 507(a)(8)(A) to include employment taxes and excise taxes highlights a significant information problem. See our response to this proposal, Commission Track number 335, infra. The rules in section 507(a)(8)(A)(i) and (ii) are time sensitive. For example, without a tax history, it is impossible to know when the I.R.S. accepted an offer in compromise and when it subsequently rejected the same offer. From a practitioner's perspective, it remains very difficult to obtain tax history information (MFTRA or MFTRA-X) from the Internal Revenue Service. It is almost impossible to obtain this information from some state and local taxing authorities. If these provisions are expanded, a corresponding rule should be passed requiring taxing authorities to make tax histories readily available. Without these tax histories, a taxpayer proceeds blindly with no ability to navigate these complex rules.
NONASSESSED TAXES AS PRIORITY/NONDISCHARGEABLE DEBTS
(COMMISSION TRACK NUMBER 314)
Present Law
Unsecured tax claims in Chapter 7 can be divided into three types as follows:
Type 1--priority/nondischargeable
Type 2--nonpriority/nondischargeable
Type 3--nonpriority/dischargeable
From the perspective of a Chapter 7 debtor, Type 1 can be good or bad depending on whether assets exist to pay the tax. More often than not, they are bad because assets are not available to pay the tax. Type 2 is bad because there is no payment priority and the tax is not discharged. Type 3 is good because the taxes are discharged.
Although Chapter 13 has its own separate discharge rules, the Chapter 7 classification scheme has useful application in Chapter 13. This is because priority taxes, i.e., Type 1, are paid in full in Chapter 13 while nonpriority taxes, i.e., Types 2 and 3, can be satisfied with "best efforts" payments. The commission proposals focus on this disparate treatment between Type 1 and Type 2 taxes in Chapter 13.
Section 507(a)(8)(A)(iii) makes any tax that has not been assessed but is still assessable a priority tax. Any tax that can be assessed by the I.R.S. after an audit fits here. Thus, taxes in section 507(a)(8)(A)(iii) can be called "audit risk" taxes. As section 523(a)(1)(A) makes priority taxes nondischargeable, audit risk taxes are priority/nondischargeable or Type 1.
Carved out of the priority treatment created by section 507(a)(8)(A)(iii) are unassessed taxes related to nonfiled returns, returns filed late within two years of the petition date, fraud returns, and taxes where the debtor willfully attempted in any manner to evade or defeat tax. These carved-out taxes are nonpriority/nondischargeable or Type 2. They are the only Type 2 taxes.
Two ancillary holdings should be noted. If a debtor executes a
Form 872-A, open-ended extension of statute of limitations on assessment,
and the Form 872-A is not terminated, any audit risk tax covered by the
Form 872-A will be nondischargeable regardless of age. See, Blake,
Jr. v.
If the audit risk tax at issue is a state tax, one looks to state law to
determine whether the tax is still assessable. See, Vitaliano v.
Proposals Before the Commission
Commission Track Number 314. Commissioner Shepard proposes that (a) all unassessed taxes be treated as priority taxes, i.e., Type 1; and (b) the four carved-out items, i.e., Type 2 taxes, must be paid in full in Chapter 13. See Santa Fe Discussion Issues p.12, item II.C.3.
The Justice Department proposes that the four carved-out items, i.e., Type 2 taxes, must be paid in full in Chapter 13. Justice Proposal, p. 91-92.
The Internal Revenue Service proposes that (a) all unassessed taxes be treated as priority taxes, i.e., Type 1; and (b) the four carved-out items, i.e., Type 2 taxes, must be paid in full in Chapter 13. See IRS Proposal, p. 44.
Task Force Position
Present law should not be changed.
Reasons for Position
The Task Force believes that the availability of Chapter 13 to debtors should not be constricted. Under the Commission Track Number 314 proposals, Type 2 taxes would no longer be dischargeable with a best efforts payment in Chapter 13.(111)
The effect of these proposals on nonfilers (one of the Type 2 taxes) would be particularly devastating. Currently, it is possible for nonfilers in Chapter 13 to file returns post-petition, stay current, pay three years of back taxes, which is not easy, and reenter the system. If the proposals were adopted, it would take little effort on the part of the I.R.S. to eliminate bankruptcy relief for nonfilers.
As a matter of administrative practice, before beginning collection activity, the I.R.S. often files substitutes for returns for a nonfiler's unfiled tax years. See I.R.C. § 6040(b). No notice is given. Once the I.R.S. files a substitute for return that tax year is forever considered a nonfiled year. Bergstrom v. Untied States (In re Bergstrom), 949 F.2d 341 (10th Cir. 1991). Thus, if the proposals were adopted, by creating a substitute for return, the I.R.S. would make the nonfilers's tax obligation forever nonpriority/nondischargeable in Chapter 7 and payable in full in Chapter 13.
Commission Track Number 314 must be read in conjunction with proposals to expand the list of nondischargeable taxes in Chapter 13 to include taxes that are nondischargeable in Chapter 7, see Commission Track Number Track 213, and current case law interpreting the phrase "willful intent to evade or defeat" tax so that any nonpayment of tax results in the underlying obligation being nondischargeable. See, Toti v. United States (In re Toti), 24 F.3d 806 (6th Cir. 1994) (taxpayer had wherewithal to file his return and pay taxes, but he did not fulfill his obligation; held, tax liability nondischargeable), cert. denied, 115 S.Ct. 482 (1994); Bruner v. United States (In re Bruner), 55 F.3d 195 (5th Cir. 1995) (agreed with analysis in Toti); and see our response to Commission Track number 602, infra. In combination, bankruptcy relief for taxpayers would be lost, thereby losing sight of the need to help good people, who otherwise are without remedy, reenter the system.
Constricting the availability of Chapter 13 is particularly myopic. Chapter 13 is the government's most economical method for collecting tax debts. Constricting Chapter 13 may be a revenue negative proposal. Chapter 13, as currently drafted, works well in bringing disenfranchised taxpayers who are currently outside of the system, e.g., nonfilers and tax protesters, back into the system.
Beyond the size of collections, Chapter 13 provides an inexpensive system for the government to collect tax debt. Instead of paying a revenue officer to collect the tax, the Chapter 13 trustee enforces collection. Furthermore, instead of the government paying the revenue officer's salary, the taxpayer pays the trustee a fee.
SPECIAL BANK ACCOUNTS FOR POST-PETITION TAXES AND
OTHER PAYROLL DEDUCTIONS (COMMISSION TRACK NUMBER 315)
Present Law
Under present law, a trustee or debtor in possession is not required to set aside post-petition taxes and non-tax deductions from employee paychecks in a special bank account. Currently, trustees and individuals continue to treat post-petition taxes and deductions from employee paychecks in the same manner as any other business expenses.
Commission Proposal
Commission Track Number 315. The Small Business Working Group proposes to amend sections 704, 1106, 1202 and 1302 of the Bankruptcy Code to require that any small business establish and maintain a separate bank account for post petition taxes and non -tax deductions from employee paychecks. See also Santa Fe Discussion Issues, p. 20, Item 3F; Unnumbered Government Working Group Proposal.
Task Force Position
The Task Force generally agrees with the proposal that small businesses under the jurisdiction of the Bankruptcy Court should be required to set up special bank accounts for postpetition taxes and other deductions from employee paychecks.
Reasons for Position
By definition, debtors within the bankruptcy system are in severe financial trouble. Therefore, there is increased risk that the postpetition taxes and/or other deductions from employee paychecks might not be paid as required by law. Many of our members have observed these postpetition delinquencies by trustees and individual debtors during the bankruptcy process. We, therefore, believe that it would be prudent to require that a small business establish a special bank account to segregate any monies withheld from employee paychecks and for postpetition taxes. This method would clearly identify the monies as being in trust for the purposes for which they were set aside. It would decrease the possibility that trust monies would be used for the general operations of the estate. It would also protect employees from improper use of ERISA monies for company operations.
Section 7512 of the Internal Revenue Code should be amended to provide that in the event of a title 11 case a special bank account in accordance with section 7512(b) should be opened by the debtor and/or trustee. The Department of Treasury and/or Internal Revenue Service would not be required to give notice in accordance with section 7512(a) in the event of a bankruptcy filing, but instead the debtor and/or trustee would be required to set up a special bank account immediately upon filing a petition under the Bankruptcy Code. Internal Revenue Code § 7215 currently contains criminal sanctions for failure to comply with its requirements. The Task Force suggests that any proposal include civil sanctions as an additional alternative to the criminal sanctions contained in Internal Revenue Code § 7215.
UNITED STATES v. ENERGY RESOURCES CO.
(Commission Track Number 321)
Present Law
Under section 1129(a)(9)(C) of the Bankruptcy Code, a plan of reorganization may provide for the payment of certain priority tax claims over a six-year period commencing on the date of assessment of such claim, provided that the payments have a value, as of the effective date of the plan, equal to the allowed amount of such tax claim. Governmental authorities may have more than one tax claim in any given case. It is not clear from the statute whether each tax claim is payable over a six-year period, and if not, how payments made during the six-year period are applied in the case of any single taxing authority, among several tax claims dealt with under the plan.
It is a general principle of commercial law that when a debtor owes two or more debts, he may designate a partial payment as satisfying either.(112) The Internal Revenue Service has generally adopted this view with respect to multiple tax claims. Thus, the Service permits a debtor outside of bankruptcy to apply any payment to the principal amount of a tax claim, or to interest or penalties, as the debtor sees fit.(113) However, the Service and other taxing authorities have taken the position that if a payment is "involuntary," e.g., where the government levies against property to satisfy a tax claim, the government, and not the taxpayer, applies the payment as it sees fit.(114) The most significant consequence of the application of a payment today is that the government will apply partial payments to those tax liabilities that are nondischargeable in bankruptcy or which are not "trust fund taxes" as to which the government may pursue individuals for collection of the taxes if the primary taxpayer does not pay.
Taxing authorities historically took the position that all tax payments made in a chapter 11 plan are involuntary, so that payments under section 1129(a)(9)(C) would be applied to the trust fund portion of any liability only after all other tax debts were satisfied. Prior to the decision by the United States Supreme Court, the lower courts were divided, some holding that payments made pursuant to a chapter 11 plan were involuntary(115) and therefore could not be allocated by the debtor to the trust fund portion of its tax liabilities, while other courts permitted the debtor to make such an allocation.(116) In United States v. Energy Resources Co.,(117) the Supreme Court rejected an analysis based on whether the payments were deemed to be "voluntary" or "involuntary." Instead the Court held that the bankruptcy court may approve an allocation of payments to trust fund liabilities pursuant to a plan if it finds that such an allocation is necessary for the success of the reorganization. Thus, the bankruptcy court is to make a judgment in each case, based upon all of the facts and circumstances of the case.
Proposals Before the Commission
Commission Track Number 321. The Government Working Group proposes that the Bankruptcy Code be amended to overrule the decision in Energy Resources and "allow taxing authorities to allocate payments made in the course of bankruptcy in a manner that preserves alternative sources of collection." Government Working Group Proposal No. 3. See also Justice Proposal, p. 102; IRS Proposal, p. 45; Santa Fe Discussion Issues, p. 19, Item IIIA.
Task Force Position
The Task Force opposes these proposals. The Supreme Court's decision in United States v. Energy Resources Co. should continue to govern, and the Bankruptcy Court's authority to enjoin collection from third parties should be made clear.
Reasons for Position
Although many of the proposals now before the Commission provoke debate giving rise to a spectrum of views within both the government and the private bar, this Commission proposal is one of the few that sharply divides the government and the private sector. Without exception, government spokesmen urge the legislative overruling of the Energy Resources decision. Government representatives believe that under Energy Resources chapter 11 debtors will in bad faith propose plans that will apply partial payments to satisfy trust fund taxes, leaving the government with the risk of default on the non-trust fund portion, which cannot be satisfied until a later date. On the other hand, private practitioners almost unanimously view this proposal as either unwise, mean-spirited or striking at the heart of the chapter 11 process. It will therefore not surprise anyone that this Task Force opposes repeal. The Commission is well aware of the recitation of thc policy reasons in favor of retaining the Energy Resources rule. The Energy Resources decision already represents a balancing of views. It does not favor either the government or the debtor, but instead leaves the determination to the discretion of the bankruptcy court on a case by case basis. To confirm the plan, the bankruptcy judge must make a finding based on evidence that the plan is feasible. The taxing authority may be heard on that issue. If the plan is feasible, then the government will ultimately collect 100 percent of its priority taxes. Allocation of early payments to trust fund taxes may encourage insiders to invest further capital or key employees to continue to work for the debtor. In such case, there seems little reason to visit upon individuals the personal pain and anxiety that a six-year payout will generate, to say nothing of the very real possibility that the taxing authorities will attempt to pursue them for collection of the trust fund portion of the taxes even if there is no reason to believe that they will not ultimately be paid by the debtor. The price seems too high to pay in human terms.
It should be noted that the Congress has squarely faced this issue twice before. In 1988, legislation was introduced in the House but failed to pass. On November 3, 1989, the Senate passed the Federal Debt Collection Practices Act. Section 201 of the bill would have permitted a governmental unit to apply tax payments "in a manner that preserves alternative sources of collection, if any." There were no Senate hearings and no opportunity for public comment. There is no evidence that the Senate in enacting this provision had any idea of what it was voting on. "Because the Senate had acted on the legislation without formal hearings, the House Judiciary Committee decided to pursue the important issues raised by the proposal with a hearing in which a broad range of witnesses would testify on issues involving enforcement activity, the state of debtor/creditor laws with respect to both impediment to government collection and protection to the debtor and other non-governmental creditors, and the implications of a new Federal debt collection law for bankruptcy law and tax law."(118)
The House Committee on the Judiciary held hearings, and for the first time, these hearings elicited testimony in response to section 201. The majority and minority staff of the Judiciary Committee actively followed the argument, and members questioned witnesses during the hearing. The result was that the Energy Resources repealer was removed from the House version of the bill. More important, it was not adopted in the final version of the Act. Faced clearly with the arguments on both sides of this issue, the Congress affirmatively chose not to adopt repeal. The same agencies that sought adoption of this unwise provision in 1988 and 1990 are back in the hope of enlisting the support of the Commission.
The position of the taxing authorities before the Commission is not without irony. These authorities admit that on the day before bankruptcy the responsible officers having personal liability can write a corporate check to the taxing authority in satisfaction of the trust fund liabilities and the trustee cannot recover such a payment as a preference.(119) In fact, state taxing authorities openly encourage retail debtors to remit to them all sales tax collections up to the date of a bankruptcy filing notwithstanding that tax returns are not yet due, for the express purpose of relieving the responsible officers of personal liability and the expense and agony of resisting collection. Many retail debtors, being well advised, in fact make these payments prior to filing and spare themselves and their responsible officers this litigation. Others, unaware, create unwanted pain for their officers. Yet, these very same taxing authorities would not permit the debtor to make these payments at the front end of a plan of reorganization if the Congress adopts the government's proposals. The practical result will be that these officers will be made personally liable for taxes for which no statute provides personal responsibility. As a result, they would now be held hostage for trust fund taxes until every other penny of tax liability will be paid. These proposals contravene the goals of the Bankruptcy Code and should be rejected.
Consideration of the issues raised by Energy Resources necessarily involves the jurisdiction of the Bankruptcy Court to enjoin collection of trust fund taxes from responsible officers while deferred payments are made by the debtor under section 1129(a)(9)(C). For this purpose, we temporarily put aside the general question of bankruptcy court jurisdiction to determine the liability of non-debtors.(120) The Task Force hopes to have a proposal on this question for the Commission in the near future, but we have found it to be a "more than meets the eye" problem. Our narrow focus here is on balancing the preservation of the government's alternative sources of collection against the responsible officer's legitimate expectation that the debtor will satisfy the obligation.
When employment taxes required to be withheld are not collected and paid over, Internal Revenue Code § 6672 imposes a "100% penalty" on individuals responsible for remitting these taxes to the Treasury. Similar rules apply to federal, state and local sales and excise taxes. These amounts are not property of the estate and should be collectible by the taxing authority under applicable tracing principles. Otherwise, they are collectible in accordance with priority and deferred payment rules.
Outside of chapter 11, failure by the employer to pay gives the taxing authority immediate collection remedies against individuals determined to be responsible, and this is proper. But although a literal reading of Internal Revenue Code § 6672 might impose liability on the responsible person in addition to the employer, or upon more than one individual for the same amount, the IRS concedes that Internal Revenue Code § 6672 is merely a device to collect a tax once. Payment by the employer will relieve the responsible officer of liability.
If the Service is permitted to pursue the individuals during the time the debtor avails itself of the privilege of deferring payments under section 1129, an injustice will result. The individual's payment will, as a practical matter, relieve the debtor of the obligation it undertook in the plan of reorganization. It is not an answer that the responsible officer can then pursue the debtor. Assuming, although it is not clear, that the responsible officer is subrogated to the taxing authority's claim, he does not appear to be subrogated to the taxing authority's priority.(121) The other unsecured creditors will have received a windfall.
Accordingly, the Bankruptcy Code and the Internal Revenue Code should be amended to provide that in chapter 11 there should be an automatic stay upon filing a petition and a permanent injunction upon confirmation of a plan, against collection of trust fund taxes from a debtor's employees. The taxing authority should be entitled to a lifting of the stay or the injunction upon a showing that collection of the tax from the debtor is in jeopardy. Neither the stay nor the injunction would preclude filing a lien against the responsible officers once their liability has been determined. In this way, the taxing authority's interests would be protected.
Other Institutional Positions
The Association of the Bar of the City of
BANKRUPTCY COURT JURISDICTION IN TAX MATTERS, INCLUDING DECLARATORY
JUDGMENTS (COMMISSION TRACK NUMBERS 329 AND 433)
Present Law
Section 505 of the Bankruptcy Code provides, subject to enumerated exceptions, that the Bankruptcy Court may determine the "amount or legality of any tax . . . whether or not previously assessed, whether or not paid. . . ." In appropriate and rare cases, the Bankruptcy Courts have exercised their jurisdiction to grant declaratory judgments on tax matters, particularly where the success of the plan of reorganization depends upon the outcome of that tax dispute.
Proposals Before the Commission
Commission Track Number 329; Commission Track Number 433. Commissioner Shepard would amend Bankruptcy Code § 505 to significantly limit its scope by (i) requiring all administrative remedies be fully exhausted and "normal" channels of judicial review fully exploited before the Bankruptcy Court could entertain a request for a tax determination or other appropriate relief; (ii) deny adjudication of a tax dispute unless the debtor, and not a creditor other than the taxing authority, is the true party in interest in the outcome of the dispute and (iii) deny a debtor taxpayer or trustee who has not paid her tax the right to contest the tax where the time to file a Tax Court petition has lapsed prior to the commencement of the bankruptcy case. See Santa Fe Discussion Issues, p. 23, Item IVC1; Id., Item IIC2; See also Unnumbered Government Working Group Proposal.
Task Force Position
Bankruptcy Code § 505 jurisdiction should be expanded, not limited. We join the National Bankruptcy Conference in urging Bankruptcy Code § 1146(d) be modified to clarify that the Bankruptcy Court is authorized to declare the federal tax effects of a plan of reorganization.(122)
Reasons for Position
These innocuously worded proposals fail to take into account significant
real world concerns of debtor taxpayers and their creditors. Frequently, the
efficacy of a Plan of Reorganization depends upon its tax consequences; a
debtor's successful rehabilitation turns on her ability to determine and
satisfy her tax obligations; and a creditor's vote to confirm a plan depends
upon how a tax issue will be resolved. To require the bankruptcy judge to stay
all proceedings until all tax bureaucracies have determined their view of the
debtor's tax status, using their rules and procedures in making those
determinations, and then further delaying the bankruptcy case proceedings until
the appropriate State or Federal courts have confirmed or rejected the
administrative determinations would unnecessarily delay and defuse the
rehabilitation process.(123)
Congress refined the statute for the express purpose of providing a forum for
the rapid determination of claims so that disputed tax claims would not delay
the conclusion of the administration of a bankruptcy estate.
In re Millsaps, 133 B.R. 547, 554 (Bkrptcy. M.D. Fla. 1991) citing
124 Cong. Rec. H 11095 (1978).
Frequently, the United States Justice Department, representing the Internal Revenue Service in Bankruptcy Court proceedings, will resist a debtor's motion to fix a tax liability under Bankruptcy Code § 505, arguing the "absence of a case or controversy." The Department of Justice attorneys have been heard to argue that "the IRS may never raise the issue presented by the debtor and thus any determination at this time is conjectural and unnecessary." That assertion may well be true, but if the success of the plan depends upon a favorable resolution of the tax issue, the uncertainty cannot be removed by the chance no one will question the result or if it is questioned, a taxpayer favorable result will be achieved.
In other cases, the Justice Department has been heard to argue the debtor has not sought the determination of the IRS. Leaving aside the extended delays taxpayers routinely encounter in the IRS ruling process, the IRS frequently declines to provide definitive advice because of a "no ruling policy" or other administrative reason.(124) These are not theoretical concerns. In one case, the Plan of Reorganization called for a distribution of the debtor's subsidiary to the debtor's stockholders. If that distribution failed to qualify as a tax-free spin-off, the distribution would have triggered a $100 million taxable gain to the debtor. The success or failure of the Plan of Reorganization turned on the taxability of that distribution. What if the IRS refused to rule? Under the proposal to amend Bankruptcy Code § 505, no court would have jurisdiction to determine the efficacy of the plan of reorganization, and without assurance of the tax ramifications of the plan, the plan could not proceed. Absent a ruling from the IRS, all too frequently the tax consequences of a transaction cannot be determined with acceptable certainty. Until a tax return is prepared and filed, the IRS will make no claim to tax. Until the IRS issues a Notice of Deficiency, no court has jurisdiction to adjudicate an IRS tax assertion and unless the tax is fully paid, no refund suit will lie in the U.S. Claims Court or U.S. District Court.(125)
Where participants in the Bankruptcy Court proceedings are concerned with issues such as personal liability as a responsible officer under Internal Revenue Code § 6672 or have a need to know whether the debtor's NOLs survive the Chapter 11 confirmation or have a need to know the tax bases of the debtor's properties, even though the administrative remedies afforded nonbankrupt taxpayers have not been exhausted and even though jurisdiction would not lie in other courts, the Bankruptcy Court properly invokes its jurisdiction under Bankruptcy Code § 505 to make these necessary determinations.(126) In Holywell Corp. v. Smith,(127) the Supreme Court, in reversing the decision of the Bankruptcy Court, took no exception to the Bankruptcy Court's rendering a declaratory judgment that the liquidating trustee, appointed pursuant to a plan of reorganization, had no duty to file an income tax return or pay income tax under the federal income tax laws.
To date, Bankruptcy Code § 505 determinations have not overwhelmed the
resources of the Bankruptcy Courts. The judges have selected the issues that
had to be decided. See, e.g., In re Mahoney, 80 B.R. 197
(Bankr. S.D.
The proposal seeks to overrule In re Piper Aircraft Corp., 171 B.R. 415 (Bankr. S.D. Fla. 1994)(128) holding a bankruptcy court has authority to determine the amount of a debtor's tax, notwithstanding the debtor's failure to comply with state law administrative procedures. We believe the need to reach closure on all open tax issues in one forum overrides the claims and legitimate concerns of the various taxing jurisdictions that their administrative procedures must govern all claims and proceedings. As noted by Chief Judge Queenan in Ledgemere.
Section 505, however, bars the court only from resolving tax issues
"contested before and adjudicated by a judicial or administrative tribunal
of competent jurisdiction." These taxes were never "contested" .
. . [or] "adjudicated" through the act of assessment. 135 B.R. at
195.(129)
While we recognize some local taxing authorities may be inconvenienced by the operation of Bankruptcy Code § 505, we fail to see a compelling need to narrow its scope. The Bankruptcy Courts have in the past -- and can be expected in the future -- exercised appropriate discretion in determining which tax issues need be resolved to provide an orderly completion of the pending case.
Other Institutional Positions
The Association of the Bar of the City of
DISCHARGEABILITY OF PENALTIES RELATED
TO NONDISCHARGEABLE TAXES
(COMMISSION TRACK NUMBER 331)
Present Law
Section 523(a)(7)(A) ("Subparagraph "A") of the Bankruptcy Code is generally viewed as a codification of the pre-Code position of the government regarding the dischargeability of penalties, i.e. that all non-compensatory (i.e. punitive) penalties are dischargeable only if the related tax is dischargeable.(130) However, Congress went further and made an additional category of tax penalties dischargeable under section 523(a)(7)(B) ("Subparagraph (B)"). Subparagraph (B) provides for a discharge of a tax penalty "imposed with respect to a transaction or event that occurred before three years before the date of the filing of the petition."
Courts addressing the interpretation of the interaction of the two subparagraphs have held that Subparagraph (B) as enacted is unambiguous as a matter of statutory construction and can discharge certain penalties even if the underlying tax is not discharged, thus overriding the general approach of Subparagraph (A).(131)
The analysis continues by addressing what is the "transaction or event" which begins the running of the three year period of Subparagraph (B). Courts have variously held that the "transaction or event" is the due date or the filing date of the return. Such "events" can easily pre-date a bankruptcy petition filing by more than three years, making penalties related to such tax years dischargeable.(132)
This is of particular interest where there is a long-standing dispute with the IRS ending in an assessment of tax which is non-dischargeable but which relates to a year in which the due date or filing date precede the petition filing date by three years.
Proposals Before the Commission
Commission Track Number 331. Under a draft proposal before the Government Working Group, Bankruptcy Code § 523(a)(7) would be amended to provide that a penalty computed with reference to a tax liability is discharged only when the underlying tax is also discharged. The draft cites one particular situation as the source of its concern. In a case of civil fraud, although the underlying tax is not dischargeable, the civil fraud penalty would be discharged if the event giving rise to the penalty is more than three years old. Unnumbered Government Working Group Proposal.
The Department of Justice proposes that section 523(a)(7)(B) be clarified to provide that it is not triggered by the filing of a return and that any penalty that is calculated in reference to a tax liability cannot be discharged unless the underlying tax is discharged.
The Department of Justice cites that as a result of several courts' interpretation of section 523(a)(7)(B), filing penalties including fraud penalties may be discharged even before the liability for tax is determined.(133)
Justice Proposal, p. 94.
IRS proposes that a penalty computed with reference to a tax liability is discharged only when the underlying tax is also discharged and proposes amending Subparagraph (B) to limit its application to penalties which are computed without reference to a tax (e.g. preparer penalties). IRS Proposal, p. 49.
Task Force Position
The Task Force supports the proposal as to fraud and failure to file penalties, but otherwise opposes it.
Reasons for Position
The Task Force believes that the current language of section 523(a)(7)(B) is not merely a Congressional drafting error. Under the present structure, the government has three years from the due date or filing date of the return to the petition filing date to assess and collect a penalty before the penalty becomes dischargeable. Generally, allowing the government three years to assess and collect a penalty (other than fraud and failure to file as discussed infra) related to a specific tax year before it becomes dischargeable is an adequate amount of time to prevent prejudice to the government in a bankruptcy context.
It is important to remember that the government is a well-protected creditor with respect to the underlying tax and prepetition interest, both of which are typically priority claims and non-dischargeable. The real issue is whether a bankrupt individual should have continuing personal liability for a penalty on top of the underlying tax and interest. The Task Force believes that, generally, personal liability for tax and interest is sufficient to make the government whole and balance its interests against the fresh-start principles of bankruptcy.
However, the Task Force acknowledges the problems of fraud and failure to file penalties, both of which are cases in which a debtor's actions have frustrated the abilities of the government to reasonably pursue assessment and collection efforts and in which there is demonstrable wrongdoing by the debtor.(134) In these cases, a policy of post-discharge personal liability for such penalties is warranted. Therefore, the Task Force would agree with the draft proposal solely as it relates to fraud and failure to file. Fraud and failure to file penalties would be dischargeable only when the underlying tax is dischargeable. In cases of fraud, no such discharge of tax would ever occur due to section 523(a)(1)(C), which exempts fraud from discharge. In the case of a taxpayer who never files a return (as opposed to late filing), no discharge of tax would ever occur due to section 523(a)(1)(B)(i).
The Task Force wishes to express some concern, however, about the prospect that this may create an incentive to more aggressively pursue allegations of fraud when there is already a view among some debtor's counsel that the government has expanded the willful attempt to avoid or evade and fraud positions to a level which has become unreasonable.
Perhaps a constructive approach to the area in general should be undertaken which will result in a reasonable and balanced approach to both the issues of dischargeability and fraud and "willful attempt to evade" cases. See our response to Commission Track Number 602. The Task Force believes that a more detailed analysis and discussion is required in order to evaluate all of the effects of the proposed amendment on the whole penalty structure and its treatment under the Bankruptcy Code. The Task Force's main concern is to facilitate a position which would be equitable to the government's revenue collection efforts, and yet be reasonable in light of bankruptcy policy.
LIEN CAPPING IN CHAPTER 13
(COMMISSION TRACK NUMBER 333)
Present Law
Chapter 7 provides an in personam discharge. Thus, the discharge
in Chapter 7 has no effect on secured claims. As a result, postpetition
appreciation (or depreciation) accrues to the benefit of the creditor. In
contrast, Chapter 13 contains a "lien capping" provision. A
debtor can value the property securing the lien, pay off the value of the
secured claim under the Chapter 13 plan, and retain the property free and clear
of the lien. Nobelman v. Am. Sav. Bank, 508
In Chapter 13, what happens if (a) the secured tax claim is paid
off, (b) the debtor retains the asset, (c) the plan is not completed
and the case dismissed, and (d) unsecured tax debt remains unpaid? Does
the tax lien remain attached to the asset? Case law splits. Cf. In re
While retaining the same split in result, some cases focus on
sections 349(b)(1)(C) and 506(d). Under section 506(d), to the extent
a lien is not secured by property, it is void. Under section 349(b)(1)(C),
any lien voided under section 506(d) is reinstated if a case is dismissed.
When the secured portion of a bifurcated lien is paid in full in
Chapter 13, has the secured creditor's lien been satisfied or avoided? If
satisfied, then the government's lien is not reinstated. In re Cooke,
169 B.R. 662 (Bankr. W.D. Mo. 1994). If avoided, then the government's
lien is reinstated. In re Scheierl, 176 B.R. 498 (Bankr. D.
The same issue arises if a case is converted to Chapter 7 instead of dismissed. Again, case law splits. Compare, In re Stoddard, 167 B.R. 98 (Bankr. S.D. Ohio 1994) (if allowed secured claim paid in full in Chapter 13 before conversion, no additional payment required to redeem vehicle from creditor after conversion) with In re Jordan, 164 B.R. 89 (Bankr. E.D. Mo. 1994) (debtors not entitled to release of lien even though secured portion of claim paid in full in Chapter 13).
Proposals Before the Commission
Commission Track Number 333. The Justice Department proposes that the government's tax lien should not be released unless and until a Chapter 13 plan is completed. See Justice Proposal, p. 96-7.
The Internal Revenue Service proposes that the government's tax lien should not be released unless and until a Chapter 13 plan is completed. IRS Proposal, p. 53. See also Unnumbered Government Working Group Proposal.
Task Force Position
The Task Force proposes that if a Chapter 13 case is dismissed after full payment of the government's secured claim, the government retains its right to attach its tax lien to any property acquired postpetition or any property owned prepetition that was not included in valuing the government's secured claim.
Reasons for Position
The government should not receive a windfall. The government's lien should not reattach to property against which the debtor has previously paid off a tax lien. Thus, postpetition appreciation (or depreciation) would accrue to the debtor.
The government's windfall is particularly troubling in cases involving "small" debtors. Under current case law, a debtor cannot avoid the federal government's lien in household goods. See, Commission Track Number 334. Under the government's proposals, a debtor might be required to buy off a lien in household goods and clothing once in a bankruptcy and a second time in an offer in compromise (at least to the extent those goods exceed $2,500 in value).
AVOIDING TAX LIENS
(COMMISSION TRACK NUMBER 334)
Present Law
The federal tax lien arises automatically if, after demand, a person
"neglects or refuses to pay the tax." I.R.C. § 6321. For a lien
to arise, the tax must be assessed; the I.R.S. must make notice and demand on
the taxpayer; and the taxpayer must fail to pay. I.R.C. §§ 6321 and 6322.
The lien is deemed to arise on the assessment date. I.R.C. § 6322. The
federal tax lien attaches to all the taxpayer's property.
The automatic lien places the government in front of a taxpayer's general unsecured creditors. For the lien to be valid against any "purchaser, holder of a security interest, mechanic's lienor, or judgment lien creditor," a notice of the lien must be filed. I.R.C. § 6323(a). To create this additional power, the notice must be filed in the proper location and properly identify the taxpayer.
Even after the notice of tax lien is filed, some transactions can be undertaken without regard to the lien. See, I.R.C. § 6323(b)-(d). For example, a purchaser without knowledge of the lien can acquire stocks, securities, motor vehicles, inventory, certain goods purchased at retail, and certain household goods valued at less than $250 per item free and clear of the tax lien. A purchaser is one who takes for adequate and full consideration in money or money's worth. I.R.C. § 6323(h)(6). Securities include money. I.R.C. § 6323(h)(4). In general, this provision allows for the smooth flow of personal property in commerce without regard to federal tax liens.
The Bankruptcy Code grants some rights and powers to a bankruptcy trustee, including those of a judgment lien creditor and a bona fide purchaser of real property. Bankruptcy Code § 544. In addition, as to statutory liens, the trustee is deemed to be a bona fide purchaser of property, both personal and real. Bankruptcy Code § 545(2). These powers enable the trustee to claim property for the bankruptcy estate. For example, it is the trustee's power as a judgment lien creditor that enables the trustee to claim an interest superior to the government's in the taxpayer's property where a notice of lien has not been filed. See, I.R.C. § 6323(a).
In summary, the Tax Code allows persons who purchase certain personal property for adequate and full consideration in money or money's worth to take that property free and clear of a properly noticed federal tax lien. In avoiding statutory liens, the Bankruptcy Code grants a bankruptcy trustee the power of a bona fide purchaser. Bankruptcy Code § 545(a)(2).
Is the Bankruptcy Code's bona fide purchaser identical to the Tax Code's person who takes for adequate and full consideration in money or money's worth? If so, the bankruptcy trustee can avoid tax liens based on I.R.C. § 6323(b). Case law says the two are not identical, and therefore, a trustee cannot avoid tax liens under § 6323(b). United States v. Hunter (In re Walter), 45 F.3d 1023 (6th Cir. 1995) (bona fide purchaser takes for value without notice of defects; value is lower standard than adequate and full consideration in money or money's worth; because bona fide purchaser is not necessarily a purchaser under § 6323, trustee cannot take advantage of § 6323); and United States v. Battley (In re Berg), 188 B.R. 615 (9th Cir. B.A.P. 1995) (same).
Commission Track Number 334 revisits a controversial issue from 1978.
In the Senate version of the proposed Code, a subsection (b) was included
in § 545, which limited the trustee's power to avoid tax liens. See,
S. Rep. No. 95-989, 95th Cong., 2d Sess. 85-86 (1978),
An ancillary holding should be noted. To fully take advantage of
§ 6323(b), in some instances, the purchaser must be in possession of the
property, e.g., a motor vehicle. After a bankruptcy is filed, is a
bankruptcy trustee in possession of the property for purposes of
§ 6323(b)? Case law indicates not.
Proposals Before the Commission
Commission Track Number 334. Commissioner Shepard proposes that section 545(2) be amended to prevent the trustee from avoiding federal tax liens, thereby codifying the result in Walter. Santa Fe Discussion Issues, p.18, item II.F.9.
The Justice Department proposes that section 545(2) be amended to prevent the trustee from avoiding federal tax liens, thereby codifying the result in Walter. Justice Proposal, p. 97-8.
See also Unnumbered Government Working Group Proposal.
Task Force Position
The Task Force does not object to codifying Walter. However, is codification necessary? The Task Force proposes that some exemptions to the federal tax lien be available for bankruptcy debtors.
Reasons for Position
Analyzing the consequences of revitalizing the trustee's powers under section 545(2) is difficult. Although revitalizing section 545(2) would be good for unsecured creditors and bad for the federal fisc, the overall revenue impact would probably be small. This assumes that (i) most federal tax claims are granted priority or are nondischargeable and (ii) the funds recovered by the trustee under section 545(2) would not be consumed by administrative expenses and nontax priority claims.
Note, similar to Commission Track Number 100 (repeal of section 724(b)), the party adverse to the government in Commission Track Number 334 is the bankruptcy trustee. With this caveat, the Task Force does not object to the proposals in Commission Track Number 334. However, given Walter is the prevailing position, is codification necessary?
If Walter remains the law, a small exemption against the tax lien, similar to the exemptions against levy, I.R.C. § 6334, for the household items in I.R.C. § 6323(b)(4) should be granted. Many debtors in Chapter 13 walk a precarious line between success and failure. Forcing a debtor to buy off the I.R.S.'s tax lien in clothing, furniture, and other basic household goods seems draconian. Similarly, a Special Procedures Officer would no longer be in the uncomfortable position of talking to a Chapter 7 debtor postdischarge about buying off the I.R.S.'s lien in de minimis personal property.
Issues tangential to Commission Track Number 334, but not raised in the Commission's matrix, include the following:
1. Should United States v. McDermott, 507 U.S. 447 (1993), be overruled so that the federal tax lien does not give the government first position in all after-acquired property?
2. Should a provision be added to the Bankruptcy Code so that, if a trustee abandons property with a secret federal tax lien attached(135) after an unpaid tax debt is discharged, the I.R.S. cannot execute on the secret lien after the automatic stay is dissolved?
3. Should Bankruptcy Code § 522(h) be amended to make clear that it applies to all parties including the government?
PRIORITY FOR EXCISE AND EMPLOYMENT TAXES
(COMMISSION TRACK NUMBER 335)
Present Law
The priority provisions found in section 507(a)(8)(A)(i) (for income and gross receipts taxes), section 507(a)(8)(D) (for certain employment taxes), and section 507(a)(8)(E) (for certain excise taxes) all allow a federal, state or local governmental unit's tax claim a priority so long as the tax return with respect to those taxes was due no more than three years before the date of the filing of the bankruptcy petition (the "3-Year Rule"). With respect to income or gross receipts taxes, section 507(a)(8)(A)(ii) and (iii) can give priority to some governmental income and gross receipts tax claims that fail the 3-Year Rule.
Section 507(a)(8)(A) (Certain Income and Gross Receipts Taxes). Section 507(a)(8)(A)(ii), for example, only requires that the income or gross receipts tax be validly assessed within 240 days of the filing of the bankruptcy petition ("240-Day Rule"). Since the statute of limitations on assessing these taxes is often tolled or suspended, many valid assessments are made with respect to tax years that are 4, 5, 6 or even more years in the past. Similarly, under section 507(a)(8)(A)(iii), any income or gross receipts tax that remains assessable as of the bankruptcy filing date can get a priority, again irrespective of the tax year to which the assessment relates (the "Still Assessable Rule"). According to the Senate Report to the 1978 Bankruptcy Code, both the 240-Day Rule and the Still Assessable Rule were designed to plug "loopholes."(136) For example, a taxpayer might delay an assessment until the 3-Year Rule was exhausted by negotiating with the IRS concerning a tax audit or by commencing litigation in Tax Court.
Section 507(a)(8)(D) (Certain Employment Taxes). The Employment Taxes that are subject to section 507(a)(8)(D) include (but are not limited to) the employer's share of FICA(137), FUTA and Railroad Retirement Act taxes which -
(1) are "of a kind specified in" section 507(a)(3);
(2) are earned from the debtor before the date of the filing of the petition;
(3) which may or may not have actually been paid by the date of filing the
bankruptcy petition; and
(4) satisfy the 3-Year Rule.
The reference in section 507(a)(8)(D) to section 507(a)(3) deals with unpaid wages of less than $4,000 that were earned within the 90-day period prior to the filing of a bankruptcy. Apparently, however, section 507(a)(8)(D) is not so limited. First, the 3-Year Rule obviously reaches back longer than 90 days from the date of filing. Second, section 507(a)(8)(D) appears only to apply to employment taxes with respect to wages which were paid before the filing of the bankruptcy petition.(138) This is so because most, if not all, federal and state employment taxes only arise when wages are "paid."(139) (The reference to "whether or not actually paid before such date" found in section 507(a)(8)(D) obviously causes some confusion on these two points. See recommendation below.)
Section 507(a)(8)(E) (Certain Excise Taxes). The exact scope of subparagraph (E) is far from certain because the Bankruptcy Code has no definition of "excise tax." This definitional deficiency has led to numerous cases, including one last year before the United States Supreme Court.(140) It is hard, therefore, to be sure as to exactly what types of governmental claims are covered by this provision.(141)
Subparagraph (E) contains the 3-Year Rule and also has a separate limitation with respect to excise taxes for which no tax return is required. In this latter case, the limitation is three years from the date of the transaction which gave rise to the excise tax (the "Special Excise Tax Rule").
Section 523(a)(1)(A) (Nondischargeability). For an individual bankrupt, a consequence of having an employment or excise tax receive a priority under section 507(a)(8) is that the individual is not discharged from these tax claims because of section 523(a)(1)(A). Therefore, any expansion of the governmental claims that get priority under section 507(a)(8) increases the chances that an individual Chapter 7 debtor will not emerge from his or her bankruptcy "clean."(142)
Proposals Before the Commission
Commission Track Number 335. Commissioner Shepard proposes that the priority
treatment for excise and employment taxes be the same as the treatment of
income taxes found in section 507(a)(8)(A)(i)-(iii).
Internal Revenue Service. The IRS also recommends adding the 240-Day Rule and Still Assessable Rule to the employment tax and excise tax provisions of section 507(a)(8)(D) and (E). IRS Proposal, p. 55. Again, presumably the IRS proposal includes its suggested changes to section 507(a)(8)(A)(ii) and (iii) as well as to section 523. The rationale given by the IRS is that the purpose of the rules found in section 507(a)(8)(A)(ii) and (iii) is, essentially, to give the IRS more than three years from the due date for filing income tax returns in order to give the IRS time to solicit delinquent returns, complete audits of those returns, afford taxpayers administrative appeal rights and to give due consideration to offers and compromise. The IRS suggests that the same need for extra time exists with respect to employment and excise tax returns. See also Unnumbered Government Working Group Proposal.
Task Force Position
The Task Force opposes Commissioner Shepard's and the Internal Revenue Service's proposals to extend the 240-Day Rule and Still Assessable Rule to employment and excise taxes.
The Task Force suggests that section 507(a)(8)(D) be amended to delete the phrase "whether or not actually paid before such date" to avoid any confusion as to the applicability of that subparagraph.
Reasons for Position
None of the "loophole" problems (identified in the Bankruptcy Code's legislative history) that prompted adoption of the 240-Day Rule and the Still Assessable Rule apply to employment taxes or excise taxes. The IRS even notes in its letter that:
"The Internal Revenue Code's deficiency procedures, allowing the
taxpayer an opportunity to contest the Service's tax audit determinations for
income taxes in the U.S. Tax Court, do not literally apply to employment taxes
or to excise taxes."
Absent such a showing, there is not sufficient justification to expand the claims of governmental units at the possible expense of general unsecured creditors and individual bankrupts.
Further, at least in the employment tax arena, it seems that the IRS has ample tools to easily identify unpaid employment taxes during the three-year period prior to any bankruptcy filing. Since section 507(a)(8)(D) apparently only applies if the wages giving rise to the employment tax have been paid, the employers' W-2's and employees' Form 1040's offer ample audit opportunities. To the extent that "unemployment taxes" include state and local taxes, the rationale supporting this proposal appears to be irrelevant.
Further, it is not clear how the addition of the 240-Day Rule and the Still Assessable Rule would work with the Special Excise Tax Rule of section 507(a)(8)(E)(ii) which applies to excise taxes with respect to which no return is required to be filed. Finally, there is uncertainty as to the scope of the meaning of the term "excise tax" both at the federal and state and local levels. (In some instances, excise taxes can be assessed where the governmental unit has suffered no pecuniary loss.(144) The statutory policy against granting a priority for such non-pecuniary losses is shown in section 507(a)(8)(G).) With such uncertainty, it seems unwise to extend the reach of section 507(a)(8)(E).
TAX JURISDICTION IN NO ASSET CASES
(COMMISSION TRACK NUMBER 339)
Present Law
Section 505 of the Bankruptcy Code provides, subject to enumerated exceptions, that the Bankruptcy Court may determine the "amount or legality of any tax . . . whether or not previously assessed. . . ." Where there are no assets to administer in a Chapter 7 case (and thus no creditors would be adversely affected by a failure to determine the presence of any tax due), courts frequently have exercised their discretion to not decide the tax dispute posed by the debtor. When the courts determine to abstain from determining the amount or legality of a tax and the tax is not discharged in the bankruptcy proceeding, the taxpayer-debtor frequently encounters difficulty in securing a "fresh start." The IRS proceedings involving offers-in-compromise are typically difficult and expensive. The collateral agreements the IRS exacts are frequently prohibitively expensive, if not totally confiscatory. And the taxpayer-debtor is frequently without funds to engage the professional help she requires to process an administrative request for resolution.
Proposals Before the Commission
Commission Track Number 339. Commissioner Shepard proposes to require the
Bankruptcy Court to abstain from determining dischargeability of any tax claim
where there are no assets to administer or where the debtor's request for a
determination of the amount of a tax liability is not accompanied by a
demonstration the debtor has an interest in the property of the estate. See
Task Force Position
While there is substantial merit in many cases for the Bankruptcy Court to abstain from ruling on presented tax issues in "no asset" cases, current law, which grants the Bankruptcy Court discretion to abstain from deciding precedent tax issues, seems to work well and is flexible enough to provide relief for deserving debtors and to avoid clogging the Bankruptcy Court or presenting untoward inconvenience to the taxing authorities. For a debtor to gain a "fresh start," he is entitled to have a determination he does not owe the asserted tax.(145)
Reasons for Position
When a determination of the amount of nondischargeable tax liabilities could affect the rights of creditors or advance the administration of the bankruptcy case, the Bankruptcy Courts generally exercise their discretion to fix the debtor's tax obligation.(146) But, where creditors' rights are not affected, the Bankruptcy Courts have balanced the desirability of providing the debtor with a "fresh start" with all obligations -- including tax obligations -- fixed and provided for with the desirability of moving the court's docket, the expertise of other forums available to the debtor, including the administrative facilities of the taxing agencies, and any prejudice to either the debtor or the taxing authority.(147) In the majority of cases, the Bankruptcy Courts have abstained from determining a debtor's tax liabilities in "no asset" cases where creditors, other than the taxing authority, would not be affected.(148)
The Internal Revenue Service routinely opposes motions to fix tax liability
or secure discharge in "no asset" cases. Were the taxpayer-debtors
offered a viable alternative forum to resolve issues of liability or payment
terms, the Bankruptcy Courts could be expected to continue to exercise their
discretion in favor of abstention from deciding the debtor's motion. But, in
the real world, the no asset debtor frequently has no viable alternative to the
Bankruptcy Court's hearing and deciding the tax dispute. The condition of
pre-payment eliminates access to the Federal District Courts and the
Given the absence of demonstrated abuse by taxpayer-debtors or obvious failures to exercise appropriate judgment by bankruptcy judges who hear and decide abstention motions, we believe the proposed mandate denying jurisdiction to decide tax disputes in no asset cases is not warranted.
FILING PARTNERSHIP TAX RETURNS
(COMMISSION TRACK NUMBER 414)
Present Law
1. Duty to file partnership tax returns
There is a surprising amount of confusion concerning the obligation of a trustee to file a federal income tax return (on form 1065) for a debtor partnership in a chapter 7 or chapter 11 proceeding.
Internal Revenue Code § 6012(b)(3) requires a title 11 trustee to file tax returns for the bankruptcy estates of corporate debtors, and section 6012(b)(4) contains a similar requirement for bankruptcy estates of individual debtors.(150) But nowhere in the either the Internal Revenue Code or the Treasury Regulations is there a clear requirement that a trustee for a partnership debtor must file a federal income tax return on behalf of the bankruptcy estate.
Several courts have held that a chapter 7 trustee must file a partnership return, but the authorities cited for that proposition do not support it.(151)
Several private letter rulings appear to assume that such an obligation exists.(152)
Section 1106(a)(6) of the Bankruptcy Code provides that, if the debtor has not filed a tax return required by law for any year, the trustee shall "furnish, without personal liability, such information as may be required by the governmental unit with which such tax return was to be filed, in light of the condition of the debtor's books and records and the availability of such information . . ." But this section, which applies to all debtors and not merely partnerships, seems to be addressed at prepetition years, rather than any returns required on behalf of the estate for periods after the petition is filed. Nor does it apply in chapter 7 proceedings. And it may not apply to federal taxes.
One bankruptcy court held that a trustee of an estate had to file a return, even in the absence of sufficient estate income to require one, because of the need to determine the tax attributes and deductions under Internal Revenue Code § 1398(g) and (h).(153) Extension of this principle would require the trustee of a partnership debtor to file returns so that the individual partners could determine their respective tax attributes and other consequences.
However, in the absence of a clear requirement to file a return, a trustee who attempts to do so may be denied compensation for his time or recovery of his costs.(154)
Of course, there is no question but that a trustee must file withholding and similar payroll tax returns and pay the taxes.(155)
In Holywell Corp. v. Smith, 112 S. Ct. 1021 (1992), the Supreme Court held that a liquidation trustee in a chapter 11 case involving individuals and corporations had to file returns, but the reasoning was unclear, and there is no guidance in the opinion as to what happens if there are two or more liquidating trusts (as sometimes occurs where there are both recourse and nonrecourse liabilities to be administered) or a partnership is involved. In any event, this decision only applies to liquidating trusts, and not to the estates of partnership debtors.
The closest there is to any authority for a federal requirement to file a partnership tax return is the following language in the Senate Finance Committee Report on the Bankruptcy Tax Act of 1980(156):
"Accordingly, the bankruptcy trustee of a bankruptcy case is required
to file annual information returns (under section 6031 of the Code) for the
partnership."
Unfortunately, this reading of section 6031 is difficult to understand, since section 6031 talks about the partnership filing returns, not the trustee. Possibly, the Senate Finance Committee thought that section 1399 of the Internal Revenue Code, which provides that there is no separate taxpayer in the case of a partnership debtor under title 11, makes the trustee the alter ego of the partnership and thereby subjects the trustee to the obligations imposed by section 6031, but it is hard to sustain that interpretation, since the Bankruptcy Code does treat the debtor and the bankruptcy estate of a partnership as separate persons. See Bankruptcy Code § 541(a).
Adding to the confusion about the lack of a specific direction to file federal tax returns is the clear requirement in Sections 346(c)(2), 728(b) and 1146(b) that trustees file all state income tax returns, including partnership information returns. Given the fact that most states use the federal income tax return as the starting point for calculating the state tax return and, in most cases, require that a copy of the federal return be attached to the state tax return when it is filed, there is usually no practical way that a trustee can satisfy his obligation under the Bankruptcy Code without also preparing a federal tax return on form 1065.
2. Ability to file amended returns
Under Internal Revenue Code § 6227, only a Tax Matters Partner (or another general partner) may file a request for an "administrative adjustment", which is the procedure for amending a partnership tax return. There is no authority anywhere in the statutes (other than possibly section 323 of the Bankruptcy Code) authorizing a trustee to file an amended partnership return.
Proposals Before the Commission
Commission Track Number 414. This proposal. Commissioner Shepard suggests
that the trustee does not have this duty under present law. See
Task Force Position
The Task Force recommends that either the Internal Revenue Code or the Bankruptcy Code be amended to make it clear that a trustee in either a chapter 7 or a chapter 11 case in which the debtor is treated as a partnership for federal income tax purposes is required to file all federal income tax returns for all taxable periods of the partnership ending on or after the commencement of the case. To the best of his ability, the trustee should also be required to file any federal income tax return for any taxable period of the partnership that ended prior to the commencement of the case but which was not filed prior thereto.(157)
In addition, the statute should authorize the trustee to file on behalf of the partnership estate an amendment to any tax return previously filed by the trustee on behalf of the partnership estate.
Reasons for Position
Generally, the tax liability for the income of the estate during the pendency of a chapter 7 case falls on the estate or on an entity that will not, as a practical matter, survive as a continuing person. After the case is closed, there are few, if any, continuing tax consequences.
The estate of a partnership differs in that the obligations to pay taxes on its income falls on the partners themselves. To them, the tax consequences are extremely important and do not go away upon the closing of the bankruptcy case. In order to determine those consequences, either they must each get a properly prepared schedule K-1 from the trustee, or they must be given access to the estate's books and records to determine those consequences themselves--a clearly impractical situation, especially where there is more than a small number of partners. The bottom line is that if the trustee does not prepare the tax return, no one can do it, and no one will do it.
Since the Bankruptcy Code already requires the trustee to prepare the state partnership tax return, which cannot usually be prepared without first preparing a federal tax return, the proposed change will not increase administrative costs to the estate to any measurable extent.
In view of the fact that the IRS believes that the trustee is obligated to file a partnership return, and this Task Force is recommending that the law be clarified to confirm the IRS position on that point, it would be anomalous if the trustee, after filing a return and subsequently discovering that the return was erroneous (e.g., as a result of the discovery of additional records), was unable to correct the return by filing an amendment. This proposal would avoid that anomaly.
PROPOSAL TO REPEAL SECTIONS 728(c)
AND 728(d) OF THE BANKRUPTCY CODE
(COMMISSION TRACK NUMBER 414A)
Present Law
Sections 728(c) and 728(d) of the Bankruptcy Code provide, in essence, that if both a partner and a partnership are in bankruptcy, any state or local tax refund payable to a partner resulting from partnership items is payable to the estate of the partnership (and not the partner or the estate of the partner), and any state or local tax liability of an individual relating to undistributed partnership income is a liability of the partnership (and not of the partner or the estate of the partner).
Proposals Before the Commission
Commission Track Number 414A. This proposal.
Task Force Position
Repeal Sections 728(c) and 728(d) of the Bankruptcy Code.
Reasons for Position
These rules have some conceptual justification. If the fact of bankruptcy prevents a partnership from distributing income to a partner, then arguably the bankruptcy estate of the partnership should pay any income tax attributable thereto, and the estate of the partner should not be saddled with it. Likewise, if a partner would be entitled to a refund of taxes because of his use of partnership losses against income unrelated to the partnership, then he has received a benefit from his membership in the partnership that in equity belongs to the partnership's creditors. Notwithstanding the foregoing, the present Bankruptcy Code rules are contrary to the normal commercial expectations of both the partners and the partnership's creditors. Moreover, as presently written, they are applicable to state and local taxes only. Federal tax liabilities and refunds, which are likely to be more significant, are not within their ambit. This is another of those provisions as to which there is no theoretical justification for applying one set of rules for federal income tax purposes and another for state and local.
A case can be made for extending the present state and local tax rule appearing in Sections 728(c) and 728(d) to federal taxes. The game, however, does not seem to be worth the candle. Because of the fact that taxing authorities expect that they will be dealing with partners with respect to personal tax liability arising out of membership in a partnership, the sections even in their present form have a great potential for mischief. In the interest of simplicity, the present statutory rules, which are probably ignored in practice, should simply be repealed.
Other Institutional Positions
The National Bankruptcy Conference favors repeal of sections 728(b) and 728(c).
EFFECT OF DISCHARGE OF PARTNERSHIP INDEBTEDNESS
ON BASIS OF PARTNER'S INTEREST IN PARTNERSHIP
(COMMISSION TRACK NUMBER 415A)
Present Law
Section 108(a)(1) of the Internal Revenue Code excludes from taxation income from the discharge of indebtedness when the taxpayer is a debtor in a federal bankruptcy case or if not, to the extent the taxpayer is insolvent. When a partnership debt is discharged, the tax consequences are determined at the partner level.(158) Thus, a partner in bankruptcy may exclude the discharged amount from income. The partner, not the partnership, reduces tax attributes under section 108(b), although the partner may make certain elections to reduce the basis of his partnership interest if the partnership agrees to make basis reductions in its depreciable property at the partnership level.
Section 705(a)(1)(A) provides that a partner's basis in his partnership interest is increased by his share of taxable income of the partnership, and section 705(a)(1)(B) provides that such basis is increased by a partner's share of income "exempt from tax under this title."
As set forth below, the legislative history of the amendments to section 108 by the Bankruptcy Tax Act of 1980 clearly contemplated that the section 705(a) basis adjustment applies to discharge of partnership indebtedness excluded by a partner under section 108.
Recently, Babin v. Commissioner, 23 F.3d 1032 (6th Cir. 1994) affirmed a Tax Court memorandum decision denying such a basis increase. The tax years before the court were prior to the effective date of the Bankruptcy Tax Act amendments. Many practitioners are concerned because the courts did not explicitly confine their reasoning to pre-Bankruptcy Tax Act years.
Proposals Before the Commission
Commission Track Number 415A. This proposal.
Task Force Position
Add a new paragraph (D) to section 705(a)(1) to include discharge of indebtedness income excluded under section 108 to the items generating an increase in a partner's basis for his partnership interest.
Reasons for Position
The decision in Babin represents a continuation in the struggle among the courts, the Commissioner of Internal Revenue, and taxpayers to achieve an appropriate balance in the treatment of the cancellation of partnership indebtedness.
The leading case prior to the Bankruptcy Tax Act of 1980 was Stackhouse v. United States, 441 F.2d 465 (5th Cir. 1971), which held that the applicability of the various exemptions and exclusions from taxable income recorded by section 108 of the Internal Revenue Code to the cancellation of a partnership's indebtedness was to be determined at the partnership level, not the partner level. More important, the Fifth Circuit held that section 702, which required all partnership income to be allocated to the various partners, and required all partners to report on their individual tax returns their respective shares of each item of partnership income, gain, deduction, loss or credit, did not apply to cancellation of indebtedness income. Instead, the court held that cancellation of indebtedness income was taxable to the individual partners only through the mechanism of section 752, which treated a reduction in partnership debt as a constructive distribution of cash to each partner, and of section 731, which treated distributions of cash to a partner in excess of that partner's basis for his or her interest in the partnership as taxable income. In most cases, this income would be treated as long term capital gain.
As almost every commentator noted, this converted ordinary income eligible for section 108 or similar treatment into capital gain which was not eligible for such treatment. Although this helped partners who would not have individually qualified for any of the exclusions under section 108 or comparable provisions of the law, since capital gains tax rates were at the time substantially below the tax rates for ordinary income, it prevented partners who were personally insolvent or bankrupt from claiming the benefits of section 108. The Section of Taxation consistently supported correction of this erroneous view.
In the Bankruptcy Tax Act of 1980, Congress adopted the Section position that it did not agree with the decision in Stackhouse. Cancellation of indebtedness income was to be allocated to the individual partners, just like any other item of partnership income. Each partner would then have the right to invoke the provisions of section 108 if any applied to him or her (e.g., because the partner was bankrupt or insolvent). As stated in the Senate Finance Committee Report, "[t]he effect of these provisions of the bill is to overturn the decision in Stackhouse v. U.S., 441 F. 2d 465 (5th Cir. 1971)."(159)
However, the overturning of Stackhouse was prospective only (generally, for transactions after December 31, 1980). Congress did not attempt to change the law retroactively, but it is fair to say that Congress assumed that the passage of time would eliminate any continuing vitality of the Stackhouse holding.
The Committee Report also made very clear how the basis of the partner's interest in the partnership was to be adjusted for cancellation of indebtedness:
"For example, assume that a partnership is the debtor in a bankruptcy case
which begins March 1, 1981, and that in the bankruptcy case a partnership
liability in the amount of $30,000 is discharged. The partnership has three
partners. The three partners have equal distributive shares of partnership
income and loss items under section 702(a) of the Code. Partner A is the debtor
in a bankruptcy case; partner B is insolvent (by more than $10,000), but is not
a debtor in a bankruptcy case; and partner C is solvent, and is not a debtor in
a bankruptcy case.
Under section 705 of the Code, each partner's basis in the partnership is
increased by $10,000, i.e., his distributive share of the income of the
partnership (The $30,000 debt discharge amount constitutes income of the
partnership for this purpose, inasmuch as the income exclusion rules of amended
sec. 108 do not apply at the partnership level.) However, also by virtue of
present law, each partner's basis in the partnership is decreased by the same
amount (Code secs. 752 and 733). Thus, there is not net change in each partner's
basis in the partnership resulting from discharge of the partnership
indebtedness except by operation at the partner level of the rules of sections
108 and 1017 of the Code (as amended by the bill).
In the case of bankrupt partner A, the $10,000 debt discharge amount must be
applied to reduce net operating losses and other tax attributes as specified in
the bill, unless A elects first to reduce the basis of depreciable assets. The
same tax treatment applies in the case of insolvent partner B. In the case of
solvent partner C, such partner can elect to reduce basis in depreciable assets
in lieu of recognizing $10,000 of income from discharge of indebtedness.
If A, B, or C elects to reduce basis in depreciable assets, such partner may
be permitted, under the Treasury regulations, to reduce his basis in his
partnership interest (to the extent of his share of partnership depreciable
property), because the bill treats that interest as depreciable property.
However, a partner may reduce basis in his interest in the partnership only if
the partnership makes a corresponding reduction in the basis of the partnership
property with respect to such partner (in a manner similar to that which would
be required if the partnership had made an election under section 754 to adjust
basis in the case of a transfer of a partnership interest."(160)
In Estate of Newman v. Commissioner(161), which involved a pre-1981 tax year, the Second Circuit followed Stackhouse and determined the applicability of section 108 at the partnership level. Initially, this seemed to favor the taxpayer, since the partnership was insolvent and the effect of the decision was that no income was realized at the partnership level as a result of the cancellation. However, the constructive distribution under section 752 now created a problem for the taxpayer. If that distribution exceeded his basis, it was taxable under section 731, notwithstanding that the cancellation of indebtedness income was being excluded under section 108.
Under section 705(a)(i)(B), a partner may increase the basis of his interest in the partnership by his share of the "income of the partnership exempt from tax under this Title [the 1954 Code] . . . " Under section 705(a)(i)(A), a partner may increase the basis of his partnership interest by his distributive share of the partnership's taxable income. If, as the taxpayer contended, either of these provisions applied, the basis increase would offset the distribution under section 731 to an extent sufficient to avoid tax under section 731. The Second Circuit balked at this and held that, since the income was not being included in income, section 705 did not apply. Therefore, the very income being excluded under section 108 at the partnership level turned out to be taxable under section 731 anyway. The Court thought that a contrary holding would be a "windfall" for the taxpayer. After the Bankruptcy Tax Act of 1980, section 108(b) prevents any windfall.
To the extent that the taxpayer in Newman was solvent and should not, as a policy matter, have been entitled to the benefits of section 108, the final result was not unreasonable, but the Court got to that result by adding together two incorrect holdings.
The decision in Newman involving the basis adjustment was recently applied in Babin v. Commissioner, 23 F.2d 1032 (6th Cir. 1994). In Babin, the partner was the insolvent person, and the Tax Court (which had never agreed with or otherwise followed Stackhouse) held that the partner was entitled to exclude his share of the partnership's cancellation of indebtedness income pursuant to section 108(a). However, the Tax Court then applied the Newman rationale and refused to allow the taxpayer to increase the basis of his interest in the partnership. The result was the same as in Newman; the taxpayer wound up being taxed on the amount of the cancellation of indebtedness income as capital gain through the application of sections 731 and 752. The Sixth Circuit affirmed this decision. It was held that section 705 did not apply because, as the result of the application of the exclusion under section 108, "petitioner did not receive any taxable income, [and] there was no distributive share of taxable income of the Partnership within the meaning of . . . section 705(a)(1)(A) . . ." The effect of section 108(b) after the Bankruptcy Tax Act of 1980 was not noted.
Although Babin involved tax years both before and after the effective date of The Bankruptcy Tax Act of 1980, it is fairly clear from the facts that the cancellation of indebtedness and partnership issues only arose in the earlier years. However, many practitioners are concerned that the reasoning could be applied to post-1980 years, notwithstanding unambiguous legislative history.
From both the technical and the policy viewpoints, the basis adjustment in section 705(a)(1) is proper, and the judicial opinions to the contrary are unsound. Technically, the partner in Babin did realize his distributive share of cancellation of indebtedness income.(162) Otherwise, there was nothing for section 108 to apply to at the partner level.
The perception that this provides the taxpayers with a windfall is erroneous. With few exceptions, the exclusion of income under section 108 is invariably accompanied by a reduction in other tax attributes, including the reduction of the basis of property held by the taxpayer. In effect, the exclusion is only a deferral.
In Babin, the court was concerned that the increase in basis under section 705(a)(1) would offset the distribution under section 752 and the taxpayer would permanently escape any tax whatsoever on the amount of income arising from the cancellation of the indebtedness.(163) But after the Bankruptcy Tax Act of 1980 section 108(b) provides for a reduction of other tax attributes, such as net operating losses and the basis of other property of the taxpayer. That reduction in the other tax attributes is the Congressional method for preventing a windfall. Applying Babin now would double the tax consequences for the taxpayer. Not only would the taxpayer wind up paying tax on the cancellation of indebtedness because of the refusal of the courts to let him increase his basis under section 705(a)(1), but he will (if, following his loss in the courts, he was still sufficiently law-abiding to apply section 108(b)) pay that tax again when he sells the asset whose basis was reduced under section 108(b). At some point in time (provided he lives long enough), he will wind up reporting $2 of taxable income for each $1 of debt canceled. That is certainly neither good tax policy nor what Congress intended.
For seventeen years, taxpayers and their advisors have relied on the explanation of the operation of sections 108 and 705 as set forth in the legislative history of the Bankruptcy Tax Act of 1980. The Service and the Treasury Department lobbied heavily for that result. Moreover, the result is correct as a matter of theory. Taxpayers should not be saddled with the uncertainty created by the Babin decision. This problem would be obviated if the Internal Revenue Service issued an unequivocal announcement that it will not rely on Babin for taxable years subject to Section 108(b). A statutory fix would also be desirable, and should be retroactive.
THE TRUSTEE AS TAX MATTERS PARTNER
(COMMISSION TRACK NUMBER 415B)
Present Law
Prior to the adoption of Subchapter C of Chapter 63 of the Internal Revenue Code in 1982, controversies involving the proper treatment of items of taxable income or loss realized by a partnership and allocated to the individual partners became unwieldy, especially where there were a large number of partners with inconsistent positions and, frequently, filing their individual tax returns in different states or Internal Revenue districts. This problem was largely solved by providing that such controversies would be determined in proceedings between the partnership and the IRS or, if the matter went to litigation, by providing that the partnership was a party to the litigation. As part of this process, one of the general partners is designated the "Tax Matters Partner," and is the person who represents the partnership in its dealings with the IRS or in court.(164)
For example, the start of a tax examination is normally commenced by notifying the taxpayer that the IRS intends to conduct the examination. In the case of a partnership, the IRS normally sends that notice to the Tax Matters Partner and, depending upon the number of partners, the size of their interests and, in certain cases, other factors, to other partners. IRC § 6223. It is the obligation of the Tax Matters Partner to make sure that all of the partners are kept advised of all important developments, such as proposed settlements or other final determinations. In certain situations, the Tax Matters Partner may bind the other partners by his actions. IRC §6224(c)(3).
The 150 day period during which the IRS is barred from assessing any deficiency relating to a partnership item begins to run from the time a notice of a final partnership administrative adjustment (which is analogous to the 90 day letter or notice of deficiency in cases involving other types of taxpayers) is mailed to the Tax Matters Partner. IRC §6225
Within 90 days after the notice of a final partnership administrative
adjustment is mailed to the Tax Matters Partner, the Tax Matters Partner may
file a petition for a readjustment either with the Tax Court or the
The mailing to the Tax Matters Partner by the IRS of its notice of final
partnership administrative adjustment cuts off the right of other partners to
file requests for administrative adjustments of partnership items (i.e., refund
claims or amended returns). IRC §6227. The Tax Matters Partner may commence a
suit for refund in the Tax Court, the
Any partner may enter into an agreement to extend the period for assessing taxes, but such agreement will be binding on the other partners only if the agreement is executed by the Tax Matters Partner. IRC §6229(b)
The Tax Matters Partner also has a number of special obligations, such as the duty to notify other partners of the existence and outcome of the IRS examination. The Tax Matters Partner must also supply the IRS if it so requests with the names, addresses, profits interests, taxpayer identifications numbers and other data with respect to each person who was a partner in the partnership at any time during the taxable year. IRC §6230(e).
The net result of all of the above is that, generally, the only persons authorized to deal with the IRS or to appear in court to litigate a tax issue are the Tax Matters Partner and, in limited circumstances, certain other partners of the partnership, and only the Tax Matters Partner may bind the partnership as a whole or be required to perform certain of the administrative tasks.
Section 6231(a)(7) defines the Tax Matters Partner as a general partner designated by the partnership (in the manner specified by regulations) or, in default of such a designation, as the general partner with the largest profits interest in the partnership at the close of the taxable year involved. If more than one partner has the largest profits interest, then the partner whose name appears first on an alphabetical listing becomes the Tax Matters Partner. If this method of designating a Tax Matters Partner is impractical, the IRS may select the Tax Matters Partner.
In the context of a chapter 7 proceeding and, often, in the context of a chapter 11 proceeding, the last thing one could get the partners to agree on is the designation of one of the general partners to serve as a Tax Matters Partner. First, at this point, the interests of the general partners are not likely to be the same (assuming that they ever were). Most of the general partners probably aren't on speaking terms with each other; more likely, they are closer to suing each other than breaking bread. There is little reason to believe that any one of them could or would act in the neutral fashion contemplated by the statute for the role played by a Tax Matters Partner, or that any other general partner would trust him to do so.
In addition, no general partner is likely to be willing to serve as the Tax Matters Partner, because the Tax Matters Partner will incur significant expenses in fulfilling his or her obligations as such and at the same time run a substantial risk of being sued by his former partners as his thanks for acting in that role. It is unlikely that the partners would agree to reimburse the Tax Matters Partner for his expenses, let alone compensate him for his time and efforts (as they would probably do were the partnership still a viable and continuing business entity). Add to this the likelihood that if one of the other general partners disagreed with the actions of the Tax Matters Partner, he or she might well commence an action against the Tax Matters Partner. Under these circumstances, serving as the Tax Matters Partner would be extremely burdensome and no sane general partner would agree to act as the Tax Matters Partner.
In the absence of a voluntary designation, the statute indicates that the general partner with the largest profits interest should serve. This is a rather unrealistic test for a chapter 7 case, where there are no profits anticipated. In effect, the profits interests of all the partners have been reduced to zero, and any attempt to assign some sort of ratio in non-existent or extremely remote profits that might occur would probably run afoul of the requirements of Internal Revenue Code § 704(b) (relating to substantial economic effect of allocations). The only one who really owns the profits interests is the trustee and the creditors.(165)
This leaves the IRS with the task of designating the Tax Matters Partner, but even a brief consideration of the issues raised by this possibility indicates why this is an undesirable solution. Among others, the IRS would be forcing a general partner to serve without compensation or reimbursement and against his own will as well as against the will of his co-partners. That is not likely to achieve an effective representation of the partnership in its dealings with the IRS or, subsequently, in court.
The apparent solution is to let the trustee function as the Tax Matters Partner, or otherwise represent the partnership in any tax proceeding. This would be consistent with the provision in Bankruptcy Code § 323(a), which states the trustee "is the representative of the estate." However, in practice, the IRS has refused to recognize that the Bankruptcy Code provision overrides the specific provisions of the Internal Revenue Code restricting the IRS to dealing only with partners. Since the trustee is not a partner, he has no standing with the IRS in connection with examinations of the partnership, refund claims, extensions of the statute of limitations on assessments, and similar matters. Even though he may be the most logical person for providing the IRS with information like the names, addresses and taxpayer identification numbers of the partners pursuant to Internal Revenue Code § 6230(e), he is nearly the only person in the bankruptcy proceeding NOT authorized to do so.
The failure to recognize the trustee as a representative of the estate and the common unwillingness of the partnership to designate a Tax Matters Partner or for any general partner to agree to serve as such creates serious impediments to the efficient resolution of tax issues between the partnership and the IRS.
Proposals Before the Commission
Commission Track Number 415B. This proposal.
Task Force Position
Amend Section 6231(a)(7) by adding a provision authorizing a bankruptcy court to designate the trustee in a chapter 7 or chapter 11 proceeding to serve as the Tax Matters Partner.(166)
Reasons for Position
As a practical matter, the trustee is the only party with the knowledge and ability to represent the partnership in resolving controversies with the IRS.
In the absence of this authority, the trustee would not be authorized to file amended returns for prepetition years, to extend the statute of limitations for assessments or to enter into closing agreements with the IRS. In fact, while he may be required to file the initial return of the partnership for years ending after the commencement of the case(167), he is not authorized to file an amendment of those returns or to discuss with the IRS any adjustments of items on the returns he filed.
Designating the trustee as the Tax Matters Partner is consistent with section 323 of the Bankruptcy Code and will facilitate the administration of the bankruptcy estate.
The proposed provision would not authorize the IRS to make this decision. It would be made only by the bankruptcy court. The request to the court can be submitted by any interested person, including the trustee, the IRS, any partner and any creditor. Similarly, any interested person, including a partner, a creditor, the trustee or the IRS, who believes that the trustee would not be an appropriate selection in the particular proceeding can present his or her objections to the bankruptcy court. The court can weigh the arguments for or against the selection, and make its decision in the best interests of all parties, including the IRS and the partners of the partnership.(168) For good reason, the court could even act on its own initiative, although it is contemplated that the appointment without an opportunity for all parties to be heard would be extremely unusual.
POST-PETITION TAXES AS
ORDINARY COURSE EXPENSES
(COMMISSION TRACK NUMBER 421-4)
Present Law
Administrative expenses generally receive priority over all claims other than the claims of secured creditors. Under Chapter 7, administrative claims get paid first after secured claims on a pro rata basis, except for certain creditors and lenders who obtain superior status in return for allowing the use of collateral property or credit by the trustee or debtor in possession. Administrative claims of a Chapter 7 case take precedence over the administrative claims of a predecessor chapter from which the claim was converted. Under Chapter 11, administrative claims do not vote as a class on the reorganization plan, but must be paid in full upon the effective date of the plan. Administrative claims in Chapter 13 receive full payment.
Generally, administrative expenses are those incurred after the order for relief which are necessary to administer the estate and, if the debtor is reorganizing or not immediately liquidating, to conduct the business of the debtor. The policy behind this treatment is that the estate as a whole is benefited if pre-bankruptcy creditors subordinate their claims in order to enable the debtor to obtain the goods and services necessary to an orderly and economic administration of the estate after the petition is filed. However, the administrative claimant must prove both the reasonable value of the expense and that the expense was actual and necessary, without the favorable presumption that would attach to a proof of claim. Generally, the bankrupt estate pays no interest on administrative claims, but could be liable for interest and penalties in respect of administrative expense taxes. Moreover, if administrative expenses have been paid on an interim basis and it is ultimately determined that either the payments were not all justified or that there are insufficient funds to pay all other legitimate administrative claims, those who have received interim payments may be required to disgorge funds so that all administrative claimants share pro rata. The bankruptcy court has considerable discretion in determining what costs qualify as administrative expenses within the intendment of section 503 of the Bankruptcy Code.
Notwithstanding the priority afforded administrative claims, an important practical question of creditors with such claims is when they will be paid. Further, the timing of payment is within the reasonable discretion of the bankruptcy court, and may well affect the present value or even the face amount of payment from a practical standpoint.
Under current law, most taxes incurred postpetition have priority as administrative expenses. Under section 503(b)(1)(B) administrative expenses include (i) any tax incurred by the estate except certain prepetition assessed, assessable, or withheld taxes [§ 507(a)(8)] or (ii) asserted claims for previously paid excessive tentative tax refund allowances attributable to net operating loss carrybacks. Interest and penalties payable on postpetition taxes are usually asserted by the IRS as administrative expenses.
Under section 503(b) of the Bankruptcy Code, extraordinary administrative expenses appear generally to be payable only pursuant to a creditor's request for payment, notice, and a hearing. As a result, the timing of the payment may be delayed because of the time needed to obtain court approval. This treatment may be different from the more timely payment of ordinary administrative expenses consisting of normal operating expenses for an ongoing business of the bankrupt estate (whether based on a standing order or on the debtor's general authority to operate its business as a debtor-in-possession. Such operating costs are not generally subject to disgorgement).
At the same time, 28 U.S.C. § 960 provides that "any officers or
agents conducting any business under authority of a United States court shall
be subject to all Federal, State and local taxes applicable to such business to
the same extent as if it were conducted by an individual or corporation."
The Congressional purpose of this provision is to ensure that bankruptcy
trustees and receivers do not conduct tax-free businesses in competition with
tax-burdened operators of businesses not in bankruptcy or receivership. In
re
Under Bankruptcy Code § 362(b)(18), filing a petition for relief acts as an automatic stay for most creditor activities except certain measures, including a local taxing authority's creation or perfection of a statutory lien for an ad valorem property tax if such property tax comes due after the filing of the petition. On the other hand, the provisions of Bankruptcy Code § 363(f)(5) allow a trustee to sell property free and clear of any creditor's interest in such property under certain circumstances, including where the creditor can be compelled to accept money instead of the property (i.e., such as for a property tax lien creditor). Moreover, Bankruptcy Code § 724(b) imposes a distribution order on the proceeds from the sale of debtor estate property that effectively subordinates an allowed ad valorem property tax lien to private consensual liens and certain other administrative expense and higher priority claims (i.e., § 507(a)(1)-(7)) in Chapter 7 liquidation proceedings. See our response to Commission Track Number 100, supra.
Under Bankruptcy Code § 507(a)(1), administrative expenses under
Bankruptcy Code § 503 enjoy first priority of payment by the estate. Local
taxing authorities believe that the attachment of a county's tax lien to real
property should not remove ad valorem property taxes from treatment as
administrative tax expenses, entitled to first priority, as was held in In
re Sylvia Development Corp., 178 B.R. 96 (Bankr. D.
Under Bankruptcy Code § 506(c), the trustee may liquidate property subject to an allowed secured claim and use part of the proceeds to pay "reasonable and necessary costs and expenses of preserving, or disposing of, the property to the extent of any benefit to the holder of such claim." Local taxing authorities appear to believe that by specifically including property taxes in the definition of "reasonable and necessary or preservation" costs, this would enable them to recover some property taxes from real property that would otherwise go unpaid.
Proposals Before the Commission
Commission Track Numbers 421-4. The Commission is considering several proposals that would treat taxes as administrative expenses incurred in the ordinary course of the debtor's business so as to be payable on a more current basis without request and a hearing and/or otherwise to have special protections from the claims of other creditors. More particularly, these objectives would be obtained by the following:
1. Bankruptcy Code § 503 and 28 U.S.C. § 960 would be amended to
provide that bankruptcy estates must pay all taxes accrued postpetition,
whether or not related to a business operated by the estate, in the normal
course of the business of the estate and without request or motion. See
Justice Proposal, p. 98; Santa Fe Discussion Issues, p. 1, item IA1;
Government Working Group Proposal No. 10.
2. Bankruptcy Code § 507(a)(1) and 503(b)(1)(B) would be amended to
provide that ad valorem real estate taxes accrued postpetition are an
administrative expense whether secured or unsecured and payable as a course of
business expense. See Santa Fe Discussion Issues, p. 2, item IB2
and p.3, item IB4.
3. Bankruptcy Code § 506(c) would be amended to provide that ad valorem
real property taxes accrued postpetition are a reasonable and necessary cost or
expense of preservation of secured property. See Santa Fe Discussion
Issues, p. 2, item IB3.
Task Force Position
The Task Force agrees that a chapter 11 debtor or one operating a business should currently pay all taxes, including ad valorem real property taxes, as an administrative expense, without a request by the taxing authority. It is not clear that any statutory amendment is needed to accomplish this result. However, the same flat rule should not apply to non-operating trustees. The principle of pro-rata payment of administrative claims should be preserved.
Postpetition ad valorem real property taxes should be treated as administrative expenses even if secured. Consistent with our position with respect to repeal of Bankruptcy Code § 724(b)(2), such taxes should be borne by the secured creditor if the estate is administratively insolvent. See our response to Commission Track Number 100.
Reasons for Position
The Government believes that taxing authorities are placed at a disadvantage by bankrupt taxpayers who do not file tax returns and pay taxes when due in a timely manner or at all. Taxing authorities purportedly lose significant sums each year from debtors with unpaid or late-paid postpetition taxes, although such post-filing taxes incurred by the estate have first priority administrative status. The Government believes that it is bad policy to allow debtors to enjoy the benefits of bankruptcy without paying some of the attendant costs, such as timely payment of postpetition taxes. Outside of bankruptcy, taxpayers must pay their taxes when due, and bankruptcy should not change this obligation.
When a debtor seeks to reorganize under chapter 11 or otherwise operates a business under the jurisdiction of the bankruptcy court, such debtor should pay postpetition taxes as ordinary course expenses. We think this is the fair reading of Bankruptcy Code §§ 363(c)(1) and 503(b)(1)(B)(i) and 28 U.S.C.§ 960. We have not found anyone who thinks otherwise, and question whether any statutory change is needed to reach this result. If there is any question about the status of ad valorem real property taxes, whether because they may not be related to the operation of a business, cf. In re R.H. Macy & Co., Inc., 176 B.R. 315 (S.D.N.Y. 1994) or because they are in rem, cf. In re Carolina Triangle LTD Partnership, 166 B.R. 411 (9th Cir. BAP 1994), clarification may be needed.
When a business is not being conducted, the principle must give way to the principle of equal distribution to administrative creditors. There should be a presumption of current payment, but the court should be empowered to withhold current payment, on request of a party in interest, after notice and hearing, if the estate may be administratively insolvent.
Adoption of these positions might mean that in some situations ad valorem real property taxes might not be paid currently, and might not be paid in full if present section 724(b)(2) is retained. As we said in our response to Commission Track Number 100, "If an estate is administratively insolvent, the secured creditor should not receive a windfall at the expense of the local taxing authority. The private secured creditor should bear the burden of ad valorem real property taxes."
ABANDONMENT
(COMMISSION TRACK NUMBER 425)
Present Law
Section 554(a) of the Bankruptcy Code provides in part "after notice and a hearing, the Trustee may abandon any property of the Estate that is burdensome to the Estate or that is of inconsequential value and benefit to the Estate."
Section 1398(f)(1) of the Internal Revenue Code provides that the transfer of an asset by a debtor to the bankruptcy estate is not treated as a disposition. It does not appear to be relevant to the discussion. Neither the Commission nor the Task Force proposes any change to it.
Section 1398(f)(2) of the Internal Revenue Code provides:
Transfer from estate to debtor not treated as disposition.
In the case of termination of the estate, a transfer (other than by sale or
exchange) of an asset from the estate to the debtor shall not be treated as a
disposition for purposes of any provision of this title assigning tax
consequences to a disposition, and the debtor shall be treated as the estate
would be treated with respect to such asset.
The two sections are meant to mirror each other so that there is no taxable event upon assets going to the estate from the debtor nor, at the termination of the estate, from the estate to the debtor. Section 1398(f)(2) does not contemplate an abandonment by the trustee at some point in the proceedings prior to the termination.
Commissioner Shepard's proposal would overrule In re A. J. Lane &
Co., Inc., 133 B.R. 264 (Bankr. D.
Proposals Before the Commission
Commission Track Number 425. Commissioner Shepard proposes an amendment that
would provide specifically that the abandonment is not a taxable event. See
Task Force Position
The Task Force opposes this proposal. The Task Force instead proposes that Internal Revenue Code § 1398(f)(2) be amended to provide that in the event that an asset is abandoned by the trustee to the debtor (whether at the termination of the proceedings or before), which asset at the time of the abandonment is subject to debt in excess of the basis of such asset, the debtor will be deemed to have disposed of the asset immediately before the filing of bankruptcy and the liability for the tax on disposition shall be a nondischargeable debt of the estate. The tax would be treated as a prepetition tax and would have the same priority as any other prepetition tax. To the extent that the liability attributable to such gain is not satisfied, then the debtor shall be liable for the balance of the tax due, such liability shall be due upon the actual disposition of the asset, whether by foreclosure or otherwise.
Reasons for Position
The issue of abandonment tax consequences are limited to individual
bankruptcies under Chapter 7 and Chapter 11 because, unlike corporations and
partnerships, the filing of bankruptcy by an individual creates a new person:
the bankruptcy estate. See I.R.C § 1398(a).(169)
Commissioner Shepard argues that "the position of these cases [A. J. Lane & Co., Inc. et al] seems illogical in light of the identification of taxes generally incurred within three years of bankruptcy as being nondischargeable. See, 11 U.S.C § 507(a)(8)(A)." The Task Force has trouble with this reasoning, inasmuch as, under current law, no tax will have been incurred prior to the bankruptcy by the individual with respect to the property abandoned by the Trustee. The time a tax would be incurred would be upon a disposition by the debtor after abandonment by the estate.
Commissioner Shepard goes on to say that "the taxable abandonment is not the answer; whatever tax relief is the answer it must be specifically provided in the Code. Much of the abandonment problem is tax shelter oriented, is it desirable to extend relief in these cases?" With respect to the latter observation, for all practical purposes, there have been no significant real estate tax shelters created since the Tax Reform Act of 1986. However, there are many instances where a debtor will have property which has debt which is significantly in excess of both the basis of the property and its fair market value. Thus, upon a disposition of that property, tax will be imposed upon phantom income, that is, income will be realized but there will be no cash realized.
It should also be kept in mind that the bankruptcy estate succeeds to the debtor's tax attributes, including net operating loss carryforwards and capital loss carryforwards. These items could be used to offset the phantom income, in whole or in part. If the estate uses those attributes and still abandons the asset, then the debtor does not have those attributes to make a similar offset. The creditors often will also get to keep any tax refunds to which the debtor is entitled for the one, two or even three years preceding the commencement of the case. Those refunds are generated in part, if not whole by the same depreciation deductions which reduce the basis of the property in question and thereby create the potential tax liability. Again, the creditors get the benefit of the tax deductions but the debtor is forced to accept the continuing tax liability with which the benefit is associated. Thus, the position advanced by Commissioner Shepard results in a windfall to the creditors. The position advanced by the Task Force puts the creditors in no worse position than they would be in had the debtor actually disposed of the property prior to the filing of bankruptcy.
The tax controversy concerns the abandonment of property which is subject to a nonrecourse lien substantially in excess of its tax basis and also in excess of its fair market value (or only marginally less than its fair market value). In a real economic sense, such property is a liability, not an asset and, as a matter of policy, should be treated as a liability, and not an asset, for purposes of both the bankruptcy law and the tax law. There is no justifiable reason to treat it different from any other liability. This line of reasoning would support a position endorsing the A. J. Lane & Co., Inc. result.
The
An example of how the proposal would be applied is as follows:
The asset has a basis of $300 and a debt of $1000. The debtor has a loss
carry forward of $200 at the time of filing. At the time of the abandonment,
the estate has a gain of $700, $200 of which is offset by the loss carry
forward. The estate has to pay tax on $500. Assume the tax is $140 and the
estate can only pay $60. The debtor will be liable for the balance, $80, in the
year of disposition. That amount would be adjusted based on an actual
determination of the amount realized on disposition. A statement as to the
deferred liability would be included in each return of the debtor until the
year of disposition.
CORPORATE INCOME TAXES IN YEAR PETITION IS FILED
(COMMISSION TRACK NUMBER 432)
Present Law
Internal Revenue Code § 1399 provides that no new taxable entity is created when a corporation files bankruptcy. Moreover, it is clear that the act of filing for bankruptcy has no effect on the corporation's taxable year, which continues uninterrupted. Similarly, if the corporation is a member of a consolidated group for tax purposes, even if it is the common parent of such group, the filing of bankruptcy has no effect on the taxable year of the group or the requirement to continue filing tax returns on a consolidated basis. In short, from a corporate tax viewpoint, the act of filing for bankruptcy is a "non-event." Notwithstanding the bankruptcy, the corporation must combine all of its operating income and losses, as well as other items of gain or loss realized during the entire taxable year and come up with a net taxable income for the full period and compute the corresponding tax liability. For federal income tax purposes, it makes no difference whether that income was realized entirely before, entirely after, or partly before and partly after the bankruptcy filing.
The critical question from a bankruptcy viewpoint is whether any such income tax liability is a prepetition tax entitled to priority treatment under Section 507(a)(8) of the Bankruptcy Code,(170) an administrative expense under Bankruptcy Code § 503(b)(1)(B) entitled to priority under Bankruptcy Code § 507(a)(1), or a combination of the two. There are at least three important consequences that differ depending on whether the tax is characterized as prepetition versus administrative. These are (1) the deadline by which a proof of claim must be filed by the taxing authority in the bankruptcy proceeding, (2) how much of the claim will be paid and when will such payment be made and (3) whether the taxing authority is entitled to collect interest and penalties with respect to the unpaid taxes. If the tax liability is an administrative expense: (1) the deadline for filing a proof of claim is typically much later in the bankruptcy proceeding; and (2) the taxing authority will be paid in full not later than upon confirmation of a Chapter 11 Plan and (3) the taxpayer debtor may be liable for penalties and interest.
The relevant portions of Section 503 are as follows:
Section 503 Allowance of administrative expenses
* * * * * *
(b) After notice and a hearing, there shall be allowed administrative
expenses, other than claims allowed under section 502(f) of this title,
including-
* * * * * *
(1)(B) any tax-
(i) incurred by the estate, except a tax of a kind specified in Section
507(a)(8) of this title; or
* * * * * *
The relevant portions of Section 507 are as follows:
Section 507. Priorities
(a) The following expenses and claims have priority in the following order:
(1) First, administrative expenses allowed under section 503(b) of this
title,
* * * * * *
(8) Eighth, allowed unsecured claims of governmental units, only to the
extent that such claims are for-
(A) a tax on or measured by income or gross receipts-
(i) for a taxable year ending on or before the date of the filing of the
petition for which a return, if required, is last due, including extensions, after
three years before the date of the filing of the petition;
* * * * * *
(iii) other than a tax of a kind specified in section 523(a)(1)(B) of this
title, not assessed before, but assessable, under applicable law or by
agreement, after, the commencement of the case;
* * * * * *
Following the statutory framework courts that have addressed the issue have articulated a two prong test for determining when a tax claim will be a first priority administrative claim, as follows:
1. The tax must have been incurred by the estate; and
2. The tax must not be specified in Section 507(a)(8).
In order for a tax to be characterized as an administrative expense, it must be "incurred" by the estate. Section 503(b) of the Bankruptcy Code does not distinguish between corporate and individual debtors in the classification of taxes as administrative expenses or priority claims. However, it is important to note that there is a fundamental difference in the treatment of income taxes between individual and corporate debtors. As mentioned earlier, no separate taxable estate is created when a corporation files bankruptcy, nor is there any change to the taxable year of the corporation, even though it has filed a bankruptcy petition. In contrast, when an individual debtor files a Chapter 11 or Chapter 7 bankruptcy proceeding a separate taxable entity is created.(171) Moreover, the Internal Revenue Code specifically allows individuals to terminate their tax years as of the day before the bankruptcy filing.(172) Where the individual files bankruptcy and makes the election to close his tax year it is clear that the tax liability associated with the prepetition short period will be a priority claim under Bankruptcy Code 507(a)(8). Since a separate taxable entity, the bankruptcy estate, is created when the individual files bankruptcy, it is clear that any tax liability attributable to income earned by the bankruptcy estate will be an administrative expense.(173) Any taxable income earned by the individual after filing for bankruptcy will be taxed to him individually and will not constitute a claim of any type, either priority or administrative, against his bankruptcy estate. This is logical inasmuch as none of the individual's postpetition income will be an asset of the bankruptcy estate. Where an individual files bankruptcy but does not make the short-year election, the tax liability for the entire year is payable by the individual and not by the bankruptcy estate.(174) There is no legitimate basis to charge the bankruptcy estate for any portion of the tax liability for the year because the tax was not yet incurred at the date of the filing of bankruptcy. Only claims existing as of the date of the filing can be asserted in the bankruptcy proceeding. Of course, the individual can change this result by making the short period election.
One of the early leading cases addressing the question as to when a tax is incurred in a corporate setting was In re International Match Corporation.(175) In that case the debtor filed bankruptcy in April of 1932. The Delaware Franchise tax for 1932 was due April 1, 1933. The franchise tax was computed by reference to the capital structure of the corporation for the entire year, prorated for changes incurred during the year. The relevant section of the Bankruptcy Act required the trustee to pay all taxes "legally due and owing"(176). Thus, the key issue was whether any portion of the franchise tax was due and owing at the time the bankruptcy petition was filed. The Court found that until the last day of the accounting period, it was impossible to accurately compute the tax liability. Clearly, the same analysis is applicable to corporate income taxes. Until the accounting period is complete, the very existence of a tax liability is speculative. This case equated the concept of "due and owing" with the question of whether the tax was accrued, but continues to be cited for how to determine when a tax is "incurred" for purposes of Section 503(b).
In O.P.M. Leasing Services, Inc.,(177)
the Court analyzed whether a corporate income tax claim filed by the State of
In 1995 the Eighth Circuit in In re L.J.O'Neill Shoe Co.(179) and the Ninth Circuit in In re
Pacific-Atlantic Trading
The Ninth Circuit in In re Pacific-Atlantic Trading Company (PATCO), first considered whether the income tax for the year of the bankruptcy filing was "incurred by the estate". The Court considered the legislative history, including statements by congressmen, and concluded that the drafters of Section 503(b)(1)(B)(i) intended that a tax on income should be treated as "incurred" on the last day of the taxable period. Since the bankruptcy proceeding was filed prior to the last day of the tax year, the Court concluded that the taxes were incurred by the estate. The Court then focused its attention on the second test, which requires that the tax cannot be an administrative expense if it is described in Section 507(a)(8). In O'Neill the Court went directly this test. Each Court focused on the language of 507(a)(8)(A)(iii), which describes taxes "not assessed before, but assessable under applicable law or by agreement, after, the commencement of the case". Both Courts concluded that this language included taxes attributable to the prepetition period because such taxes are not assessed before, and do not become assessable until after, the bankruptcy filing when the tax year finally closes. In each case the government argued that such interpretation was erroneous because, if followed literally, there could never be a tax liability that would be characterized as administrative. This is because even taxes relating solely to a postpetition year would not have been assessed before but would be assessable after the commencement of the case. The Court in PATCO acknowledged that this conclusion would be absurd and accordingly rejected the interpretation that would give rise to such an absurd result.(181) Each court concluded, based on legislative history and analysis, that Section 507(a)(8) was only intended to deal with prepetition taxes. Accordingly, it was necessary to interpret this section in that context.
In summary, present law is that a corporate income tax liability related to the year of the bankruptcy filing should be bifurcated. The tax liability attributable to the prepetition portion of the year should be treated as a priority claim under Section 507(a)(8) and the tax liability associated with the postpetition portion of the year should accorded administrative status under Section 503(b).
Proposals Before the Commission
Commission track number 432. Both the IRS and the Justice Department have urged the Commission to propose legislation to the effect that a corporate income tax liability for a tax year that straddles the petition date is "incurred" for purposes of Section 503(b) of the Code on the date when that liability can be calculated, namely, the last day of the tax year. The primary concern expressed by the IRS and the Justice Department is that absent this change the government will lose out on significant tax revenues because claims for prepetition tax claims will typically be subject to an early bar date (generally 180 days after the filing of the bankruptcy petition). Both the Justice Department and the IRS maintain that the possible solution of filing of protective claims in every corporate bankruptcy case would be unduly burdensome on the debtor, the courts, and the taxing authorities. Justice Proposal, p. 99; IRS Proposal, p. 60.
Task Force Position
The Task Force takes no position on these proposals.
Reasons for Position
The Justice Proposal and the IRS Proposal would amend the Bankruptcy Code to provide that straddle year taxes are "incurred" on the last day of the taxable year. We assume this to mean that the entire year's liability is an administrative expense, entitled to a first priority. If so, the statute should say so. Both O'Neill and PATCO held that the taxes were incurred by the estate. The Task Force is concerned that merely stating that it is incurred on the last day of the taxable year leaves room for continued confusion.
This issue divided the Task Force, and others we consulted, on the merits. Some members believe that because no actual liability arises until the last day of the taxable year when all income and deductions, regardless of when during the year they are incurred, are netted against each other. The liability is properly treated as an administrative expense. These members agree with the IRS and the Justice Department.
Other members (the "Opponents") are of the view that the present law treatment is appropriate. Specifically, the Opponents believe that it is appropriate to bifurcate the tax liability for the year of filing. The portion of the liability attributable to the prepetition period would have priority status under Section 507(a)(8) and the portion attributable to the post-petition period would be accorded administrative priority status under Section 503(b). However, the Opponents are sympathetic to the concern of the governmental authorities that they could be subject to a bar date that precedes the normal due date of the relevant tax return.(182) The Opponents would suggest that a provision be made to allow claims for the prepetition portion of the tax liability to be filed up to the later of the normal bar date or the normal due date for the a tax return plus an additional period of time.(183) The Opponents believe that in the majority of the Chapter 11 cases that are filed by corporations, there is no corporate tax liability for the year of the bankruptcy filing and in those cases, the issue is academic. However, in those cases where there is a significant tax liability, to the extent it is characterized as prepetition the Chapter 11 Plan can provide for the payment of the prepetition tax liability over an extended period of time of up to six years.(184) This may well be a critical element of formulating a successful plan of reorganization. This privilege should not be taken away merely to ease an administrative burden otherwise imposed on taxing authorities.
As a result of these divisions, the Task Force takes no position on these proposals at this time.
Although the Opponents believe that the Government's interests would be adequately served by giving the taxing authority a reasonable extension of the bar date, the Task Force notes that there is another possible solution. A corporate debtor could be given an election, similar to that now provided to individuals under Internal Revenue Code § 1398(d)(2), to terminate its tax year as of the day prior to petition filing. The liability attributable to the prepetition short period would be an eighth priority tax subject to the deferred payment provisions of Bankruptcy Code § 1129(a)(9)(C); the postpetition tax liability would be an administrative expense. The Task Force recommends that if this approach is adopted the due date for both returns be the normal due date for a full year return and that the taxing authority be given an appropriate extended bar date for the prepetition return.
The Task Force will continue to consider this question in hopes of reaching a consensus. We hope the Commission will give careful consideration to crafting a solution which reconciles theoretical correctness with the legitimate concerns of the taxing authorities.
Other Institutional Positions
The Association of the Bar of the City of
FRESH START NOL PROPOSAL
(COMMISSION TRACK NUMBER 4312)
Present Law
Under current law, if a corporation is reorganized pursuant to a Chapter 11 plan, that corporation will not include in income any cancellation of indebtedness realized as a result of the plan.(185) It will, however, be required to reduce its tax attributes, including net operating loss carryforwards ("NOLs"), capital loss and credit carryforwards, and asset basis in excess of post reorganization liabilities.(186)
Until January 1, 1995, the "stock-for-debt exception" provided an exception to the requirement that tax attributes be reduced by the amount of any excluded cancellation of indebtedness. It provided that, to the extent the cancellation of indebtedness was the result of the issuance by the corporation of its stock to the creditors in satisfaction of the corporation's debt and certain other requirements were met, no attribute reduction was required.(187) However, this "stock for debt" provision was repealed by the Omnibus Budget and Reconciliation Act of 1993 ("OBRA 93").
Furthermore, if a plan of reorganization under Chapter 11 results in a change of ownership of the debtor corporation within the meaning of section 382 of the Internal Revenue Code, the ability of that corporation to use its pre-reorganization tax attributes (primarily "NOLs") to reduce its annual tax liability with respect to post-reorganization income will be subject to additional limitations.(188) To the extent the annual Section 382 limitation is not used in any year, the unused amount will be added to the succeeding year's limitation. Unless the corporation qualifies for and does not elect out of the benefits of section 382(l)(5) of the Internal Revenue Code,(189) these limitations are determined under section 382(l)(6). Section 382(l)(6) requires that the value of the loss corporation shall be increased to reflect any cancellation of debt which occurred in a Title 11 case.(190) Under regulations, the equity value of the corporation immediately after the reorganization will generally be equal to the lesser of: (i) the aggregate value of the corporation's stock immediately after the reorganization and (ii) the value of the corporation's assets immediately before the reorganization (with certain adjustments).
Therefore, under the current law, a corporation which issues stock to its creditors realizes substantial income from debt cancellation which must then be applied to reduce tax attributes including net operating losses, capital losses and credits as well as the basis of property. In cases in which there is substantial debt canceled and the value of the stock on the date of issuance is low, there have arisen cases in which the attribute reduction is so substantial as to eliminate all NOLs and reduce the basis of assets. The result in these cases is that the company emerges from bankruptcy with a tax balance sheet lower than its financial balance sheet with inordinate levels of income for tax purposes, resulting in effective tax rates significantly in excess of the 34-35% federal rate generally applicable. Depending on the nature of the business, these high effective tax rates can occur over a varying period of time post-reorganization.
In these cases, the "horizontal equity" purportedly sought by the repeal of the stock for debt exception has produced an inequity and put these companies at a competitive disadvantage as compared to their peers. It is also believed that in some cases, the repeal of the stock for debt exception and the effects thereof have created tax disincentives which weigh in favor of liquidation and against reorganization, thus making tax policy inconsistent with general bankruptcy policy favoring reorganization as appropriate.
Proposals Before the Commission
Commission Track Number 4312. This proposal. Please note that this is not an original proposal of this Task Force. The proposed bill attached as Appendix C is the product of the efforts of an ad hoc group to obtain legislative response to the repeal of the "stock for debt" exception. This legislation has not yet been introduced.
Task Force Position
The Task Force proposes that Section 108 of the Internal Revenue Code be amended to provide that a corporation undergoing a reorganization in bankruptcy be allowed to make a "fresh start" election. Under the Fresh Start proposal, any corporation reorganizing in a bankruptcy proceeding will have the option of either applying current law or making a "fresh start" election, with the following consequences:
The electing corporation ("Old Debtor") will be treated as having sold all of its assets at fair market value in a single transaction to a new corporation (the "New Debtor") after the close of business on the consummation date of the reorganization. Old Debtor's status as a taxpayer will terminate on that date and the New Debtor will be treated as a newly organized corporation, unrelated to Old Debtor, that acquired all of the Old Debtor's assets and assumed such of Old Debtor's liabilities (including tax liabilities) that were not extinguished under the plan of reorganization as of the opening of business of the next following day. It is expected that the details of such deemed sale rule will be modeled, as closely as is appropriate, on the deemed sale rules of Section 338 of the Internal Revenue Code.
The deemed sale would be treated as a taxable event to Old Debtor and any resulting income, gain or loss will be included in determining Old Debtor's tax liability for its final taxable year. Solely with respect to any gain recognized due to the deemed sale, section 56(d)(1)(A), which limits the amount of the alternative tax net operating loss deduction to 90% of alternative minimum taxable income, would be inapplicable and would not limit the Section 172 deduction for alternative minimum tax purposes. No cancellation of indebtedness arising out of the plan of reorganization will be included in Old Debtor's taxable income.
New Debtor will not succeed to any of Old Debtor's tax attributes. New Debtor will have a fair market value basis for all of its assets and be entitled to a "fresh start net operating loss carryforward" which will be equal to 5 times New Debtor's annual limit under Section 382, as determined using equity value as set forth in Section 382(l)(6) and accompanying regulations. The total amount of NOL shall not exceed the NOL remaining after the effect of the gain or loss recognition in the deemed sale event. The net operating loss will be treated for all purposes of the Internal Revenue Code as if it were a net operating loss carryforward under Section 172 of the Code that arose in the year prior to New Debtor's first taxable year, except that the NOL will have a five year carryforward period. The limitation of Section 382(l)(6) would apply to this deemed NOL.
To mitigate the potential for debtor's using this provision to freshen expiring NOLs, the fresh start election would be available only to companies undergoing a substantial equity reorganization as evidenced by an ownership change in the context of a bankruptcy plan where at least 50% of equity is issued to creditors.
Proposed statutory language implementing this proposal is attached as Appendix C.
Reasons for Position
It is believed that the tax inequities created by the repeal of the stock-for-debt exception are an unintended effect of the repeal and that remedial legislative action is necessary. The proposal is an elective provision designed to permit those companies inordinately disadvantaged under current law to obtain a fairer tax treatment postreorganization and a period of tax benefit consistent with the economics of the business under Section 382(l)(6). Anti-abuse provisions requiring creditor continuity should prevent the possibility of windfall benefits to inappropriate companies and creditor groups. In addition, sizing the post-reorganization tax benefits to equity value under Section 382(l)(6) is consistent with incentives to recapitalize through equity rather than heavy debt. Finally, with respect to companies which will elect this treatment, the provision is also consistent with bankruptcy "fresh start" policy and financial "fresh start" accounting treatment.
Other Institutional Positions
The draft is supported by the Business Bankruptcy Committee of the American Bar Association's Section of Business Law with referral to the Section of Taxation. It was also presented at the Spring Meeting of the American Bankruptcy Institute.
THE ESTATE AS SUCCESSOR UNDER SECTION 505(b)
OF THE BANKRUPTCY CODE
(COMMISSION TRACK NUMBER 438A)
Present Law
Bankruptcy Code § 505(b)(1) provides:
(b) A trustee may request a determination of any unpaid liability of the
estate for any tax incurred during the administration of the case by submitting
a tax return for such tax and a request for such determination to the
governmental unit charged with responsibility for collection or determination
of such tax. Unless such return is fraudulent, or contains a material
misrepresentation, the trustee, the debtor, and any successor to the debtor
are discharged from any liability for such tax --
(1) upon payment of the tax shown on such return, if--
(A) such governmental unit does not notify the trustee, within 60 days after
such request, that such return has been selected for examination; or
(B) such governmental unit does not complete such a examination and notify
the trustee of any tax due, within 180 days after such request or within such
additional time as the court, for cause, permits.
(Emphasis supplied.) Although the law is well-settled with regard to the dischargeability of the trustee, the debtor, and the successor to the debtor from further tax liability, the code is silent with regard to the dischargeability of the "estate" from such debts. Several courts have, however, addressed the issue of estate's tax liability in such matters. Matter of Fondiller, 125 B.R. 805 (N.D Cal 1991); In re Rode, 119 B.R. 697 (Bankr. E.D. Mo. 1990); and Matter of West Texas Marketing Corp, 54 F.3d 1194 (5th Cir. 1995) all held that the estate is not entitled to a discharge because the "estate" is not specifically referenced in the emphasized language above.
Proposals Before the Commission
Commission Track Number 438A. Commissioner Shepard proposes that the
Bankruptcy Code § 505(b) be amended to provide that the estate be
discharged from additional tax obligation in the same manner as the trustee,
the debtor, and the successor to the debtor are discharged, thus overruling Matter
of Fondiller, 125 B.R. 805 (N.D Cal 1991); In re Rode, 119 B.R. 697
(Bankr. E.D. Mo. 1990); and Matter of West Texas Marketing Corp, 54 F.3d
1194 (5th Cir. 1995). See
Task Force Position
The Task Force supports the proposal to amend Section 505(b) to include the "estate" in the list of dischargeable entities.
Reasons for Position
The Task Force believes that this amendment would be consistent with Congressional intent of providing for expedited audits and speedy, final determination of tax liabilities in bankruptcy.(191)
Currently, even if all procedures are followed under Section 505(b), the trustee who is working diligently to settle the estate and make a final distribution to creditors still can have the government assert an unexpected deficiency against the estate long after the time period under Section 505(b) has passed. There are at least two negative practical results from a trustee's perspective, as follows.
First, the trustee is prevented from finalizing the estate in an efficient, accurate and timely manner. If Section 505(b) does not protect the estate, then the estate is effectively subject to the normal statutes of limitations, e.g. three years for federal income tax audit and additional assessment purposes.(192) Therefore, only tax years which are past the statute can be deemed final. Taken to the absurd, this means that until the day the trustee makes a final distribution, there is no assurance that an unexpected deficiency will not be asserted by a taxing authority to the detriment of the other creditors. If the income tax returns for any of the "open" years contain any complex issues (e.g. sales of assets, etc.), Section 505(b) filing would not offer much reassurance to the trustee or the creditors until the final distribution was made.(193) This effect has sometimes stymied the willingness of trustees to make partial distributions during the pendency of the case. In addition, even if the trustee were to prevail in defeating a late-asserted claim, the delay and cost of defending the claim would cause a significant detriment, and would probably further diminish the assets of the estate.
Second, a serious problem stemming from this open-ended estate exposure is the potential for suits(194)
against the trustee's bond by creditors. Disgruntled by the last-minute assertion of a priority governmental claim other creditors may attack the trustee in a tort claim in order to recoup some of their losses. The creditors may claim that the delayed additional assessment against the estate arose because the trustee was negligent in the preparation and analysis of the tax return. This result is inconsistent with the purpose of Section 505(b) to absolve the trustee from liability related to additional assessments. In essence, the government has developed a mechanism of indirectly extracting the payment of additional taxes from the trustee's bond. In addition, exposure to such liability is a disincentive to serving as trustee .
The Task Force recommends that the amendment be accomplished by adding the
word "estate" to the enumerated list of parties discharged under
Section 505(b), as opposed to a mere interpretation that the estate should be
deemed a "successor to the debtor."(195)
RETROACTIVE CHALLENGE TO NONCONFORMING CHAPTER 13 PLANS
(COMMISSION TRACK NUMBER 441)
Present Law
Prior to confirmation of a chapter 13 plan any party in interest may object to confirmation and be heard (Bankruptcy Code § 1324).
Bankruptcy Code § 1327(a) provides that a confirmed chapter 13 plan is binding on ". . . the debtor and each creditor, whether or not the claim of such creditor is provided for by the plan, and whether or not such creditor has objected to, has accepted, or has rejected the plan."
Following confirmation, the plan may be modified on motion of the debtor, the trustee, or the holder of an allowed unsecured claim, for the purposes of changing the amount of, or the length of the plan, or to reflect payments made to a creditor made outside the plan (Bankruptcy Code § 1329).
Proposals Before the Commission
Commission Track Number 441. Commissioner Shepard proposes an amendment to
provide that the government may move for retroactive modification or
nullification of a confirmed chapter 13 plan on grounds that it does not comply
with the Bankruptcy Code or other statutory law. See
Task Force Position
The Task Force opposes this proposal. The law with respect to finality as to issues that could have been raised, but were not, at the confirmation hearing should be preserved without modification.
Reasons For Position
This proposal, instead of improving the administration of chapter 13 plans or correcting an imbalance in the treatment of the government under the Code would instead merely reward government inefficiency and interfere with public policy regarding prompt administration of such cases.
As Robin Phelan, former president of the American Bankruptcy Institute, observed,
There seems to be more concern about the ineptitude of the taxing
authorities' computers than there is about the taxpayer and the crushing tax
debt that sometimes occurs that people just can't get out from under . . .(196)
This proposal seeks to save the Government from the effects of the occasional confirmed plan that fails to treat a tax claim with all of the rights or privileges that the IRS may deem itself entitled to. The proposal would appear to suggest that the Code is unfairly deferential to debtors who may have proposed a faulty plan, either negligently or deliberately, with resulting prejudice to a tax claim.
However, the proposal fails to adequately consider the reasons for the res judicata effect of the confirmation process:
1) The rule that a confirmed plan is res judicata as to objections that could have been raised at the confirmation hearing is a two-edged sword. Granted it binds the government even in the event of an unfair plan, but it also prevents the debtor from making repeated attempts to obtain reconsideration of a plan with which the debtor may not be pleased;
2) Allowing reconsideration of a plan on grounds that it does not comply with law would invite a new wave of post-confirmation litigation by creditors of all categories seeking an advantage, regardless of the merits of such grounds. Such a result would be contrary to explicit Congressional intent for establishing the Commission in the first place, which is to find ways to simplify and shorten, not complicate and extend the bankruptcy process;(197)
3) One of the reasons advanced for the adoption of the proposal is "Requiring that a Chapter 13 plan comply with law on pain of dismissal even after confirmation is fair inasmuch as the debtor is seeking equitable relief and should bear the burden of any plan failures."(198) However, this suggestion fails to mention the corollary of equitable remedies, namely that ". . . equity aids the vigilant, not those who slumber upon their rights."(199)
4) In a similar vein, relaxing the binding effect of a confirmed plan and the concomitant increase in litigation will add to the costs of administration, including attorneys' fees. This is contrary to the mission of the Commission; in remarks made on the Senate floor in favor of creation of the Commission it was observed, ". . . it is vital that the costs of all litigation be reduced, but nowhere more so than in bankruptcy."(200)
Under existing procedure the government receives adequate notice of the filing of the case, and is given actual notice, or at the very least information putting it on inquiry notice(201) of the contents of the plan. There is no reason the government cannot adhere to the rules of procedure to the same extent as non-governmental creditors, nor is there reason the government cannot file timely objections to plans it feels do not comply with law.
FAILURE OF TAX AUTHORITY TO FILE CHAPTER 13 PROOF OF CLAIM
(COMMISSION TRACK NUMBER 441A)
Present Law
Bankruptcy Code § 502(b)(9) provides that a claim shall be allowed except to the extent that ". . . proof of such claim is not timely filed. . ." This section further provides that a proof of claim of a governmental unit (e.g., tax claim) ". . . shall be timely filed if it is filed before 180 days after the date of the order for relief. . ."
Thus, failure to file a proof of tax claim within 180 days of filing the chapter 13 case, or later pursuant to an order extending the deadline, will result in the claim being extinguished.(202)
Proposals Before the Commission
Commission Track Number 441A. The IRS proposes that Bankruptcy Code § 1322(a) be amended to provide that priority taxes must be paid in chapter 13 even if no proof of claim is filed. IRS Proposal, p. 62; see also Santa Fe Discussion Issues, p. 13, Item IIC4.
Task Force Position
The Task Force opposes this proposal. The law with respect to the requirement for filing timely proofs of claim should remain unchanged.
Reasons For Position
The proposal to allow payment of priority taxes notwithstanding failure to file a timely proof of claim is asserted, presumably, to provide relief to the government for the occasional failure of the I.R.S. to file a proof of claim on time for priority taxes in chapter 13 cases.
Adoption of such a rule would result in:
1) substantial impairment of the administration of chapter 13 cases;
2) reward a governmental agency for inefficiency;
3) discriminate against private entities, such as general unsecured creditors, whose claims would still be extinguished in the event of tardy filing of claims; and
4) an undesirable situation in which the debtor is expected to pay claims the amount, extent and validity of which are unknown for years during which he is expected to perform under the plan.
Prior to the adoption of the Bankruptcy Reform Act of 1994, the law governing chapter 13 proceedings provided a creditor, including a governmental agency, 90 days from the date first set for the meeting of creditors in which to file a proof of claim. In the case of unsecured claims, failure to file a timely claim generally resulted in extinction of the claim. However, the courts were split on this issue.(203)
In those jurisdictions following the rule in Tomlan, the IRS and other governmental taxing entities occasionally missed the 90-day deadline, resulting in some cases in discharge of priority taxes, including trust fund taxes and excise taxes.
In order to settle the split in authority on this issue, and, as well, in order to accommodate the need of the IRS for more time to react to chapter 13 filings and problems of identifying taxpayer's claims in time to meet the deadline, Congress increased the amount of time given governmental entities to 180 days following the filing of the case (or, in essence, about 150 days following the first meeting of creditors).
It should be noted that this extra time already grants governmental entities a privilege not extended to the holders of other unsecured or priority claims, who are still required to file within 90 days, or risk extinguishment of their claims.
From a practical point of view, allowing priority or any other kind of claim to survive past a reasonable deadline for filing of the claim will result in chaos in the administration of cases in which the debtor owes one or more tax claims.
Chapter 13 is established to be a fast, efficient remedy which avoids the costly and protracted proceedings found in chapter 11 cases. The prompt identification of claims, in particular tax clams, is essential to allow the debtor, the trustee and the court to evaluate a proposed chapter 13 plan and fix the proper manner in which various claims should be handled in the plan. This point is made perfectly clear by the requirement that a plan be filed immediately, and that payments under the plan commence within 30 days of filing the plan.(204)
The debtor and the trustee need reasonably prompt notice of claims, including tax claims, and the nature of such claims, in order to have time to sort out the extent, amount, and validity of such claims.(205)
For example, the government frequently files proofs of claim that are incorrect. The IRS routinely files claims as completely "secured" because liens have been recorded for them. However, in a great many such cases the property securing such claims is less than the face value of the liens. Thus, these are undersecured claims which should be bifurcated into their respective secured and unsecured portions, because these categories of claims are treated differently in the plan in terms of whether interest may accrue, whether they must be paid in full, the priority of payment, and the like. The debtor must have an opportunity to object to such claims which are asserted to be fully secured when in fact they are not.
Similarly, many personal income tax claims are asserted by the government to be priority taxes when in fact they are merely general unsecured claims. Tax claims are incorrectly deemed priority for a variety of reasons, all of which require early notice in order to provide the debtor fair opportunity to identify and correct the errors by communication with the taxing entity, or objection to claim.
If the government requires more time in which to study and properly characterize its tax claims, existing law permits it to move for an order extending the deadline pursuant to Bankruptcy Rule 3002(c)(1).
Were the government allowed to slide by the deadlines with no repercussions, the result would be further relaxation by government employees and deterioration of vigilance and the standard of care in promptly identifying and filing claims. Claims would be filed late, perhaps years late, and claims would be filed with even more errors than already occur in tax claims.
As Robin Phelan, former president of the American Bankruptcy Institute, observed:
There seems to be more concern about the ineptitude of the taxing
authorities' computers than there is about the taxpayer and the crushing tax
debt that sometimes occurs that people just can't get out from under . . .(206)
The result would be that the debtor, the trustee and the court would be required to draft and approve plans based on only the vaguest notions regarding the amount or correct treatment of the tax claims. In some cases the plans would not properly characterize some claims as priority or secured, with the result that at the end of the plan the debtor, instead of receiving a fresh start, would be presented with a surprise from the government . . . a substantial unpaid balance of taxes. This can only hurt the government as well as the debtor. In other cases the government would be paid an undeserved windfall, at the expense of general unsecured creditors, by debtors who pay tax claims unaware that they are being treated as priority or secured when in fact they are neither.
Because Chapter 13 serves as a flexible vehicle for the repayment of allowed claims, all unsecured creditors seeking payment under a Chapter 13 plan must file their claims on a timely basis so that the efficacy of the plan can be determined in light of the debtor's assets, debts and foreseeable earnings.
INTEREST ON DEFERRED CHAPTER 13 TAX PAYMENTS
(COMMISSION TRACK NUMBER 503A)
Present Law
Bankruptcy Code § 1322(a)(2) provides, in essence, that priority taxes shall be paid in full in a chapter 13 plan, together with such prepetition interest as has accrued to date of filing, but without postpetition interest.(207)
[I]t is also important to note that while section 1322(a)(2) requires
payment in full of priority claims, it does not provide for payment of their
present value as of the effective date of the plan. Therefore, the payment of
interest on priority claims is not required unless the court finds it necessary
to satisfy the best interest of the creditors test.(208)
This is the majority rule in the published opinions.(209)
Proposal Before the Commission
Commission Track Number 503A. Commissioner Shepard and the IRS recommend that the law be amended to provide that priority taxes paid through a chapter 13 plan include interest on deferred payments in a manner similar to chapter 11 deferred payments. Santa Fe Discussion Issues, p. 13, Item IIC7. IRS Proposal, p 62.
Task Force Position
The task force opposes amending the Bankruptcy Code to provide for the interest on deferred payment of prepetition priority tax claims(210) in chapter 13. In addition, Congress should consider amending the Code to provide that the prepetition interest that has accrued on prepetition priority tax claims up to date of filing the chapter 13 be deemed non-priority for purposes of chapter 13.
Reasons For Position
Increasing the burden of tax payments in chapter 13 by adding interest on priority taxes will:
1) By costing more, erode incentives to choose chapter 13 over straight liquidation and increase incentives to simply remain "underground" and "on the run" from the tax collector. Thus, such a policy will deter tax burdened individuals from attempting to reenter the system and come into compliance with the tax laws. "Chapter 13 succeeds if incentives to the debtor are adequate and demand for payments is not excessive . . .";(211)
2) By costing more, reduce the already inadequate level of successful adjustments of debt under chapter 13;(212)
3) By reducing the chapter 13 incentives and increasing the failure rate of chapter 13 plans, ultimately reduce the total amount of recovery of tax revenue currently enjoyed by the Government at relatively little cost or effort;
4) By shifting more money away from general creditors to the government, further erode the credit industry's confidence in the fairness of the bankruptcy system and ignite new legislative warfare in a struggle for preferential treatment.(213)
Consistent with the notion of a fair and equitable balance of competing interests in bankruptcy is the rule that priority claims (including priority tax claims) paid through a chapter 13 plan should not be entitled to interest.
The basic reasons for the rule denying post-petition interest as a claim
against the bankruptcy estate are the avoidance of unfairness as between
competing creditors and the avoidance of administrative inconvenience.(214)
As Prof. Jack F. Williams points out in his extensive exploration of tax policy in bankruptcy cases ". . . general unsecured creditors partially subsidize the payment of a debtor's taxes, even those that result from debtor misconduct. It is questionable whether this is an appropriate cost for the general creditors to bear."(215) He further observes:
Priority treatment accorded most current taxes increase the number of no-asset cases filed in bankruptcy. It also increases general creditor disenchantment with the entire process.(216)
Unsecured creditors essentially pay priority claims and no matter how extensive, there is always one deserving creditor who is excluded.(217)
It may reasonably be presumed that each additional dollar that a debtor must pay to the government decreases the amount of recovery that may be enjoyed by the already underprivileged general unsecured creditors, and increases the difficulty of completing a successful adjustment of debt by the taxpayer in chapter 13.
The notion of increasing the debtor's debt service burden by adding interest to priority tax claims will almost certainly elicit a clamor in the legislature to provide the same privilege to other priority claims in bankruptcy, and possibly to other unsecured claimants as well.(218) Observed Prof. Williams:
Priority claims are the antithesis to the bankruptcy principle that similar
creditors be treated similarly. . . . Priority claims reduce the distribution
to general unsecured creditors and make it more difficult to reorganize.
Furthermore, to the extent the government insulates itself from the impact of
bankruptcy through the use of priority and nondischargeability treatment for
governmental claims, a bankruptcy system may be viewed as hypocritical if not
contemptuous.(219)
The notion of adding interest on priority claims is made without due appreciation for the problems, needs and motivations of individuals experiencing tax problems. In the typical debtor's attorney's office, the privilege of paying off nondischargeable taxes through chapter 13 without additional interest and penalties is one of the chief selling points to get a distressed taxpayer to take the plunge into chapter 13.(220) The no-interest feature of repayment in chapter 13 is clearly perceived by the average potential debtor as a major advantage to trying to cope with the problem outside of bankruptcy, because even an unsophisticated potential debtor senses how a small or manageable tax claim may skyrocket in a few years on account of interest and penalties.
Many taxpayers come into the law office only after years of trying to pay off an old tax claim through a voluntary payment plan, and having come to the depressing realization that the balance owed on the original tax claim has not only not shrunk, but in many cases is increasing due to runaway interest and penalties.
Finally, any further tilting of the balance of treatment as between the government and other priority or general unsecured creditors may embroil the courts in a new round of litigation over the Constitutional issues of due process and equal protection:
While, therefore, the Fifth Amendment forbids the destruction of a contract it does not prohibit bankruptcy legislation affecting the creditor's remedy for its enforcement against the debtor's assets, or the measure of the creditor's participation therein, if the statutory provisions are consonant with a fair, reasonable, and equitable distribution of those assets.(221)
DEFINITION OF "WILLFULLY" FOR PURPOSES OF
SECTION 523(a)(1)(C) OF THE BANKRUPTCY CODE
(COMMISSION TRACK NUMBER 602)
Present Law
Bankruptcy Code § 523(a)(1)(C) provides that a tax claim based on a fraudulent tax return or "with respect to which the debtor . . . willfully attempted in any manner to evade or defeat such tax" is nondischargeable.
Proposals Before the Commission
Commission Track Number 602. This proposal.
Task Force Position
The Task Force proposes that the Code should be amended to provide that the term "willful" as used in Bankruptcy Code § 523(a)(1)(C) be defined in a manner consistent with the criminal standard for willfulness under Internal Revenue Code § 7201, such that a finding of "willfully attempted to . . . evade or defeat such tax" must be supported by such affirmative act or acts as evidence a wrongful intention to avoid paying a lawful tax.
For purposes of this section, evidence of intent merely to defer payment, failure to file a lawfully required return when due, or to pay a lawful tax when due, shall not, without further evidence of affirmative misconduct evidencing an intent not to pay the tax, justify a finding of willful attempt to evade the tax.
Such a definition is consistent with the rulings of several recent cases holding that mere omission is not enough to constitute willful evasion. Thus, the Task Force proposes to codify the rule in Haas v. Internal Revenue Service, 48 F.3d 1153 (11th Cir. 1995).(222)
Reasons For Position
The Task Force proposes that the definition of "willful" be clarified in order to resolve a split in case decisions, and to bring the treatment of this issue closer to congressional intent. Failure to resolve the split in authority creates lack of uniformity in application of the laws, and continuing uncertainty among bankruptcy courts and professionals as to the rights and duties of debtors.
Some courts have interpreted "willful" to mean any act or omission evidencing failure to report or pay taxes when due. Thus, some courts have held taxes nondischargeable merely because the debtor failed to file tax returns or pay taxes, even in the absence of any affirmative conduct evidencing a bad purpose, or deliberate intention to avoid paying the tax.(223)
The Task Force believes that the better rule is that only affirmative misconduct, and not merely passive omissions (such as failure to file or pay) should be considered sufficient to support a finding of "willful" within the meaning of § 523.
Existing law under the Code provides for the discharge in bankruptcy of, among other things, "stale" income taxes, together with the concomitant interest and penalties as may have accrued in connection with such taxes.(224)
This privilege is intended to benefit the "honest but financially unfortunate debtor," and not "to create a tax evasion device" or to benefit a taxpayer who ". . . had otherwise attempted to evade" a tax.(225) The purpose of the discharge privilege is to permit . . . an industrious debtor to reestablish himself as a productive and taxpaying member of society."(226)
The Bankruptcy Code currently permits discharge of personal income taxes where the taxpayer may have filed his or her return late, but at least more than two years prior to the filing of the bankruptcy.(227) And, separate language in the section provides that the tax is dischargeable if the tax return in question was not fraudulent, and with respect to which the debtor had not ". . . willfully attempted in any manner to evade or defeat such tax"(228)
Accordingly, the Code contemplates that a taxpayer may have failed to file a return on time, but as long as he or she eventually files it the failure to file it in a timely manner would not by itself render the tax excepted from discharge.
The Code also obviously contemplates that a taxpayer may have failed to pay all or a portion of a lawful tax liability; the mere failure to pay the tax would seem to be insufficient by itself to render such tax nondischargeable, or else the whole portion of section 523 dealing with tax discharge would seem to be pointless; why provide for the discharge of unpaid taxes, and in the same breath provide that if one owes taxes he or she must be guilty of tax evasion, and therefore not eligible for discharge of the taxes?
This notion is similar to the argument that merely filing bankruptcy to escape a tax is, by itself, evidence of a willful attempt to evade the tax; such arguments have been raised in the past, and rejected by the courts. For example, the court in In re Peterson stated:
Seeking bankruptcy relief as soon as debts for taxes are arguably
dischargeable is not per se evidence of a willful attempt to evade the taxes. If
it were, then it would effectively negate the provisions of the Bankruptcy Code
which make debts for taxes generally dischargeable.(229)
In a similar vein the court in In re Williams rejected the argument that mere failure to pay the tax constituted willful evasion. Were mere failure to pay sufficient to constitute willful evasion, said the court, " . . . no debtor who owes taxes to the government would be entitled to the protection of the general bankruptcy discharge."(230)
Certainly, a pattern of failing to file returns or pay taxes, when considered along with the totality of circumstances, may indicate a bad intention by the debtor; such evidence, for example, is often cited in cases of tax protesters. However, typically, tax protesters perform other affirmative conduct making their lack of intention to pay the taxes quite clear.
The argument that mere failure to file a timely return by itself, or pay the tax when due by itself constitutes willful evasion, spreads the "evasion" net so widely as to scoop the vast majority of delinquent taxpayers into the nondischargeable category. An empirical study would probably demonstrate that a great many, if not a vast majority, of delinquent taxpayers who seek a fresh start in bankruptcy fall within the "honest but financially unfortunate debtor" who deserves bankruptcy protection. These are, after all, individuals and families who produced taxable income; else how could they owe taxes? They produced taxable income by being, or trying to be, productive participants in the economic life of the nation.
CONSOLIDATED RETURN ISSUES WHERE COMMON PARENT,
BUT NOT ALL SUBSIDIARIES, IS A DEBTOR
(COMMISSION TRACK NUMBER 604A)
Present Law
Under the Consolidated Return Regulations (Treas. Reg. § 1.1502-1 et. seq.) authorized by Section 1502 of the Internal Revenue Code (the "Consolidated Return Regulations"), an affiliated group of corporations, as defined in Section 1504 of the Internal Revenue Code, has the right to file a consolidated income tax return for Federal income tax purposes. The Consolidated Return Regulations require the members filing such a consolidated return (a "Consolidated Group") to report their combined results of operations and provide intricate and detailed rules for determining the consolidated tax liability of the Consolidated Group. These regulations also provide that each member of the Consolidated Group for any part of the year is severally liable for all of the taxes of the Consolidated Group for the year. Treas. Reg. § 1.1502-6.(231) Moreover, if a corporation ceases to be a member of the group it nevertheless remains liable for all the taxes of the Consolidated Group for any year during which it was a member of the group. Only the Common Parent of the Consolidated Group has authority as the sole agent for each of the members of the affiliated group to act for the subsidiaries in determining the tax liability of the group.
When the Common Parent is under the jurisdiction of the Bankruptcy Court, the court has the power under Section 505 to determine the taxes of the corporation. When other members of the Consolidated Group are also subject to the jurisdiction of the same Bankruptcy Court, it is not difficult to obtain a single determination of the tax liabilities of all of the members subject to the court's jurisdiction. It is not clear whether such a determination by the Bankruptcy Court of the tax liability of the Common Parent (and other filed members) for a tax year is binding on the Internal Revenue Service or the other corporations that were members of the Consolidated Group during such tax year, but that are not in cases under title 11 and joined in the proceeding. By the same token, when the Common Parent is in a title 11 proceeding, the other members of the Consolidated Group are precluded from filing a petition with the Tax Court for the redetermination of the Consolidated Group's tax liability. J & S Carburetor Co. v. Commissioner, 93 T.C. 166 (1989).
Proposals Before the Commission
Commission Track Number 604A. This proposal.
Task Force Position
The Task Force proposes that Section 505 and related provisions of the Bankruptcy Code be amended to provide that whenever the Common Parent of a Consolidated Group is under the jurisdiction of the Bankruptcy Court, the Bankruptcy Court has jurisdiction to determine the tax liability for all members of the Consolidated Group in a proceeding to determine the tax liability of the Common Parent, and that payment provisions applicable to the Common Parent, such as the priority of such tax liability under Section 507(a)(8) and the deferred payment provisions of Section 1129(a)(9)(C), apply equally to such members.
Reasons for Position
Under the Consolidated Return Regulations, the Common Parent of the Consolidated Group is appointed the agent for the Consolidated Group. For nearly all purposes, the Common Parent is the sole agent for each member of the Consolidated Group, "duly authorized to act in its own name in all matters relating to the tax liability for the consolidated return year" to the exclusion of the subsidiary. Treas. Reg. § 1.1502-77(a). Among the enumerated powers of the Common Parent is the power to "file petitions and conduct proceedings before the Tax Court of the United States." Id. Any such petition is considered as also having been filed by each subsidiary. Craigie v. Commissioner, 84 T.C. 466 (1985).
The Commissioner of Internal Revenue is not precluded by the automatic stay provisions of Section 362(a) from issuing a notice of deficiency to the Consolidated Group. The other members of the Consolidated Group have no individual authority to file Tax Court petitions seeking redeterminations of such tax liability, even if the Common Parent is in a title 11 proceeding and precluded by Section 362(a)(8) from filing a timely petition with the Tax Court for redetermination of the Consolidated Group's tax liability. J & S Carburetor Co. v. Commissioner, 93 T.C. 166 (1989). See also Entertainment Systems, Inc. v. Commissioner, 70 TCM (CCH) 460 (1995). This is true even if the corporations are former subsidiaries no longer members of the same Consolidated Group with the Common Parent.
The effect of these rules is that the unfiled corporations may have no effective prepayment remedy and may be subject to collection of the entire asserted consolidated return tax liability.(232)
For example, the Internal Revenue Service could issue a Notice of Deficiency (90 day letter) to the Common Parent in respect of the entire Consolidated Group demanding payment of $30 million dollars. The parent and the other filed subsidiaries, while subject to the automatic stay of Section 362, would not be at risk of collection efforts by the Internal Revenue Service. The unfiled subsidiaries would have no clear prepayment forum to litigate with the Internal Revenue Service the asserted tax deficiencies and at the end of the ninety days they might be subject to collection efforts by the Service. In order to provide absolute protection to its subsidiaries from collection of asserted consolidated return taxes and postpetition interest (as measured by the date of filing of the petition of the Common Parent) in respect of such consolidated return taxes, the Common Parent would be forced to cause bankruptcy petitions to be filed for subsidiaries that otherwise need not be subjected to the jurisdiction of the Bankruptcy Court. This needlessly increases the administrative burden on the Bankruptcy Courts.
In addition to the authority of the Common Parent with respect to Tax Court petitions, under the Consolidated Return Regulations, the Common Parent is authorized to file claims for refunds of taxes and, in general, payment to the Common Parent discharges any liability of the Internal Revenue Service. But see Treas. Reg. § 301.6402-7T (regarding refunds on carrybacks from insolvent financial institutions). Moreover, the Common Parent in its name will execute waivers of the statute of limitations (see Treas. Reg. § 1.1502-77(c)) and execute closing agreements. Clearly, the Common Parent by its actions can bind all of the members of the Consolidated Group.
The effect of these rules can be seen clearly by the following. At present it is unclear that a final order of the Bankruptcy Court following a Section 505 proceeding to determine the consolidated return tax liability in the Common Parent's case would bind the unfiled subsidiaries. The unfiled subsidiaries would not have been parties to the proceeding under Section 505. In contrast, the Common Parent, while subject to the jurisdiction of the Bankruptcy Court and prior to a final order of the court, could enter into a settlement of such tax matters and execute a closing agreement with the Internal Revenue Service with respect to the tax liability of the Consolidated Group for such tax year. The unfiled members would be bound by the administrative actions of the Common Parent in settling the tax liability of the Consolidated Group. Given the broad scope of the sole agency authority of the Common Parent, it is not inappropriate to make the actions taken with respect to the Common Parent in the parent's title 11 case the determinant for all members of the Consolidated Group. Since the Bankruptcy Court is authorized by Section 505 to determine the tax liability of the Common Parent when that corporation is subject to its jurisdiction, it makes little sense in terms of administrative and judicial efficiency not to stay collection efforts against the unfiled members of the Consolidated Group while action is stayed under Section 362 against the Common Parent and for such unfiled members not to be bound by such any determination of the consolidated tax liability of the Common Parent in a proceeding under Section 505.
As noted earlier, two other items deserve similar treatment. In addition to the determination of the tax liability of the Consolidated Group by reference to the determination with respect to the Common Parent, the priority status of the consolidated tax liability, the prepetition or postpetition status of interest payable with respect to the consolidated tax deficiency, the priority status of the taxes and any penalties and the payment terms under Section 1129(a)(9)(C) applicable to the Consolidated Group should also be determined by reference to the status of the Common Parent.
Finally, a similar rule should apply for state and local tax purposes where consolidated or combined returns are filed if the applicable law does not provide for a separate liability and separate contest rights for the nondebtor corporations.
DISCLOSURE STATEMENTS
(COMMISSION TRACK NUMBER 701)
Present Law
Bankruptcy Code § 1125(b) generally requires a debtor or other plan proponent to furnish creditors and equity security holders with a written disclosure statement before an acceptance or rejection of the plan can be solicited. The disclosure statement must be approved by the court before it can be distributed to such parties.
In order to approve the disclosure statement, a bankruptcy court must find that it contains "adequate information." "Adequate information" generally is defined as information of a kind, and in sufficient detail, that would enable a hypothetical reasonable investor typical of holders of claims or interests of the relevant class to make an informed judgment about the plan.
The extent to which tax-related information must be discussed in a disclosure statement in order to satisfy the "adequate information" requirement of Bankruptcy Code § 1125 currently is unclear. The actual practice of bankruptcy and tax attorneys appears to vary widely, with some disclosure statements providing a full and complete discussion of all or nearly all material tax matters while others providing only the most cursory discussion of tax matters. Occasionally, creditors are told nothing more than, in effect, "go see your own tax advisor."
The failure to analyze and discuss the tax aspects of a plan of reorganization sometimes results in serious consequences. In Smith v. Bank of New York,(233) a creditor proposed a plan of reorganization providing for the establishment of a liquidating trust, the funding of such trust with all of the debtor's assets and a sale of certain real property (valued at $255.3 million) to the creditor-proponent. The creditor-proponent's disclosure statement "failed to include any analysis of the state and federal tax consequences of consummation of the plan."(234) In particular, the disclosure statement failed to address whether the liquidating trust would owe any taxes and, if so, the amount by which distributions to creditors would be reduced because of such tax payments.
The creditor-proponent's plan was confirmed and became effective. The trustee of the liquidating trust subsequently was found liable to pay federal income taxes and consequently was unable to pay creditors the full amount they expected to be paid under the plan.(235) The trustee brought suit against the creditor-proponent for negligent misrepresentation regarding the liquidating trustee's tax obligations under the plan. The bankruptcy court found the creditor-proponent liable to the trustee on this claim.(236)
Proposals Before the Commission
Commission Track Number 701. This proposal.
Task Force Position
Amend Bankruptcy Code § 1125(b) to provide that the bankruptcy court shall not approve a disclosure statement unless it contains (1) a discussion of the material federal and state tax consequences of the plan to the debtor and any entity created pursuant to the plan, and (2) with respect to each class of claims and interests, a discussion of the material federal tax consequences of the plan to a hypothetical investor typical of the holders of claims or interests of the relevant class.
Reasons for Position
As the Bank of New York case indicates, a failure to discuss the plan of reorganization's tax consequences in the disclosure statement can result in seriously misleading creditor constituencies and other parties in interest about the plan's economic effects.
There is no justification for allowing a plan proponent to ignore a plan's tax consequences in the disclosure statement. A plan's tax consequences represent an important aspect of the plan and should be fully discussed to the extent they are material.
A chapter 11 debtor or other plan proponent who possesses the financial resources to propose a plan of reorganization and draft a disclosure statement is likely to possess the necessary resources to analyze the plan's tax effects.
From a bankruptcy court's standpoint, the feasibility of a plan of reorganization cannot be properly evaluated unless the plan's material tax consequences to the debtor have been identified. An understanding of the plan's tax consequences will aid the bankruptcy court in making the feasibility determination required for plan confirmation by Bankruptcy Code § 1129(a)(11).
From a creditor's standpoint, information regarding the plan's tax effects has twofold importance. First, information concerning the plan's tax effect on the debtor aids the creditor in making its own determination whether the debtor can successfully reorganize. Naturally, this will influence the creditor's decision to accept or reject the plan. Second, information concerning the tax effect of the plan on a hypothetical creditor in such creditor's own class will aid the creditor in determining its own tax consequences under the plan.
From a debtor's standpoint, a requirement that the disclosure statement address material tax matters affecting the debtor is in a debtor's enlightened self-interest. It will reduce the likelihood of unpleasant tax surprises in the post-effective date period.
Smith v. Bank of New York shows what can occur when a disclosure statement fails to address the material tax issues inherent in a plan of reorganization. The amendment of section 1125 as proposed by the Task Force will preclude a recurrence of this type of case.
The Task Force's proposal adopts a middle position between the extremes of no tax disclosure at all and burdensome tax disclosure. The actual tax effect of a plan on creditors may vary from creditor to creditor based upon a creditor's accounting period and method and the tax basis in its claim. Likewise, the effect of a plan on a creditor under state tax law may vary from state to state. A debtor or other plan proponent cannot be expected to provide each creditor with individually tailored tax information; it would be impractical and unreasonably expensive. On the other hand, addressing the material federal tax matters affecting a hypothetical creditor or equity security holder in each class created under the plan is not burdensome, and a plan proponent fairly can be required to supply such information in its disclosure statement.
SUBORDINATION OF TAX PENALTIES
(COMMISSION TRACK NUMBERS 703 AND 704)
Present Law
Noncompensatory prepetition tax penalty claims are subject to subordination in Chapter 7 cases under the authority of Section 726(a)(4) of the Bankruptcy Code. There is no corresponding authority in Chapter 7, however, for the subordination of penalties relating to postpetition taxes. Nor does Chapter 11 provide any automatic subordination; tax penalties are entitled to priority over all other unsecured claims by virtue of Section 507(a)(1) and 503(b)(1)(C), in the case of postpetition taxes, and Section 507(a)(8)(G), in the case of prepetition taxes. Moreover, recent Supreme Court decisions have struck down the use of equitable subordination under Section 510(c) as a basis for categorical subordination of tax penalties, although general principles of equitable subordination may allow a bankruptcy court to subordinate a tax penalty when justified by particular facts. U.S. v. Reorganized CF&I Fabricators of Utah, Inc., 116 S. Ct. 2106 (1996); U.S. v. Noland, 116 S. Ct. 1524 (1996).
Proposals Before the Commission
Commission Track Numbers 703 and 704. This proposal.
Task Force Position
Amend Section 507(a)(8) of the Bankruptcy Code to exclude subsection (G) (affording priority status to "a penalty related to a [tax claim] and in compensation for actual pecuniary loss"), and amend Section 510 to add a new subsection (d) providing for the subordination of all such tax penalties to claims of ordinary unsecured creditors.
Reasons for Position
Before the 1996 Supreme Court decisions in Noland and CF&I, a majority of lower courts had concluded that bankruptcy courts could and should subordinate tax penalties in chapter 11 cases on general equitable grounds. Although Section 510(c) does not define the phrase "principles of equitable subordination," the legislative history includes the following statement by the House sponsor of the Bankruptcy Code:
It is intended that the term "principles of equitable subordination" follow existing case law and leave to the courts development of this principle. To date, under existing law, a claim is generally subordinated only if [the] holder of such claim is guilty of inequitable conduct, or the claim is of a status susceptible to subordination, such as a penalty . . . .
124 Cong. Rec. 32,398 (1978) (Rep. Edwards).
Notwithstanding Representative Edwards's statements, however, the actual state of the case law at the time Section 510(c) was enacted was that the doctrine of equitable subordination always required creditor misconduct and never was based merely on a "status susceptible to subordination, such as a penalty." Nevertheless, perhaps partly on the strength of the legislative history, many circuit courts thereafter reasoned that government misconduct was not a prerequisite to the equitable subordination of tax penalties. In re C-T of Virginia, 977 F.2d 137 (4th Cir. 1992), cert. denied, 113 S. Ct. 1644 (1993) (excise tax on reversion of pension assets denied priority status); Cassidy v. Dumler (In re Cassidy), 983 F.2d 161 (10th Cir. 1992) (excise tax on premature withdrawal of pension funds denied priority status); In re Virtual Network Services Corp., 902 F.2d 1246 (7th Cir. 1990) (employment tax held unenforceable penalty in bankruptcy); Schultz Broadway Inn v. U.S., 912 F.2d 230 (8th Cir. 1990) (court should consider equities in applying subordination test; stamp tax subordinated as penalty); In re Burden, 917 F.2d 115 (3d Cir. 1990) (tax penalties may be subordinated after weighing of equities); In re Seneca Oil Co., 906 F.2d 1445 (10th Cir. 1990) (denying subordination because claim found not to be penalty); In re Unified Control Systems, Inc., 586 F.2d 1036 (5th Cir. 1978) (pension excise tax under Internal Revenue Code § 4971 held unenforceable penalty under Bankruptcy Act); but see In re Mansfield Tire & Rubber Co., 942 F.2d 1055 (6th Cir. 1991), cert. denied, 112 S. Ct. 1165 (1992) (pension excise tax deemed "tax," not penalty, under "plain meaning" rule).
Even if the Supreme Court had not overruled this line of cases in Noland and CF&I, the former approach created a difficult problem: it raised the specter of extending equitable subordination to other types of claims in which no creditor misconduct was proven, which is anathema to the investment community and could chill the availability of credit. This concern would be addressed by a statutory amendment that was limited specifically to tax penalty claims.
Granting a priority to penalties works an unfairness on general unsecured creditors by, in effect, punishing them for the debtor's wrongdoing. The unreasonableness of this result is partially recognized by the express subordination of tax penalties to general unsecured claims in chapter 7 cases. While there is every reason to enforce a tax penalty in preference to the retention of equity, there is no obvious policy justification for enforcing a tax penalty in preference to innocent creditors who have suffered pecuniary loss.
Absent a statutory amendment, unsecured creditors will have only one realistic means of protecting their recoveries from devastation by potentially huge tax penalty claims: they may rely on their right to receive at least as much as they would have received in a liquidation (the so-called "best interests of creditors" test codified at Section 1129(a)(7)). Because prepetition tax penalty claims are clearly subordinated by statute, the allowance of any such claim in a significant amount would prevent unsecured creditors from receiving distributions as large as they could have expected in a chapter 7 liquidation, even taking into account the expected discrepancy between the going-concern and liquidation values of the debtors' estate. This approach offers little comfort to creditors, however, because it requires difficult and often expensive litigation over the projected value of distributions in a theoretical liquidation. Thus, Section 510 should be amended to generally subordinate tax penalties to the claims of unsecured creditors.
A possible middle ground is the subordination only of those penalties that relate to prepetition taxes. Granting a priority to penalties for postpetition taxes would create an incentive for creditors to monitor and work with the debtor to prevent the estate's failure to pay all taxes when due postpetition. Granting a priority to penalties for prepetition taxes would serve no such purpose and, in fact, would not address the purported policy underlying tax penalties in any defensible way.
APPENDIX A
Guide to Track Numbers and Cross-References
A reader unfamiliar with the development of the Commission's tax proposals will undoubtedly find the numbering system and designation of source material perplexing.
The first submission to the Commission containing proposals now being considered was made by the Internal Revenue Service in a letter dated August 28, 1996 to the Commission from Joyce E. Bauchner. That submission is in the form of a letter with a series of attachments writing up proposals and suggesting statutory language. Unfortunately, the pages containing the proposals and suggested statutory language are not numbered. At the request of the Commission, the Internal Revenue Service resubmitted its positions on March 10, 1997 by letter to Professor Jack Williams, Chairman of the Advisory Committee, from Robert A. Miller. The proposals are the same proposals made in the August 28, 1996 letter but this letter contains a table of contents and all of the pages are numbered. We have referred to this second letter in this report as the "IRS Proposal" and page references are to pages in the IRS Proposal. Each of these documents is on file with the Commission.
The Department of Justice created its own Bankruptcy Working Group, which considered both tax and nontax issues. It submitted a legislative proposal to the Commission dated September 1996. This document is on file with the Commission. References in this report to the "Justice Proposal" are to that report, and page references are to pages in that report.
In connection with the September 1996 meeting of the Commission in Santa Fe, New Mexico, Commissioner Shepard prepared a list of discussion issues posing questions and containing editorial comments. References in this report to "Santa Fe Discussion Issues" are to Commissioner Shepard's memorandum. In all cases we have referenced these by page number and outline item number, because of the large number of proposals made by Commissioner Shepard in that memorandum.
Under procedures adopted by the Commission, when an item is ripe for a proposal by the Government Working Group the staff of the Commission writes up a proposal for discussion by the Working Group. Each of these is given a number and is designated, for example, Government Working Group Proposal No. 1, Government Working Group Proposal No. 10, Government Working Group Proposal No. 17. The Government Working Group has tentatively adopted some of these proposals but has yet to formally consider others of them at a meeting. Chairman Williamson has informed us that every tax issue is still open, regardless of previous tentative action by the Government Working Group. Accordingly, whenever there is a Government Working Group proposal covering an issue, we have cited it by number, regardless of whether the Commission has yet tentatively adopted it.
At the January meeting of the Commission, there was distributed to the public a substantial number of draft Government Working Group proposals, which, we are informed, were rough first drafts. None of these drafts has a number, and none of them has been discussed by the Commission. However, since they have been publicly disseminated, we have sometimes referred to them in the report as an "Unnumbered Government Working Group proposal." By so doing, we do not mean to imply that the Government Working Group has adopted them, either tentatively or finally, but each of them reflects some proposal of the IRS, Department of Justice or Commissioner Shepard.
As set forth in the Preface, on December 23, 1996 Mr. Case and Ms. Frasier promulgated the first matrix listing briefly describing each of the proposals then before the Commission, all coming at that time from either the IRS, the Department of Justice or Commissioner Shepard. Mr. Case and Ms. Frasier adopted a numbering system which in part reflected an attempt by them to prioritize all of the proposals. Those in a 100 track, for example, were high priority items and those in a 500 track were low priority items. As the Commission and the Advisory Committee have considered these proposals, they have kept Mr. Case's and Ms. Frasier's initial matrix numbers, with the exception that they have split multiple proposals into component parts (hence numbers like 414, 414A and 414B) and have added new track numbers for subsequent proposals, including the proposals herein. Although the numbering system has remained the same, there should be no implication that the original priority designations have any further meaning. The Commission has dropped some items with relatively "high" priority numbers and is actively considering some items with relatively "low" priority numbers because such consideration has been pressed upon the Commission by proponents of the various proposals.
This report makes no effort to prioritize items or to subdivide them into subject matter categories. Simply for convenience of those who have followed the Commission's work, we have put all of our comments in the numbering sequence of the December 23, 1996 matrix and its subsequent revisions.
APPENDIX B
Dissenting Views
This product is a group effort. Obviously, the process must begin with one member drafting a proposal, but we have tried, where possible, to reach consensus. Each recommendation has been circulated to the members of the Task Force and many proposals reflect member comments. Several proposals were changed after circulation of the original draft.
In spite of the foregoing, it should not be assumed that all members agree with the substance of every proposal, and certainly not with every word of the draft. In particular, one of our members, Diane E. Tebelius, who is an Assistant United States Attorney from Seattle, Washington, wishes it to be noted that while she values membership on the Task Force, she does not agree with all the views expressed herein.
Members were invited to express strongly held dissenting views. One, Kenneth C. Weil, wishes the following views to be noted with respect to Commission Track Number 211, dealing with the burden of proof.
"The Task Force proposes that a taxpayer's burden of proof in Bankruptcy Court should not differ from the taxpayer's burden of proof in other forums. The Task Force also proposes a complicated burden shifting rule if the trustee or creditor objects to the government's claim, rather than the debtor.
"In rebuttal, there is a view that the government should not receive treatment different from other creditors in bankruptcy courts. The prevailing rule in circuits where the government has the identical burden as other creditors can be expressed as follows: A properly filed claim constitutes prima facie evidence of a claim's validity; the debtor has the burden of rebutting this prima facie validity; if that burden is met, the creditor must present evidence to prove the claim. Franchise Tax Bd. of Cal. v. MacFarlane (In re MacFarlane), 83 F.3d 1041, 1044-1045 (9th Cir. 1996), cert. denied, ___ U.S. ___ (March 17, 1997).
"A primary objection to leaving the ultimate burden on the government is that the taxpayer has the records. However, if the taxpayer does not produce those records, then the taxpayer cannot rebut the prima facie validity of the proof of claim. Thus, the issue of "who has the records" is a red herring.
"The Task Force's burden shifting rule also adds unnecessary work for the creditor or trustee who objects to the government's claim.
"The government's burden of proof should be identical to any other creditor's."
1. See American Bar Association, Section of Taxation, Manual on Government Submissions (September 1996).
2. Publ. L. No. 103-392, 108 Stat. 4106.
3. Letter to the Commission from Joyce E. Bauchner dated August 28, 1966. The IRS reordered these proposals by letter of Robert A. Miller to Prof. Jack Williams dated March 10, 1997. The latter document is hereinafter referred to as the "IRS Proposal."
4. Report of the Department of Justice Bankruptcy Working Group (September 1996). This report contains many proposals in addition to tax proposals. We refer to this document as the "Justice Proposal."
5. National Bankruptcy Review Commission, Government in Bankruptcy Focus Meeting, Santa Fe, New Mexico, September 18, 1996, Suggested Discussion Issues - Tax ("Santa Fe Discussion Issues").
6. See, e.g., National Bankruptcy Conference, Reforming the Bankruptcy Code (May 1, 1994); Asofsky, "Towards a Bankruptcy Tax Act of 1993, "51st N.Y.U. Institute on Fed. Tax'n Chapter 13 (1993); Report of the Section 108 Real Estate and Partnership Task Force, 46 Tax Law. 209 (1991), 46 Tax Law. 397 (1993).
7. Mark Browning, Stephen Csontos, Robert Miller and Joan Pilver.
8. Paul Asofsky, Robert McKenzie, Mark Segal and Kenneth Weil.
9. Professor Grant Newton and Professor Jack Williams. Professor Williams was designated by the Commission to chair the Advisory Committee.
10. See S.J. Res. 88, 84 Stat. 468, 91st Cong., 2d Sess. (1970); see also S. Rep. 91-240, 91st Cong., 1st Sess. (1969); H. Rep. 91-927, 91st Cong., 2d Sess. (1970).
11. See Report of the Comm. on the Bankruptcy Laws of the United States, H.R. Doc. No. 93-137, Part II, 93d Cong., 1st Sess. (1973).
12. See Report of the Comm. on the Bankruptcy Laws of the United States, H.R. Doc. No. 93-137, Part I, 93d Cong., 1st Sess. (1973). A third volume included selected papers prepared for the Commission's study.
13. See id. ch. 12.
14. See Plumb, The Tax Recommendations of the Commission on the Bankruptcy Laws--Tax Procedures, 88 Harv. L. Rev. 1360 (1975); Plumb, The Tax Recommendations of the Commission on the Bankruptcy Laws--Reorganizations, Carryovers and the Effects of Debt Reduction, 29 Tax L. Rev. 229 (1974); Plumb, The Tax Recommendations of the Commission on the Bankruptcy Laws--Income Tax Liabilities of the Estate and the Debtor, 72 Mich. L. Rev. 935 (1974); Plumb, The Tax Recommendations of the Commission on the Bankruptcy Laws--Priority and Dischargeability of Tax Claims, 59 Cornell L. Rev. 991 (1974).
15. See Changes in Bankruptcy Tax Law Hearings on H.R. 9973 Before the House Comm. on Ways and means, Serial 95-61, 95th Cong; 2d Sess. (1978) at 116; The Bankruptcy Tax Act and Minor Tax Bills: Hearings on H.R. 5043 Before the Subcomm. on Select Revenue Measures of the House Comm. on Ways and Means, 96th Cong., 1st Sess (1979) at 175; Written Comments on Certain Aspects of H.R. 5043, Bankruptcy Tax Act of 1979 (Comm. Print 1980) at 5; Miscellaneous Tax Bills VII: Hearings on S.2484, S.2486, S.2500, S.2548 and H.R. 5043 Before the Subcomm. on Tax'n and Debt Management Generally of the Senate Comm. on Finance, 95th Cong. 2d Sess. (1980) at 5.
16. These recommendations are arranged in numerical order according to the Case/Frasier matrix. See Appendix A, "Guide to Track Numbers and Cross-References."
17. H.R. Rep. No.595, 9th Cong., 1st Sess. 382 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 6338.
18. Bankruptcy Act § 67c, as amended by the Chandler Act, P.L. No. 696, 52 Stat. 877 (June 22, 1938); P.L. No. 546, 66 Stat. 427 (July 7, 1952); P.L. No. 89-495, 80 Stat. 269 (July 5, 1966); and Bankruptcy Code § 724(b).
19. Fed. R. Bankr. P. 3002(a). Bankruptcy Rule 3002(a) also requires holders of equity securities to file proofs of interests in order for their interests to be recognized in the debtor's bankruptcy case. The filing requirements for the holders of equity securities are virtually identical to the filing requirements of creditors. For the sake of simplicity, however, this comment will discuss the Bankruptcy Rules only as they apply to creditors.
20. Chapter 9 of the Bankruptcy Code applies when the debtor is a municipality. Chapter 11 of the Bankruptcy Code generally involves the reorganization of a business; however, it can, at times, apply when the debtor is an individual.
21. Fed. R. Bank. P. 3003(b)(1).
22. Chapter 7 involves the liquidation of the assets of an individual or an entity. Most chapter 7 cases involve individuals.
23. Chapter 12 involves the adjustment of debts of a family farmer with a regular annual income.
24. Chapter 13 involves the adjustment of debts of an individual with a regular income.
25. The Task Force takes no position as to whether any notices related to environmental clean-up costs specify each particular property involved.
26. No tax liability attributable to an unfiled return can be discharged in a bankruptcy proceeding. Bankruptcy Code §523(a)(1)(B)(i).
27. 27. See Official and Procedural Bankruptcy Forms (As Amended to November 1, 1995) generally and Forms 6 and 7 specifically. A separate schedule does exist for unsecured priority claims, which can cover some unpaid some tax claims. See Official Form Schedule E - CREDITORS HOLDING UNSECURED PRIORITY CLAIMS. See also Rule 1007, F.R.Bankr.P.
28. I.R.C. § 108(b)(2)(E) requires the basis adjustment; § 1017 defines the manner in which the adjustment should be made.
29. See Fed. R. Bank. P. § 2004.
30. Indeed the Chapter 11 debtor must report the COD income and make the adjustments required by § 108.
31. At any time a creditor or trustee desires, the debtor can be required to appear and produce all tax returns and other financial data necessary to determine the tax consequences of liquidating the debtor's assets in a Rule 2004 examination. No litigation needs to be initiated.
32. I.R.C. § 6012(a)(9) for individual estates in chapter 7 or 11; and (b)(3) for trustees for corporations under Title 11, whether in Chapter 7 (liquidation) or Chapter 11 (Reorganization).
33. In an abandonment, the trustee actually determines only if the asset has little value to the estate and is burdensome to the estate. The Trustee does not have to consider any adverse tax consequences to the debtors if the property is abandoned. Johnston v. Webster, 49 F.3d 528 (8th Cir. 1995).
34. In re Allegheny Int'l, Inc., 954 F.2d 167 (3d Cir. 1992); In re Fullmer, 962 F.2d 1463 (10th Cir. 1992). See cases collected at Lawyers Edition, Bankruptcy Service,§ 6B20 (1996).
35. Id. See also Henderson & Goldring, Failing & Failed Businesses, § 1013.4 (Little Brown 1996).
36. See, e.g., Tax Court Rule 142(a), "The burden of proof shall be upon the petitioner, except as otherwise provided by statute or determined by the Court; and except that, in respect of any new matter, increases in deficiency, and affirmative defenses, pleaded in the answer, it shall be upon respondent." The most significant statutory exception is for fraud, which the Service must prove by clear and convincing evidence. I.R.C. § 7454.
37. Franchise Tax Board v. Macfarlane, 83 F.3d 1041 (9th Cir. 1996); In re Placid Oil Co., 988 F.2d 554 (5th Cir. 1993); In re Fullmer, 962 F.2d 1463 (10th Cir. 1992).
38. In re Landmark Equity Corp., 973 F.2d 265 (4th Cir. 1992); Resyn Corp. v. United States, 851 F.2d 660 (3d Cir. 1988); United States v. Charlton, 2.F.3d 237 (7th cir. 1993).
39. See In re Gran, 964 F.2d 822 (8th Cir. 1992) and In re Uneco, Inc., 532 F.2d 1204 (8th Cir. 1976).
40. Justice Proposal at p. 87 (September 1996).
41. See letter from Hon. Arthur J. Spector to the Reporter for the Commission dated February 6, 1997. Judge Spector believes that the debtor should bear the burden if a successful outcome would inure to his benefit, but the government should bear the burden if other creditors are the real parties in interest.
42. 42. I.R.C. §6001.
43. 43. I.R.C. §7203.
44. 44. Bankruptcy Code §523(a)(1)(B)(i).
45. 45. I.R.C. §1398.
46. 46. I.R.C. §6012(b)(4).
47. 47. Id.
48. 48. Id.; Bankruptcy Code §1107(a).
49. 49. I.R.C. §§1398, 6012(a)(1).
50. 50. I.R.C. §1398(a).
51. 51. Elkins v. Commissioner, 88-1 U.S.T.C. Para. 9338 (Bankr. D.C. 1988) (chapter 13 case).
52. 52. I.R.C. §1399.
53. 53. I.R.C. §6012(b)(3), Bankruptcy Code §1106(a)(6).
54. 54. I.R.C. §6012(a)(2), Bankruptcy Code §§1106, 1107(a).
55. 55. I.R.C. §7203.
56. 56. Bankruptcy Code §1129(a)(9)(A).
57. 57. Bankruptcy Code §§ 1222(a)(2) (chapter 12), 1322(a)(2) (chapter 13).
58. 58. See text accompanying footnote 5, supra.
59. 59. Bankruptcy Code § 727(a)(1).
60. 60. See text accompanying footnote 6, supra.
61. 61. Cf. Bankruptcy Code § 1129(a)(11)(feasibility requirement).
62. 62. Bankruptcy Code § 507(a)(8)(A), (D), (E).
63. 63. See text accompanying footnote 18 supra.
64. 64. Bankruptcy Code § 1129(a)(9)(A).
65. 65. Bankruptcy Code §§ 1222(a)(2), 1322(a)(2).
66. 66. Bankruptcy Code §§ 1226(b)(1), 1326(b)(1).
67. 67. Bankruptcy Code §523(a)(1)(B)(ii).
68. 68. Bankruptcy Code §1322(a)(2) and 11 U.S.C. §1328(a).
69. 69. In re Daniel, 170 B.R. 466 (Bankr. S.D. Ga. 1994) at page 468 (exceptions to discharge do not apply to a §1328(a) discharge.")
70. 70. In re Bailey Bradley, 36 B.R. 655 (Maryland 1984).
71. 71. Bankruptcy Code §523(a)(1)(C).
72. 72. Bankruptcy Code §1322(a)(2).
73. 73. In re Muina, 75 B.R. 192 (S.D. Florida 1987).
74. 74. A discussion of factors to be considered in determining the good and bad faith of the plan may be seen in In re Coburn, 1994 B.R. LEXIS 1875 (B.R. D. Oregon 1994).
75. The courts generally have rejected using either I.R.C. § 6621 or the federal judgment rate (28 U.S.C.A. § 1961) as per se benchmarks, although some courts have viewed such rates as relevant in their determination. See, e.g., Southern States Motor Inns, Inc., 709 F.2d 647 (11th Cir. 1983), cert. denied, 465 U.S. 1022 (1984); In re Camino Real Landscape Contractors, Inc., 818 F.2d 1503 (9th Cir. 1987); U.S. v. Neal Pharmacal Co., 789 F.2d 1283 (8th Cir. 1986).
76. The rate on underpayments is equal to 3% above the average market yield on 3 year Treasury obligations during the first month of the preceding calendar quarter. I.R.C. §§ 6621(b) and 1274(d).
77. I.R.C. § 6621(c).
78. Compare In re Volle Electric, Inc., 139 B.R. 451 (C.D. Ill. 1992) (Court approved small payments initially and large fuel balloon payment) with In re Mason & Dixon Lines, Inc., 71 B.R. 300 (Bankr. M.D.N.C. 1987) (Court rejected plan provides for single balloon payment at end of six years). See also In re Gregory Boat Co., 144 B.R. 361 (Bankr. E.D. 1992); In re Sanders Coal & Trucking, Inc., 129 B.R. 516 (Bankr. E.D. Tenn. 1991).
79. See, e.g., In re Snowden's Landscaping, 110 B.R. 56 (Bankr. S.D. Ala. 1990).
80. Similarly, to protect the holder of the priority tax claim, a debtor should be required to pay accrued interest on an annual or more frequent basis, as the bankruptcy court determines.
81. In re Collins, 184 B.R. 151 (Bankr. N.D. Fla. 1995); In re Cline, 100 B.R. 660 (Bankr. W.D.N.Y. 1989).
82. Bankruptcy Code § 362(a)(7).
83. Local rules and standing orders in some districts allow taxing authorities to make some such setoffs without a motion. See Justice Proposal, p. 100; IRS Proposal, p. 16.
84. If the taxing authority assesses the tax against the estate, debtor or trustee, if the assessment is not satisfied out of the estate's assets or discharged on the termination of the title 11 case, they may be collected from the debtor thereafter. Bankruptcy Code §§ 505(a)(2)(B), 505(c) and 523.
85. I.R.C. § 1398(a). The rules provided by the section do not apply if a case, once having been commenced, is subsequently dismissed. I.R.C. § 1398(b). In such case, presumably, the individual files the same returns and reports the same income as if the bankruptcy case had never been commenced.
86. I.R.C. § 1398(c)(1). The tax rates are those applicable to married individuals filing separately. I.R.C. § 1398(c)(2).
87. Bankruptcy Code § 346(b)(1).
88. Bankruptcy Code § 346(d).
89. Bankruptcy Code § 728(b). 11 U.S.C. § 1146 requires a chapter 11 return, but it is not limited to a situation in which there is net taxable income during the entire period of administration of the case.
90. Bankruptcy Code § 1231(b).
91. The latter sections deal with gain recognition and tax attribute carryovers when property is transferred between the estate and the debtor. Once separate entity classification is repealed, these provisions will become obsolete.
92. This section terminates the taxable year of an individual when a chapter 12 case is filed. Once separate entity classification is repealed, this provision will become obsolete.
93. I.R.C. § 1398(c).
94. I.R.C. § 1398(d)(1).
95. I.R.C. § 1398(d)(2). This section also contains special rules coordinating the taxable years of nonbankrupt spouses to enable such spouses to file joi