(Revised)
Arizona State Bar, Bankruptcy Section
August 30, 2005
September 9, 2005
September 14, 2005
Tracy S. Essig, Esq.
§ 362. Automatic stay.
(b) The filing of a petition under section 301, 302, or 303 of this title, or of an application under section 5(a)(3) of the Securities Investor Protection Act of 1970, does not operate as a stay--
(9) under subsection (a), of--
(A) an audit by a governmental unit to determine tax liability;
(B) the issuance to the debtor by a governmental unit of a notice of tax deficiency;
(C) a demand for tax returns; or
(D) the making of an assessment for any tax and issuance of a notice and demand for payment of such an assessment (but any tax lien that would otherwise attach to property of the estate by reason of such an assessment shall not take effect unless such tax is a debt of the debtor that will not be discharged in the case and such property or its proceeds are transferred out of the estate to, or otherwise revested in, the debtor).
The automatic stay does not prevent an audit. However, the lien that would arise under statute upon the audit becoming a final assessment cannot take effect. See Section IX herein.
Determination of Tax Liability
11 U.S.C. § 505
Section 505 (11 U.S.C. § 505)
§ 505. Determination of tax liability.
Section 505(a) of the Bankruptcy Code allows a debtor to have a Bankruptcy Court determine the amount or even the legality of a certain types of taxes, as well as any interest or penalties relating to the tax. If the debtor has already litigated the amount or legality of the tax, then he/she/it cannot bring it before the Bankruptcy Court under Section 505(a). Alert: under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (hereinafter “BAPCPA”), ad valorem taxes (property taxes) cannot be challenged if the time for appeal under applicable non-bankruptcy law has expired. 11 U.S.C. § 505(b)(2) (C).
BAPCPA ALERT: A governmental entity can now file with the Clerk of the Court a designated place to receive service of the return and/or any protest of a liability which can be challenged under § 505.
Taxing authorities can have statutes which directly impact their claim. Each agency/governmental entity may have/not have such provisions or statutory powers. A statute check would be required to determine the exact limitations/powers of a governmental entity. For example, the date of when the taxing authority’s lien takes effect is governed by statute. The following is an example of a taxing authority’s lien:
An example of a state tax lien
A. If any tax, interest or penalty which the department is required to collect is not paid by a taxpayer when due, such unpaid amounts constitute a lien upon all property and rights to property, whether real or personal, belonging to the taxpayer or acquired by him from the date the amounts are assessed or the date the return prescribing the liability is filed until the liability for the assessed amounts is satisfied.
A.R.S. Section 42-1151(A).
Upon a final assessment, the taxing authority may pursue collections against the taxpayer. The property the lien can attach to is also governed by statute. For example, the homestead exemption is not enforceable against the Arizona Department of Revenue. A.R.S. §42-1202. However, unless the lien is “perfected,” the taxing authority cannot affect collections against the taxpayer’s property where other creditors hold a perfected superior secured interest. Again, this limitation is per statute. See A.R.S §§ 42-1151, et seq. BAPCPA ALERT: Taxing authorities’ liens were not subject to avoidance by a Bankruptcy trustee/debtor under Bankruptcy Code § 545. Under the revisions to the Bankruptcy Code, this is no longer true. A taxing authorities lien can be avoid now per §545, where appropriate.
A. General
The priority of the claim is set forth in Section 507 of the Bankruptcy Code. This Section establishes the order in which the various creditors’ unsecured claims are paid in all chapters of bankruptcy. This provision does not apply to secured tax liabilities (assuming that the taxing authority’s claim is fully secured; it can be split becoming both secured and unsecured. The latter would need to be analyzed to see if it qualifies as a priority tax.
The order of priority was created by Congress. BAPCPA ALERT: Congress did change the order of priorities under ss507. Administrative expenses (i.e. attorney’s fees, post-petition taxes set forth in § 503(b)(1)(B), etc) now are second in order of priority, behind domestic support obligations and chapter 11 trustee fees versus a chapter 7 trustee’s.
BAPCPA ALERT: Administrative tax liabilities have been modified. The Bankruptcy Code now clearly states that taxes are entitled to administrative status, including property taxes. Id. It further states that the post-petition taxes (administrative expenses) shall be paid and not request for payment should be required. Id. This is consistent with the requirements of 28 U.S.C. 960 which requires that post-petition taxes be paid, which certain exceptions, i.e. taxing authority excuses it, it was a tax incurred prior to a Chapter 7 trustee taking over the business, a court finding of “probable insufficiency of funds.” Also, the failure to keep current on the post-petition taxes, both the filing of the returns and the payment of the liabilities there under, are grounds for dismissal or conversion in Chapter 11 bankruptcy. See 1112(b)(4)(I). To note, BAPCPA does require a debtor to have filed those pre-petition tax returns or face dismissal or conversion [§ 1308(c)(11)] or denial of confirmation [1328(a)(4)].
Section 507(a)(8) determines which pre-petition taxes are entitled to priority treatment. It is the type of tax that will govern whether it is entitled to priority treatment under the Bankruptcy Code. The analysis of the type of tax is based on its statutory language as interpreted versus how it viewed in the “tax arena.” For example, it is commonly stated that in Arizona there is a “sales tax” and that it would be a excise tax. In the tax world that may be true. However, under the statute, Arizona has a gross receipts tax, thereby directly impacting which provision of § 507 applies. No difference exists between transaction privilege taxes and income taxes under the Bankruptcy Code.
Taxes, also, are not merely a tax because it is called one. Like wise, the opposite is true. Thus, the scope of what can be a tax can be quite broad (i.e. worker’s compensation payments to an injured employee when the employer did not have the requisite insurance).
BAPCPA ALERT: Note that any time period contained in § 507(a)(8) shall, as to a governmental unit, be suspended in certain circumstances. The stay shall be for any period of time, for a specific time period based upon a given event having occurred, such as: the governmental unit was prohibited from collecting the tax due to applicable non-bankruptcy law as a result of a request by the debtor for a hearing and an appeal of any collection action taken or proposed to be taken; a bankruptcy stay was in effect or where collections was stayed due to the existence of a plan, plus 90 days added to whatever extensions would occur based upon the event which applies. § 507(a)(8) (unmarked, look to the end of that provision).
1. Income and/or Transaction Privilege Taxes.
11 U.S.C. § 507(a)(8)(A)
Bankruptcy Code § 507. Priorities.
(a) The following expenses and claims have priority in the following order:
(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 for a taxable year ending on or before the date of the filing of the petition --
(i) for which a return, if required, is last due, including extensions, after three years before the date of the filing of the petition;
(ii) assessed within 240 days before the date of the filing of the petition exclusive of –-
(I) any time during which an offer in compromise with respect to that tax was pending or in effect during that 240-day period, plus 30 days; and
(II) any time during which a stay of proceedings against collection was in effect under this title during the 240-day period, plus 90 days.
(iii) other than a tax of a kind specified in section 523(a)(1)(B) or 523(a)(1)(C) of this title, not assessed before, but assessable, under applicable law or by agreement, after, the commencement of the case;
Steps to Follow
1. Is the tax an unsecured claim?
If yes, proceed to the next question.
If no, the priority provision of the Bankruptcy Code does not apply.
2. Is the tax for income or gross receipts (e.g., transaction privilege taxes, commonly referred to in Arizona as “sales tax”)?
If no, see other subsections (B) through (E) of § 507(A)(8)
If yes, do one of the follow rules apply:
the three (3) year rule --507(a)(8)(A)(i)
the 240 day rule -- 507(a)(8)(A)(ii)
the not assessed but assessable rule -- 507(a)(8)(A)(iii)
The Three (3) Year Rule -- 507(a)(8)(A)(i)
The key focus of the “Three Year Rule” is the date the return was required to be filed. Look to the type of tax involved, applicable statutes and regulations; and what the debtor is – an individual’s filing requirement may be different then a business entities’. The common cause of confusion is that the date the return was filed will be analyzed. Such action is erroneous. For purposes of the Rule, it does not matter when the return was filed or if it was filed at all.
Petition filing date
minus three years Petition filing date
MM/DD/YY MM/DD/YY
(1) Draw a time line showing the petition filing date on the far right, and the petition filing date minus three years, on the far left.
(2) Mark on the time line the date when the tax return was required to be filed, include all extensions (requested by the debtor, governmental entity is stayed from enforcing collection action, etc, plus 90 days).
(3) If your mark falls on or to the right of the far left of your time line (within the three (3) year period determined above), then the taxes are entitled to priority treatment.
(4) If the mark falls before the far left of your time line, the tax is not entitled to priority under the “Three Year Rule.” Go to the next page and see if the “240 Day Rule” applies.
The 240 Day Rule -- 507(a)(8)(A)(ii)
The key focus of this rule is the date the tax was assessed. An assessment can occur two ways, either by the taxpayer filing a return or by an audit. If the assessment is by a filed return, then the assessment date is the Department’s “Established Date.” If the assessment is by an audit then it depends on whether the proposed audit is protested. “Protesting” a proposed audit means that the taxpayer disputes some aspect of it, ranging from not owing any of it due to factual reasons to challenging the underlying law. After the notice of audit is mailed to the taxpayer, if the taxpayer does not protest within the following designated time frames (depending on tax type), then the assessment will become final.
(a) The protest period of transaction privilege taxes is 45 days.
(b) The protest period for income taxes is 90 days.
(c) Jeopardy assessment is good immediately.
If the audit is protested, there are many avenues it can go (i.e., Hearing Office, Board of Tax Appeals, Tax Court, etc.). When the audit protest is resolved, the assessment date is the Department’s “Audit Demand Date.” The Arizona Department of Revenue is prohibited from taking collection actions until ten (10) days after the Audit Demand Letter is sent, assuming that the tax is not paid or a payment arrangement is not entered into between the parties. BAPCPA ALERT: Thus, when a proposed assessment is appealed it is prohibited from taking collection actions and, the suspension now added as a part of § 507(a)(8) under BAPCPA would apply.
In determining if the 240 Day Rule applies apply the following:
(1) Was there a final assessment?
If yes, go to No. 2.
If no, go to the next rule (Not Assessed But Assessable).
Petition filing date
minus 240 days Petition filing date
MM/DD/YY MM/DD/YY
(2) Draw a time line showing the petition filing date on the far right and the petition filing date minus 240 days on the far left. Go to No. 3.
(3) Determine when the assessment became final, include all extensions (requested by the debtor, governmental entity is stayed from enforcing collection action, etc, plus 90 days), and mark on the time line the assessment date. Go to No. 4.
(4) Does the mark (the assessment date) fall on or to the right of the far left of the time line?
If yes, then the tax is a priority tax.
If no, the tax is not a priority tax.
(5) If the mark falls before the far left of your time line, then go to the “Not Assessed, But Assessable Rule.”
Not Assessed But Assessable Rule -- 507(a)(8)(A)(iii)
This rule can be confusing due to it being poorly written. The best way to understand it is to know what kind of assessment it does not apply to and what kind it does not. It does not apply to audits which have become final, to debtors who have not filed the tax return for the period in question, filers or taxpayers who have filed late returns within two (2) years of the date of the bankruptcy petition. The “Not Assessed But Assessable Rule” applies to “add tax audits.”
An add-tax audit occurs in situations where the taxpayer has filed the requisite return, but the there has been a determination that more money is/may be owed. This rule can come into effect in either the situation where no audit has been started, but under the law, one could begin or, alternatively, one was started prior to the filing of bankruptcy, but not completed before the petition date, i.e. the state’s audit is put on hold pending the resolution of a federal one and, the tax payer forgets about before filing bankruptcy. BAPCPA ALERT: The effect of the BAPCPA is to make non-filer audits non-dischargeable against individuals, regardless of whether this rule specifically does not apply. The application of §523(a)(1)(A), and its incorporation into Chapter 13 in §1328(a), have the effect of making non-filer audits non-dischargeable.
In determining whether the Rule applies, apply the following:
(1) Does the tax liability relate to a final assessment?
If yes, this rule does not apply.
If no, go to No. 2.
(2) Do the taxes relate to a non-filer audit?
If yes, this rule does not apply.
If no, go to No. 3.
(3) Was the return filed late within two (2) years of the filing of the bankruptcy petition?
If yes, this rule does not apply
If no, go to No. 4.
(4) Could an audit pursuant to state law (A.R.S. § 42-113) be performed as of or after the date of the debtor’s filing of bankruptcy?
If yes, then the tax is a priority tax.
If no, this rule does not apply.
2. Ad Valorem Taxes Priority - 11 U.S.C. § 507(a)(8)(B)
Ad valorem taxes are property taxes. They can be either real or personal property type taxes. The type of tax involved will be dependent upon the type of property involved. Additionally, the type of property may impact the calculation of and/or the tax liability in general. Certain types of property are governed by statute to determine their liability, i.e. religious institutions, mines, telecommunications, shopping centers, etc. Likewise, the type of property involved will directly impact what actions are required for filing tax reports, payment of tax liabilities, etc. and may impact how claim is viewed/treated.
Property taxes have a payment date after the assessment date (aka lien date). For example, real property taxes for the 2004 tax year works as follows: the lien date is January 1, 2004, but the taxes do not come due until October 1, 2004 and March 1, 2005. BAPCPA ALERT: The Bankruptcy Code now provides that a priority ad valorem tax is that tax which comes due within one (1) year of the filing of bankruptcy. This is a change in that the Bankruptcy Code used to look to the assessment date for priority tax determinations instead. The new change will increase the window for those types of ad valorem taxes that will qualify as a priority.
The question is: did the ad valorem tax liability amount come due with one (1) year of the filing of bankruptcy?
If yes, then the tax is a priority tax.
If no, this rule does not apply.
Note: Property taxes that now come due post-petition are clearly entitled to payment as administrative expenses under § 503(b)(1)(B)(D). Whether it is secured during the p3endency of the bankruptcy or not is irrelevant.
3. Trust Fund Taxes (
11 U.S.C. § 507(a)(8)(C)
All trust fund taxes (i.e., withholding) are entitled to priority status regardless of the time period of the tax in issue.
Exceptions to Discharge
“Discharge” is what every debtor hopes to achieve by filing for protection under Title 11, aka the “Bankruptcy Code;” it is the “Brass Ring,” so to speak. It is not a “forgiveness of debt” as some like to say. Instead, it is the “extinguishment of personal liability of a Claim.” A Claim under the Bankruptcy Code is much more widely defined under the Bankruptcy Code [virtually anything per 11 U.S.C. §101(5)]. Collections may not be affected against a debtor personally through means such as levy, garnishment, seizure, perfection of lien, etc. However, if a lien was perfected against a debtor’s existing property pre-petition, then collections can be affected against that property up to the debtor’s interest in it.
“Exceptions to Discharge” means those debts which for policy reasons, Congress has determined cannot be discharged, i.e., alimony, child support, damages due to drunk driving, etc. It does not extinguish perfected secured liability which has attached to property.
The receipt of a discharge does not necessarily preclude collection actions against collateral, as opposed to pursuing collection/an action against the debtor. Dischargeability analysis must occur either from both the creditor and the debtor perspective. That, however, is not the end of the analysis. It is important to note that even though a Claim may be discharged, it does not mean that the claim will not be paid. The debt in question could be required to be paid as a priority debt (i.e. in a Chapter 13 bankruptcy all priority tax claims must be paid under the plan, these same liabilities would be non-dischargeable otherwise). Alternatively, if the creditor possesses a secured claim, the debtor will either satisfy it or surrender the security; thus, the creditor receives payment one way or another.
The bottom line is that a “discharge” in a bankruptcy and its ramifications are very much case-fact specific. It is dependant upon:
1) The type of debtor
2) The Bankruptcy Chapter filed
3) The type of discharge sought and;
4) The Claim, NOT debt, in issue..
1. Introduction.
BAPCPA ALERT: BAPCPA has impacted the discharge provisions of the most common Chapters filed in bankruptcy, namely Chapters 7, 11, and 13. The effects are on a variety of claim types. The focus here is the impact on taxes; to educate both the creditor and debtor, so as to protect their respective interests and to know their rights, respectively BAPCPA. The applicable provision is:
Section 523 is the most significant provision. BAPCPA ALERT: As a result of BAPCPA, it now has application in the aforementioned three (3) bankruptcy types. It provides:
(a) A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title does not discharge an individual debtor from any debt-
(1) for a tax or a customs duty—
(A) of the kind and for the periods specified in section 507(a)(2) or 507(a)(8) of this title, whether or not a claim for such tax was filed or allowed:
(B) with respect to which a return, or equivalent report or notice, if required—
(i) was not filed or given; or
(ii) was filed or given after the date on which such return, report or notice was last due, under applicable law or under any extension, and after two years before the date of the filing of the petition, or
(C) with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax;
While these changes may seem minor on their face, nothing could be further from the truth. The following discussion shall cover the dischargeability analysis in the predominant chapters of bankruptcy.
The following is a guide to determine whether income taxes and/or non-trust fund transaction privilege (“sales”) taxes for an individual debtor in either a Chapter 7 or 11 bankruptcy are non-dischargeable. BAPCPA ALERT: It does now apply to a Chapter 13 individual debtor bankruptcy. § 1328(a)(2). If the tax liability is for trust fund taxes (i.e., withholding), it is non-dischargeable for an individual in either a chapter 7, 11or 13. If an individual debtor files a Chapter 7, 11 or 13 bankruptcy, answer the following questions:
1. Was a required tax return, equivalent report or notice filed?
If yes, proceed to question No. 2.
If no, the tax is non-dischargeable pursuant to Section 523(a)(1)(B)(i).
2. Was there a late return, report or notice filed within the two (2) years immediately preceding the filing of bankruptcy?
If yes, the debt is non-dischargeable pursuant to Section 523(a)(1)(B)(ii).
If no, proceed to question No. 3.
3. Was the return fraudulent or was there an attempt to evade taxes?
If yes, the debt is non-dischargeable pursuant to Section 523(a)(1)(C).
If no, proceed to question No. 4.
BAPCPA ALERT: The recent changes make the above listed types of tax liabilities non-dischargeable. Thus, a Chapter 13 debtor receives the same discharge, as to those factors listed above, as that of an individual Chapter 7 and/or Chapter 11 debtor.
BAPCPA ALERT: Further, the types of tax liabilities that now are non-dischargeable have been expanded. Where a taxing authority’s law(s) provides that a taxpayer who has had some change in income is required to file a return, report or some type of notice with the taxing authority, it was questionable whether that such was an instance where a tax return was required under the Bankruptcy Code. (Note: this determination is not limited to only income tax. Foe example a tax on gross proceeds would also have this issue.) A review of the applicable statute was, and is, required to see if the taxpayer has (had) the choice of what to provide to the taxing authority. Where such an instance existed, a tax return was not required. Based on this, the Ninth Circuit Court of Appeals held that the “required return” element of § 523 (a)(1)(B) was not satisfied and, therefore, if a taxpayer did have additional liability, was required to notify the taxing authority of this fact and did nothing or did it late within two (2) years of the filing of bankruptcy, the tax claim would be discharged, assuming it did not fit within any of the other requirements. Now, the failure of a debtor did have additional liability, was required to notify the taxing authority of this fact and did nothing or did it late within two (2) years of the filing of bankruptcy, the tax claim would be non-dischargeable. This analysis would also apply to §507(a)(8)(A), which is makes a take non0-dischargeable under §523(a)(1)(A).
Back to the Guide to determine dischargeability for Individuals, Sole Proprietorships, and General Partners in Chapters 7 [523(a)(1)], 11 [1141(d)(2) & (6)] and 13 (hardship discharge).
4. Were the taxes for a taxable period for which the return(s) was (were) required to be filed, including all extensions, within three (3) years of the filing of bankruptcy?
If yes, the debt is non-dischargeable pursuant to Sections 523(a)(1)(A) and 507(a)(8)(A)(i).
If no, proceed to question No. 5.
5. Were the taxes assessed within two hundred forty (240) days of the filing of bankruptcy?
a. If yes, the debt is non-dischargeable pursuant to Sections 523(a)(1)(A) and 507(a)(8)(A)(ii).
b. If no, did the debtor make an offer-in-compromise with respect to the taxes?
i) If yes, and the taxes were assessed within the past two hundred forty (240) days, plus the additional time now provided under BAPCPA (See the Priority Guidelines for income taxes and/or transaction privilege taxes herein), the debt is non-dischargeable pursuant to Sections 523(a)(1)(A) and 507(a)(8)(A)(ii).
ii) If no, the debt is dischargeable.
c. If no and the debtor did not make an offer-in-compromise, the debt is dischargeable. Proceed to question No. 6.
6. Have the taxes been assessed?
If yes, see question No. 5 above.
If the answer is no, then ask the following:
a. Does the tax relate to a non-filer?
If yes, the assessable but not assessed rule of Section 507(a)(8)(A)(iii) does not apply, but the debt is not dischargeable pursuant to Section 523(a)(1)(B)(i).
If no, proceed to (b).
b. Was the return filed late and within two (2) years of the filing of the bankruptcy petition?
If yes, the assessable but not assessed rule of Section 507(a)(8)(A)(iii) does not apply, but the debt is not dischargeable pursuant to Section 523(a)(1)(B)(ii).
If no, proceed to (c).
c. Were the taxes still assessable under state law as of the date of filing of bankruptcy?
If yes, then the tax is a priority tax and is non-dischargeable pursuant to Sections 523(a)(1)(A) and 507(a)(8)(A)(iii).
BAPCPA ALERT: The reason this portion has been separated is due to the limitations on Chapter 13, non-hardship discharge. These provisions do not apply to a regular Chapter 13 discharge. That being said, the effect is of no consequence since the types of tax liabilities shall be paid under the Chapter 13 plan if a discharge is desired. § 1322(a)(1). BAPCPA ALERT: Under BAPCPA, liabilities that arise from non-filed tax return(s) in a Chapter 13 case are non-dischargeable. This rule applies to both the non-filed original returns and/or amended returns. If the taxing authority was to do a non-filer audit now under BAPCPA, the liability would be non dischargeable or payable in the plan per §507(a)(1)(8)(A)(iii). The debt would continue to accrue interest and, if applicable, penalties, until the plan is completed and tax collection could occur. The only two exceptions would be if either, the liability involved a tax period where the return (or the equivalent, etc) was required to be filed within three (3) years of the filing of bankruptcy or the debtor signed off on the proposed assessment/filed the outstanding returns within 240 day of the filing bankruptcy (assuming that no other portion of §§ 507 or 523 apply). The latter would have the impact of creating a tax return under certain case law. (Remember under BAPCPA,Section 523 also now defines “return” much broader which would further support this argument.) Thus, the debtor would not be a non-filer.
BAPCPA ALERT: Per § 1141(d)(6), a private entity (non-governmental entity) can benefit from the non-dischargeability provisions listed above. Section 523 (a) 14A) now provides that if the debt, i.e. credit card, was used to pay a tax that would be non-dischargeable under § 523(a)(1), then it would also be non-dischargeable.
Note: Although a tax liability may be non-dischargeable under the guide listed above, if a Chapter 11 plan of reorganization for an individual is confirmed with language providing the debt is discharged and is completed, the liability will be discharged. The plan will be viewed as a contract between the debtor and the Department. The Bankruptcy Court will hold that the taxing authority gave up its right to assert the taxes were non-dischargeable. However, BAPCPA does impact this issue as well. BAPCPA ALERT: In order for an individual debtor to receive the Chapter 11 discharge, all payments under the plan must be completed. § 1141(d)(5)(A). Also, a Chapter 11 debtor (not limited to individuals) must pay the pre-petition tax liability within 5 years of the filing of bankruptcy, regardless if it is secured or unsecured priority. § 1129(a)(9)(C) & (D). The payments must be regular, equal payments (no balloon payments) and can not be any less favorable than any non-priority unsecured creditor. Id.
3. Guide to Determine Dischargeability for Corporations in Chapters 7 and 11
Per the Bankruptcy Code, a corporation does not receive a discharge. 11 U.S.C. § 727(a)(1). For an entity to receive a discharge it must survive the bankruptcy. In a Chapter 7 bankruptcy, the assets of the corporation are liquidated by the chapter 7 trustee. Since the assets of the corporation are liquidated, it will be subsequently a defunct, non-viable entity. Therefore, it cannot receive a discharge.
A corporation receives a “superdischarge” upon confirmation of its plan of reorganization. 11 U.S.C. § 1141(d). BAPCPA ALERT: Section 1141(d)(1) has been modified to limit the “super-discharge” of a Chapter 11. Now, a corporation will not receive a discharge if the debt was the result of a a fraudulent tax return or willfully attempted to evade or defeat a tax or custom. §1141(d)(6). The same is true if the debt to the government arose out of improper conduct on behalf of the corporate debtor in obtaining money, property, services, credit, etc. Id Regardless of the discharge, claims will be paid per the terms of the confirmed plan of reorganization. As a result of the “superdischarge,” all liabilities arising pre-confirmation are discharged. Id. This would even include pre-petition tax liabilities which, but for the bankruptcy, could have been assessed after confirmation. Provided that the proper default language is contained in the plan of reorganization, collections can be affected against the debtor in the event there is a default in the plan (i.e., the required plan payments are not made). It is important to remember that the Chapter 11 discharge does not affect the Department’s ability to pursue collections on post-confirmation liabilities. If the confirmed plan of reorganization provides that it is of a liquidating nature, then the dischargeability analysis set forth herein would apply.
4. Guide to Determine Dischargeability in a Chapter 13
Only an individual can receive a discharge in a Chapter 13. 11 U.S.C. §§ 109 and 1328. Chapter 13 is limited to only individuals; a corporation, partnership, etc. cannot file for protection under Chapter 13. The discharge formally received by an individual in a Chapter 13 is commonly referred to as a “superdischarge.” BAPCPA ALERT: Now, the individual debtor who completes the Chapter 13 plan receives an “Enhanced Discharge.”
The Chapter 13 debtor must make regular monthly payments to a Chapter 13 trustee (who distributes the funds to creditors) pursuant to a confirmed Chapter 13 plan before the enhanced discharge is received. A Chapter 13 plan will now last five (5) years. The “enhanced discharge” still does give a debtor a better discharge than in a Chapter 7. See §§ 523 & 1328(a). An enhanced discharge is less favorable than a super discharge. The successful Chapter 13 debtor can not now discharge taxes and/or certain civil restitution and/or damages incurred in a personal injury action, but can still extinguish personal liabilities that arose in other situations which would not be discharged in a Chapter 7. Id. It is important to remember that secured claims will be paid up to the value of the debtor’s interest in the property, regardless of whether they are dischargeable or not. BAPCPA ALERT: Unlike in Chapters 7 or 11, the individual debtor can discharge the unsecured debt created when pre-petition, a creditor’s funds (i.e. a credit card like Via, Master Express, etc.) are used to extinguish the otherwise non-dischargeable tax debt. See §§ 1328 and 523(a)(14A).
The Chapter 13 enhanced discharge does not affect post-petition tax liabilities. Collection of post-petition tax liabilities may be affected by the bankruptcy in general. See 11 U.S.C. §§ 1306 & 1327.
Attached is a chart which discusses the changes, focus being on the tax issues, as a result of the implementation of the BAPCPA. It includes some of those changes discussed herein, as well as other tax and non-tax changes
DISCHARGE
“Discharge” is what every debtor hopes to achieve by filing for protection under Title 11, aka the “Bankruptcy Code;” it is the “Brass Ring,” so to speak. It is not a “forgiveness of debt” as some like to say. Instead, it is the “extinguishment of personal liability of a Claim.”
First, a Claim under the Bankruptcy Code is much more widely defined under the Bankruptcy Code [virtually anything per 11 U.S.C. §101( )]. Second, the receipt of a discharge does not necessarily preclude collection actions against collateral, as opposed to pursuing collection/an action against the debtor.
The bottom line is that a “discharge” in a bankruptcy and its ramifications are very much case-fact specific. It is dependant upon:
5) The type of debtor
6) The Bankruptcy Chapter filed
7) The type of discharge sought and;
8) The Claim, NOT debt, in issue.
A general overview, as well as miscellaneous notations concerning changes to the Bankruptcy Code as a result of the Reform Act, are on the following page.
|
Bankruptcy Chapter |
Entity Type |
Bankruptcy Code Provision |
General Summary |
General Notatations |
|
Chapter 7 |
Individual (Note: presumption is no longer that a person qualifies under Chapter 7. Individual may have to be under a Chapter 13 (See discussion of “Means Test”). |
11 U.S.C. §523 Discharge: If qualifies under Chapter 7 (rebutable presumption is that Chapter 7 is not available), then occurs in the ordinary course of the given bankruptcy locale/district. |
Not all debts are dischargeable. Some non-dischargeable debts do not require any further action (i.e. certain tax claims), while others require litigation (i.e. 11 U.S.C. §523(C). Changes: per the Reform Act: No longer limited to on “returns: being “required.” Also, includes “equivalent report or notice.” (Applies to all Chapters, regardless of debtor type.) Note: there are various changes to Section 507(a)(8), the priority provision. This provision is incorporated into Section 523 for dischargeability purposes. (Applies to all Chapters, regardless of debtor type.) “Three Year Rule” - tax period definition to be inclusive of the year of filing bankruptcy. §507(a)(8). (Applies to all Chapters, regardless of debtor type.) “240 day Rule” – look to 240 days before the filing of bankruptcy. The period is greater if an offer-in-compromise is pending or in effect. Id. Date is extended by 30 days from those extensions. Also, if collections has been stayed during the 240 day rule, then add an additional 90 days to it. (In re Harris). Amount for determining secured claim status is replacement- standard is the retail merchant would pay for it standard. §506(a)(2). (Applies to all Chapters, regardless of debtor type.) Property tax now go by the date the tax was incurred, instead of assessed. (Applies to all Chapters, regardless of debtor type.) Important Global Change to all Section 507(a)(8) provisions: If governmental unit is prohibited “from collecting” a debt either due to: 1.) “applicable non-bankruptcy law” due to a protest filed by the debtor, then governmental entity get the remainder of the 240 days, plus an additional 90 days, and/or 2.) if a prior bankruptcy (ies) had (have) been filed, then the number of applicable time period is increased by the number of days the stay was in effect if another bankruptcy had been filed which caused the stay of collections. If a debt to a private creditor for which the funds obtained went to pay a non-dischargeable tax, then it too would be non-dischargeable. §507(a)(14A). The applicable interest rate is that which it would be under applicable non-bankruptcy law. §551. (Applies to all Chapters, regardless of debtor type. |
Varies by jurisdiction. In Arizona 4 – 6 months from the first meeting of the creditors. Changes: per the Reform Act: Administrative expenses are now second in Priority behind alimony, child support, and trustee fee if appointed. Impacts on payments, not dischargeabilities. Post-petition tax liabilities for an ongoing business may be impacted. §507(a)(2). Additionally, the taxing authority no longer needs to file a request to have its administrative expense claim allowed. §503(b)(1)(D). The administrative tax debt can be either secured and/or unsecured. §503(b)(1)(B). Tax returns due post-petition and all liabilities due thereunder must be filed and paid unless specifically excepted out in a particular provision of Title 11 or particular situations in a Chapter 7 bankruptcy. 28 U.S.C. §960. Also See §521 which provides that a debtor can be compelled to file outstanding tax returns that become due post-petition or obtain an extension. Failure to do so can result in a dismissal or conversion. Tax liens now qualify as statutory liens for purposes of Section 545. This will result in tax liens perfected within the 90 days which did not occur in the normal course of businesses for that industry, being subject to preferences. §547 Taxing authorities can setoff pre-petition income tax refunds against pre-petition income tax liabilities without first obtaining stay relief. §362(b)(26). (Applies to all Chapters, regardless of debtor type.) |
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Partnership |
Discharge: Same as individuals for the individual, human partners. The only limitations are dependent on the type of partnership (same as with a limited liability corporation). |
Many of the provisions of an individual apply since an individual, non-corporate partner may apply. The only limitations are dependent on the type of partnership (same as with a limited liability corporation). |
As to individuals, the same as above. Taxing authorities can setoff pre-petition income tax refunds against pre-petition income tax liabilities without first obtaining stay relief. §362(b)(26). (Applies to all Chapters, regardless of debtor type.) |
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Corporation |
Discharge: Corporations do not receive a discharge. Their assets are liquidated, leaving nothing at the end of the bankruptcy. |
Some of the various provisions would apply if the Debtor business continued to operate post-petition, which is very rare. |
Does not occur Taxing authorities can setoff pre-petition income tax refunds against pre-petition income tax liabilities without first obtaining stay relief. §362(b)(26). |
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Chapter 11 |
Individual |
Discharge: Same as with a Chapter 7 bankruptcy. 11 U.S.C. §1141 incorporating 11 U.S.C. §523 |
Changes: per the Reform Act: Debtor has five (5) years from the date of the petition to pay in “cash” regular installments in a manner not less favorable than the “most favored non-priority unsecured creditor provided for by the plan (excluding the administrative convenience class). §1129(a)(9)(C). Same treatment can be applicable to secured tax claims. Id. In a “small business case” bankruptcy, the plan must be filed and confirmed within 45 days of the filing of bankruptcy. §11929(e). The applicable interest rate is that which it would be under applicable non-bankruptcy law. §551. May retain property even if he/she does not pay all claimants in full, as long as all required domestic support obligations. See 1129(b)(2)(B). This negates the “absolute priority rule” for purposes of an individual. Property of the estate is now expanded to be in line with the provision contained in Chapter 13. §1115(a). That is, “property of the estate” shall include pre- and post-petition property until the case is either dismissed, converted or closed. If governmental unit is prohibited “from collecting” a debt either due to: 1.) “applicable non-bankruptcy law” due to a protest filed by the debtor, then governmental entity get the remainder of the 240 days, plus an additional 90 days, and/or 2.) if a prior bankruptcy (ies) had (have) been filed, then the number of applicable time period is increased by the number of days the stay was in effect if another bankruptcy had been filed which caused the stay of collections. (Applies to all Chapters, regardless of debtor type.) If a debt to a private creditor for which the funds obtained went to pay a non-dischargeable tax, then it too would be non-dischargeable. §507(a)(14A). The applicable interest rate is that which it would be under applicable non-bankruptcy law. §551. Taxing authorities can setoff pre-petition income tax refunds against pre-petition income tax liabilities without first obtaining stay relief. §362(b)(26). Can still obtain other setoff relief under §553, but requires either Court order or debtor/trustee ok. |
Upon entry of confirmation order or other plan date specified. Changes: per the Reform Act: Failure to keep current on the filing of returns post-petition can result in the dismissal or conversion of the case. §1111. Tax returns due post-petition and all liabilities due thereunder must be filed and paid unless specifically excepted out in a particular provision of Title 11 or particular situations in a Chapter 7 bankruptcy. 28 U.S.C. §960. Also See §521 which provides that a debtor can be compelled to file outstanding tax returns that become due post-petition or obtain an extension. Failure to do so can result in a dismissal or conversion. Tax returns due post-petition and all liabilities due thereunder must be filed and paid unless specifically excepted out in a particular provision of Title 11 or particular situations in a Chapter 7 bankruptcy. 28 U.S.C. §960. Also See §521 which provides that a debtor can be compelled to file outstanding tax returns that become due post-petition or obtain an extension. Failure to do so can result in a dismissal or conversion. Additionally, the taxing authority no longer needs to file a request to have its administrative expense claim allowed. §503(b)(1)(D). The administrative tax debt can be either secured and/or unsecured. §503(b)(1)(B). The “small business debtor” must file periodic reports stating various things, including whether r it is in compliance with the filing of and the payment of taxes. § 308. If the Debtor is not current, then it must state so and explain how it got in such situation and it will correct the situation. Id. Tax liens now qualify as statutory liens for purposes of Section 545. Confirmation does not equate to discharge for an individual. Discharge occurs upon the completion of all payments required under a confirmed plan. §1141(d)(5). |
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Partnership |
Discharge: Same as individuals for the individual, human partners. The only limitations are dependent on the type of partnership (same as with a limited liability corporation) |
Same as individuals |
As to individuals, the same as above. |
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Corporation |
Discharge - A Corporation gets a “super-discharge” upon confirmation, albeit a smaller one then pre-Reform Act. All claims that did and/or could have arisen before the filing of bankruptcy (pre-petition) and/or after the filing of bankruptcy but before confirmation (post-petition and pre-confirmation) are discharged and paid, or not, per the terms of the plan. 11 U.S.C. §1114. |
New Change: Tax which arise due fraudulent corporate debt or tax/customs that arise due to a fraudulent return or willfull attempt to evade or to defeat the taxes. §1141(d) See Individual Chapter 11 herein for terms under a plan. |
See Individual above as to interest rates, requirement to file tax returns setoffs, and pay; keeping current on tax returns and priority provisions. |
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Chapter 13 |
Individual |
Discharge: Old way: If a debtor completes their plan, then a “super-discharge” is given. The “super-discharge” extinguishes the personal liability of a claim on all but a few (i.e. child support, alimony, criminal restitution, etc.). Changes: per the Reform Act: The Debtor still receives a larger discharge then in a Chapter 7, but not as great as it was pre reform. An individual now receives the same discharge as to taxes as he/she would in a Chapter 7 debtor. The net effect is now debtors have certain types of tax debts be non-dischargeable (i.e. non-filers up to four years prior to the bankruptcy being filed, non-filer audits which did not become final or start pre-petition; filed late within two (2) years of the filing of bankruptcy). Priority taxes [§507(a)(8)] per will be paid in the plan, but certain ones (i.e. those mentioned above) will neither be paid nor discharged upon completion of the plan. 11U.S.C.§1328(b) |
Changes per the Reform Act: Taxing authorities can setoff pre-petition income tax refunds against pre-petition income tax liabilities without first obtaining stay relief. §362(b)(26). Note setoff under §553 is still allowed, but requires Court approval or debtor and trustee approval.
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Old Way: Upon completion of plan payments (3 – 5 years). Changes Per the Reform Act: The plan shall be last for five (5) years from the date the first payment is due. §1322. Confirmation hearing shall be held 20 – 45 days after the first meeting of creditors (“FMC”). Tax claims under §507(a)(8) are entitled to interest if debtor has dollars left after paying all allowed claims. §1322. Delinquent pre-petition tax returns (up to 4 years prior to the petition date) must be filed prior to the FMC. §1307. If not, filed, trustee can continue FMC 120 days to get returns filed. If debtor establishes that failure to file return is due to “circumstances beyond the control of the debtor” can get an additional 30 days to file return(s). Id. Note: Failure to keep current on the filing of returns post-petition can result in the dismissal or conversion of the case. §1308. Tax returns (these are note limited to only income taxes) due post-petition and all liabilities due thereunder must be filed and paid unless specifically excepted out in a particular provision of Title 11 or particular situations in a Chapter 13. See §521 which provides that a debtor can be compelled to file outstanding tax returns that become due post-petition or obtain an extension. The Bankruptcy Code now looks to whether the plan has been confirmed or not to determine when the post-petition returns must be filed. §521(f). Failure to do so can result in a dismissal or conversion. bankruptcy. Id. If a taxing authority requests the filing of such returns and the debtor fails to comply within 90 days, the bankruptcy court”shall” dismiss or convert the case. Arguably the requirements of 28 U.S.C. §§959 and 960 apply which also require the filing of tax returns and payment of sums due thereunder as required by applicable, non-bankruptcy law. There can be setoffs of pre-petition tax refunds against pre-petition debts. §362(b). Note: if there is a dispute regarding the liability, the taxing authority can hold the tax refund until resolution of the matter. Tax liens now qualify as statutory liens for purposes of Section 545. |
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If a debtor does not successfully complete their plan, they can request from the Bankruptcy Court that a “hardship discharge” be entered. The effect is the individual debtor receives the same discharge as in a Chapter 7. The applicable interest rate is that which it would be under applicable non-bankruptcy law. §551. |
Upon entry by the Court. |
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Partnership |
Discharge: Same as individuals (Assuming that the partner is an individual not a business entity). If not an individual, they cannot qualify for a Chapter 13. |
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As to individuals, the same as above. |
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Corporation |
Discharge: Chapter 13 does not apply. |
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The views expressed herein do not necessarily reflect those of the Maricopa County Attorney’s Office.
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reform tax provisions Revised September 2005.doc