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DISCHARGING TAXES IN
BANKRUPTCY AFTER REFORM
This will provide an overview of the content of the Seminar regarding bankruptcy discharge after Bk Reform. It is important to learn the principles of tax discharge in bankruptcy if you represent clients with tax problems. There are several reasons to learn bankruptcy discharge.
First, it may be that you client will fare far better in a bankruptcy than in some other type of relief from their tax liability.
Second, you will be better able to advise your client if you know the principles of Bankruptcy Discharge.
Third, knowing the principles may help you avoid a mistake that could result in a negligence action against you.
Finally, knowing the rules of tax discharge in bankruptcy gives an attorney a definite advantage when negotiating with the Internal Revenue Service.
I. PRINCIPLES OF CHAPTER 7 DISCHARGE
- The tax must be over three years old from when the return first came due.
- Two years since the tax since the tax return was filed.
- Two hundred and forty days since the tax was assessed.
- Obtain and review tax transcripts to show your clients history.. We always obtain tax transcripts when there are a significant amount of taxes involved.
- Tolling events on the time periods. There are numerous events which will toll the periods required for discharge.
II. PRINCIPLES OF CHAPTER 13 DISCHARGE
Tax Discharge in Chapter 13 WAS far more flexible than a Chapter 7. It allowed for taxes to be discharged pursuant to the provisions of the "Super Discharge". It still allows a way for clients to payoff otherwise non-dischargeable taxes throughout the life of the chapter 13 plan yet still abate penalties and reduce interest to, at this current writing, 5% on secured claims.
- Tax more than three years old. After Reform, the requirements that the tax be more than three years old are virtually the same as in a Chapter 7 case.
- Two Years since the Tax Return was filed. Under the former law, it was not required that it has been more than two years since the tax return had been filed. As noted below, taxes where the returns had not yet been filed as of the date of filing of the bankruptcy WERE still, in many cases, subject to discharge. Bankruptcy Reform has changed this! This is probably the greatest single change from the previous law. Now, the return must have been filed 2 years before the Bankruptcy was filed in both Chapter 13 and Chapter 7.
- Two hundred forty days since assessment. It is required that the taxes owing be assessed at least two hundred forty days before the chapter 13 is filed.
- Tolling events on the time periods. There are numerous events which will toll the periods required for discharge.
III. TREATMENT OF TAXES IN CHAPTER 11
- Taxes in Chapter 11 are treated very similar to treatment in Chapter 13, with certain exceptions.
- With regard to priority taxes, the Debtor in Possession has 5 years from the date of Confirmation to pay the Priority Taxes.
- The DIP must pay interest on the Priority Taxes
- Secured Taxes may be paid over a longer period of time. This depends on how long a time period set either through negotiations or by Court Order.
IV. TAX CLAIMS IN BANKRUPTCY
The Internal Revenue Service in Chapter 11 and 13 cases will file a Proof of Claim breaking down their claim into Priority Claims, Secured Claims, and Unsecured General Claims.
- Priority Taxes: Priority taxes are those taxes which do not meet the test for discharge. That is, they are:
- Less than three years old, or;
- Less than two years since the tax return has been filed,or;
- Less than 240 days since assessment.
- Payroll Withholding Taxes
- Other Priority Taxes
- Secured Tax Claim: If the IRS has filed a valid tax lien, the taxes subject to the lien may be treated as secured. In Chapter 11 or 13, the secured portion of the claim is only up to the value of the Debtors property. It should be noted that the security for the claim includes ALL of the Debtors property, without any deduction for the exemptions which the Debtor may otherwise claim.
- Unsecured General Claims: This is the category that we try to fit as much of the tax as possible into. This category of tax is treated the same as any other general unsecured debt. That is, the IRS will receive its pro rata share of any dividend to unsecured creditors.
- Payroll Taxes: The general rule is that Payroll taxes are trust fund taxes and are not subject to Bankruptcy Discharge. They are treated as priority taxes or secured if a tax lien has been filed. They must be paid through the Chapter 13 plan and are not subject to discharge in a Chapter 7. Priority Taxes do not receive interest on them, however. Penalties are treated as unsecured. This favorable treatment often allows a Chapter 11 or 13 plan to deal with the taxes on a favorable basis.
- Sales Tax: If the sales tax is just that, a tax on the buyer, (it is in Idaho) generally it is treated as a tax which is subject to the same rules relating to Discharge as normal income tax.
V. Tax Liens and Bankruptcy
- The rule in Chapter 7, where the taxes owed exceed the value of the Debtor's property, that the lien may NOT be stripped down to the value of the debtors property.
- The lien survives Bankruptcy and even though the tax might have been discharged, the lien remains on the Debtor's property for its full amount. This creates a trap for the unwary.
- If a lien is not released, it remains.and attaches to all of the debtors property. The issue may arise years later. An example of how onerous this can be arises where a client has real property, there is a tax lien and a Bankruptcy is filed. In that situation, if the lien is not released and the property appreciates, the lien creditor (the IRS or ISTC) gains the benefit of the appreciation in the property value.
- In Chapter 7, the lien is not stripped down to the value of the collateral. (Dewsnup v. Timm 112 S.Ct. 773.)
- Methodology for dealing with Tax Liens:
- Challenge the validity of an invalid Tax Lien.
- Requesting a Certificate of Release from the IRS.
- Negotiate a release for an amount to be paid.
- Advise client to wait out the Statute of Limitations.
- Liquidate the assets and pay the funds to the IRS.
- File a Chapter 13 and pay the value of the assets.
- File an Offer in Compromise.
VI. OTHER BANKRUPTCY REFORM CHANGES
Bankruptcy Reform has created numerous other changes in the way taxes are handled in Bankruptcy. A summary follows:
- Means testing does not apply to Tax Discharge matters.
- Taxes are not Consumer Debt.
- Taxes are involuntary.
- Still must apply for Credit Counseling.
- For budgeting might be able to include secured value of tax claim in budget (divided by 60).
- This is where one of the fights will occur.
- Ability to pay 10k over 5 years.
- Will use IRS Collection standards to calculate budget.
- Same as we have been doing in OIC, Levy Release, etc.
- Big departure as IRS standards are very low.
- Removes much of the flexibility from the Ch 13 process.
- Tax liens will be useful in Chapter 7 cases to reduce amount of monthly excess income; we will try to divide the amount of the tax lien claim by 60 then deduct that amount from the budget.
- Question- What will this do to estimates of value?
- Increase them (as ethically permissible) to maximize the secured portion of a claim to reduce excess income?
- What happens if converted to 13….stuck with high estimates?
- Priority tax claims will be deducted from excess income.
- Useful for budgeting.
- May make 13 not feasible.
- Not able to do Chapter 20. New law prohibits filing a 13 if there was a discharge within 4 years.
- Will have to provide tax return or transcript to any creditor requesting it.
- Last 4 tax returns will have to be filed before the 341 hearing.
- If Post petition taxes not filed or paid, then case may be dismissed on motion.
Contact Us:
The Tax Group LLC
dba
Attorneys Tax Group
82 E. State St. Suite E
Eagle, Idaho 83616
1800 TAX CREW
1800 829 2739
Fax:208 938 8503
Martelle Law Offices PA
208 938 8500
webmaster@attorneystaxgroup.com
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