Presenting a live 90 minute webinar with interactive Q&A. Td Today s faculty features:

Transcription

1 Presenting a live 90 minute webinar with interactive Q&A Tax Issues in Consumer Bankruptcies Navigating Discharge of Tax Liability, Impact of Tax Obligations on Means Testing, and Debt Related Tax Consequences TUESDAY, JANUARY 15, pm Eastern 12pm Central 11am Mountain 10am Pacific Td Today s faculty features:, Principal, Law Office of, Burke, Va. Richard S. Gendler, Principal, Law Offices of Richard S. Gendler, Miami Gardens, Fla. The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 10.

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5 Tax Issues in Consumer Bankruptcies Strafford Webinars -- January 2013 Law Office of

6 Using Bankruptcy to Deal With Tax Problems after the BAPCPA 6

7 Types of Bankruptcies Chapter 7 liquidating id bankruptcy. Trustee is appointed to protect the unsecured creditors (the secureds are already protected). t Trustee identifies, marshals and sells debtor s nonexempt, unsecured assets. Trustee abandons encumbered assets. No payments from future income are required. 7

8 Types of Bankruptcies Chapter 13 Small debtors with regular income who can make monthly payments against debts, and whose debts are under the statutory limits: Unsecured debts less than $360,475. Secured debts less than $1,081,400. Debtor makes monthly payments to trustee for distribution ib ti to creditors (less commission). i Plan must provide full payment of priority debts. 8

9 Effect of Bankruptcy on IRS Collection Action Automatic stay arises under BC 362(a). All IRS collection action must cease, except: Demanding delinquent (unfiled) tax returns. Auditing prepetition or postpetition returns. Issuing a statutory notice of deficiency. Assessing uncontested prepetition liabilities and dtaxes shown on filed dtax returns. Refiling a previous notice of federal tax lien. Issuing a summons s to determine e a tax liability. 9

10 Effect of Bankruptcy on IRS Collection Action Property levied on but not transferred to the IRS prepetition is property of the estate, and subject to a turnover action by trustee. Tangible property seized prepetition but not sold by IRS prepetition p is property p of the estate, subject to turnover action by trustee. When IRS has received payment prepetition, p ownership has transferred to IRS, and the asset is not property of the estate (but may be subject to recovery as a preference). 10

11 Effect of Bankruptcy on IRS Collection Action Specific IRS collection actions are prohibited: Starting or continuing an administrative or judicial i proceeding (including a CDP hearing). Issuing a levy or instituting a seizure. Verbally requesting payment or sending written notices demanding payment. Making a setoff against a postpetition p refund to collect a prepetition tax. Filing, perfecting or enforcing a tax lien for prepetition tax periods (refiling is permitted). 11

12 Effect of Bankruptcy on IRS Collection Action Violations of the BC 362 automatic stay or the BC 524 discharge permanent injunction by IRS: IRC 7433(e)(1) permits action against the IRS for willful or negligent violations of the stay or the permanent injunction arising on discharge. Taxpayer or injured third parties may recover up to $100, for IRS negligent violations, and up to $1,000,000 for reckless or willful violations. 12

13 Classifying Tax Debts Three crucial determinations must be made in classifying tax debts in bankruptcy: Secured vs. unsecured. Priority vs. nonpriority. Exceptions to discharge 13

14 Secured vs. Unsecured IRS can be: A secured creditor, if a lien was filed; or An unsecured creditor, if no lien was filed; or Partially secured and partially unsecured, if a lien was filed but the tax exceeds taxpayer s equity in the property covered by the lien. 14

15 Secured vs. Unsecured A tax claim is unsecured if: no notice of tax lien was filed; a tax lien was filed but the debtor has no equity in assets to which the lien may attach; a tax lien was filed but other creditors had recorded liens prior to the tax lien, consuming all available equity in the property. 15

16 Priority vs. Nonpriority BC 507(a)(8)(A)(i) 3 year rule: Taxes are priority debts if the return was due (with extensions) less than 3 years prior to the filing of the bankruptcy petition. Period is extended: (1) while a prior bankruptcy case was open, plus 90 days; or (2) while the IRS was barred from taking collection action by "an appeal of any collection action taken or proposed against the debtor, plus 90 days. 16

17 Priority vs. Nonpriority BC 507(a)(8)(A)(ii) ) 240 day rule: Taxes are priority debts if assessment was made less than 240 days prior to petition date. Self-assessment starts with filing a return; but the filing date is NOT the assessment date. 240 day period is extended: (1) while an offer in compromise was pending, plus 30 days; (2) while a prior bankruptcy was open, plus 90 days; or (3) while the IRS was barred from collection action by "an appeal of any collection action taken or proposed p against the debtor, plus 90 days. 17

18 Priority vs. Nonpriority Relation back: For purposes of the BC 507(a)(8)(A)(ii) 240- day rule, interest and penalties are deemed to relate back to the assessment date of the tax. Thus, each incremental assessment of penalty or interest t is not protected t from discharge by a separate 240-day priority period. 18

19 Exceptions to Discharge BC 523(a)(1)(B) 2 year rule: Taxes are excepted from discharge if the return was filed less than 2 years prior to the filing of the petition (or was not filed at all). The IRS has recently begun arguing that the pre- BAPCPA concept of equitable tolling 19

20 Exceptions to Discharge Prior to BAPCPA, this 2 year from date filed rule applied in Chapter 7, but not in Chapter 13. Post-BAPCPA, it applies to both Chapter 7 and Chapter 13, with the result that taxes for years for which no tax returns were filed are now nondischargeable regardless of the type of bankruptcy used. 20

21 Exceptions to Discharge Return for discharge purposes: To constitute a tax return under BC 523, a document must contain enough information for the IRS to compute the tax liability, and must evidence an honest attempt to comply with the tax laws. A frivolous return is not a return for this purpose. Tax protestors are constantly dreaming up new variants, and the taxes later assessed are not dischargeable if what was filed is deemed not to constitute a return for purposes of

22 Exceptions to Discharge Substitute for Return (SFR) Assessments. IRS can compute tax if taxpayer fails to file, and can assess without ih consent. IRC C 6020(b). Prior to BAPCPA, many courts held that once an SFR assessment was made, a late filed return was ineffective. Since you can t satisfy the 2 year from date filed rule of 523(a)(1)(B), ), an SFR assessment is nondischargeable in Chapter 7. See In re Moroney, 352 F.3d 902 (4 th Cir. 2003). 22

23 Exceptions to Discharge The BAPCPA has its own definition of tax "return:... a return prepared pursuant to 6020(a)... or similar State or local law, or a written stipulation to a judgment or a final order entered by a nonbankruptcy tribunal, but does not include a return made pursuant to 6020(b)... or a similar State or local law. So sometimes a return is not a return, and sometimes something that is not a return is a return. Who writes this stuff? 23

24 Interest on Tax Debts Prepetition interest: Interest t follows the underlying tax. So if the prepetition tax is discharged, the related interest will also be discharged. But if the tax survives the discharge, so too does the pre-petition interest. 24

25 Penalties BC 523(a)(7) disjunctive test for penalties: Penalties are dischargeable to the extent they (A) relate to a dischargeable tax claim, OR (B) where the event giving rise to the penalty occurred more than three years prior to the filing of the bankruptcy petition. See In re Burns (11 th Cir 1989) and In re Allen 272 B.R. 913 (E.D. Va 2002) following majority rule, contra In re Putnam 131 B.R. 52 (W.D. Va 1991). 25

26 Penalties Pecuniary loss penalties are priority claims and not dischargeable (e.g. 100% penalty or TFRP). But punitive ii penalties li are not priority i claims, even if the underlying tax is entitled to priority, and such penalties are dischargeable if they meet either prong of the disjunctive test of 523(a)(7). Punitive penalties include those for late filing, late payment, negligence and even civil fraud. 26

27 Nondischargeable Taxes BC 507(a)(8)(C): The Bankruptcy Code gives priority to a tax required to be collected or withheld and for which the debtor is liable in any capacity, thereby making such taxes nondischargeable. Withheld portion of payroll taxes. Trust fund recovery penalty (TRFP). Sales taxes collected from customers. 27

28 Nondischargeable Taxes Employer s share of payroll taxes: While the withheld portions of the payroll tax are nondis- chargeable, the tax imposed on the employer (1/2 of FICA and Medicare) are dischargeable if the wages were paid and the return was due more than three years prior to the bankruptcy. See BC 507(a)(8)(D). FUTA taxes are not trust fund taxes and are similarly dischargeable. 28

29 Nondischargeable Taxes Chapter 7: Nondischargeable taxes survive the discharge, and must be addressed later. Chapter 13: Priority taxes are paid, since to be confirmed a plan must provide for full payment of priority it debts. Any nonpriority debts excepted from discharge survive and must be addressed later. 29

30 Nondischargeable Taxes BC 523(a)(1)(C) bars discharge if the taxpayer made a fraudulent return or willfully attempted in any manner to evade or defeat such tax. Circuits are split on whether mere nonpayment, without more, constitutes willful attempt to evade or defeat tax. Compare Haas (11th), Toti (6th), Dalton (10th) and Fegely (3rd). Does civil or criminal definition of evasion apply? 30

31 Nondischargeable Taxes BC 523(a)(1)(C) does not require that the taxpayer be prosecuted for fraud for the taxes to be found nondischargeable (in Chapter 7). For example, see Meyers v. IRS (6 th Cir. 1999). Tax protestor did not file returns and claimed excessive withholding exemptions to reduce the amount of tax withheld by his employer. Or see US U.S. v. Schmidt(4 th Cir. 1991). Taxpayer assigned wages, yet maintained dominion and control over the funds. 31

32 Equitable Considerations If the BAPCPA means test applies, it compares monthly income to "allowable" deductions. Income is debtor's average income over the six full months prior to petition. (Even if only one spouse files bankruptcy, income for the means test includes income of non-petitioning spouse.) 32

33 Equitable Considerations Deductions for means test start with the IRS s "allowable" living expenses: National standard for food, clothing, etc.; Local transportation standard; and County specific standard for housing and utilities. (Bankruptcy attorneys must now understand the IRS s collection standards which are used in the means test, even in cases with no tax debts.) 33

34 Strafford Webinars - January 2013 Richard S. Gendler, J.D., LL.M, J.S.D. (Cand.) Richard S. Gendler & Associates, P.A. rgendler@miami-law.com

35 In 2005 BAPCPA imposed a "means test" for debtors with "primarily consumer debt. 35

36 - Under 11 U.S.C 707(b), bankruptcy court has ability to dismiss a case filed by an individual debtor... whose debts are primarily consumer debts... if it finds that the granting of relief would be an abuse... - To determine whether this presumption p of abuse exists, most debtors earning income are subject to an income-based test called the "means test." - Presumption of abuse arises if debtor's income is higher than the debtor s presumed expenses.. 36

37 The crux of the means test is that a debtor may be obligated to file a chapter 13 case if 1. 1 Can repay 25% or more of his/her general unsecured debt over a 60-month period and 2. Minimum payments of $ per month ($7,025 total), or Debtor can pay $11,725 or more over 60 months without regard to the percentage repaid. *** However - If debtor s income is below the median income for this or her state the presumption p is inapplicable. 37

38 - First Step is to calculate debtor s current monthly income as defined by 101(10A). - Not the same definition as IRC 61. No regard as to whether the income is taxable. For instance help from family may be defined as income. Includes amounts regularly paid by another other than debtor for household expenses. - Determine debtor s average monthly income received from all sources within 180 prior to the filing of the bankruptcy case (Include income of non-filing spouse living in same home). - Does not include Social Security benefits. 38

39 Once current monthly income calculated must deduct the following expenses 1. Debtor s contractually due post-petition monthly average payments on secured debt. 2. Debtor s allowable monthly expenses as calculated by the IRS guidelines. 3. Debtor s monthly expenses for priority claims as defined under Section

40 Because the BAPCPA means test is used to determine what debtor could pay on nonpriority unsecured debts, the computation also deducts contractually scheduled payments to secured creditors for five years after petition date. For example, this may permit deduction of mortgage payments in excess of IRS housing allowance for purposes of the means test. 40

41 This formula is contained under 11 U.S.C. 707(b)(2)(A) which determines when a presumption of abuse will arise when a debtor files a chapter 7 case. If Debtor is subject to the means test and has the presumed ability to repay according to the formula, a case filed under Chapter 7 the case would be subject to dismissal as a presumption of abuse unless the concerts the case to a chapter 13 - Presumption can be raised by the Court, by the trustee, or by a creditor.. 41

42 - A finding of a presumption of abuse may be rebutted in a chapter 7 case with a showing of special circumstances which would require that the debtor's current monthly income be adjusted. - Could a student loan payment which is not defined as a priority claim under section 523 but is nevertheless non-dischargeable be deemed a special circumstance? 42

43 US Trustee Website that should be consulted periodically for updated d criteria i pertaining i to allowable expenses and household median income changes regularly.. 43

44 Recall for the Means test to apply, the plain language of 707(b) states that a debtor s debts must primarily be consumer debts. In re Leigy, 2009 Bankr. LEXIS 3678, at *7 (Bankr. M.D. Pa. 2009). 44

45 Section 101(8) provides some clarity: Consumer debt is debt incurred by an individual id primarily il for a personal, family or household purpose. See In re Stewart, 175 F.3d 796, 806 (10th Cir. 1999) ( Courts consistently have applied [the 101(8)] definition for the purposes of 107(b). ). 45

46 - Although Code does not define or otherwise quantify primarily, a majority of courts have determined that the standard is met when more than half the debts owed are consumer in nature. In re Leigy, 2009 Bankr. LEXIS 3678, at *7 (Bankr. M.D. Pa. 2009) (citing In re Stewart, 175 F.3d 796, 808 (10th Cir. 1999); In re Booth, 858 F.2d 1051, 1055 (5th Cir. 1988); In re Kelly, 841 F.2d 908, 913 (9th Cir. 1988); In re Victoria, 389 B.R. 250, 254 (M.D. Ala. 2008)). Thus, primarily indicates that no means test is required if less than 50 per cent of total scheduled debt is consumer in nature. 46

47 Income tax obligations may comprise the majority of a debtor s pre-petition obligations in a chapter 7 case. It is important to determine whether these obligations are deemed consumer debt, which would subject the debtor to the means test under 707(b). Few courts have addressed this issue. Many courts have analyzed the meaning of consumer debt under other provisions of the Code and determined, for the most part, that tax obligations do not constitute consumer debt. Whether these obligations are considered d consumer debt for the purpose of triggering the means test has not been definitively settled. 47

48 Bankruptcy courts have also examined the legislative history of 101(8). See In re Booth, 858 F.2d 1051, 1054 (5th Cir. 1988); In re Millikan, 2007 Bankr. LEXIS 4696, at *3 (Bankr. S.D. Ind. 2007). The drafters of the Code looked to consumer protection laws, such as the Truth in Lending Act, to define the term consumer debt. These consumer-protection statutes reflect that when a borrower s motivation to secure credit is driven by profit, the debt will fall outside the meaning of consumer credit. cedt In re Booth,, 858 F.2d at

49 Bankruptcy courts have adopted profit-motive test to determine whether debt is a business debt that falls outside definition of consumer debt for purposes of 101(8). See, e.g., In re Davis, 378 B.R. 539, 547 (Bankr. N.D. Ohio 2007); In re Stewart, 175 F.3d 796, 806 (10th Cir. 1999). In bankruptcy, test for determining whether debt should be classified as business debt, rather than [consumer debt]...is whether debt was incurred with [an] eye toward profit. In re Booth, 858 F.2d 1051, 1055 (5th Cir. 1988); see also In re Westerberry, 215 F.3d 589, 593 (6th Cir. 2000). Therefore, if majority of debtor s prepetition liabilities incurred with eye toward profit, debtor not subject to means testing under 707(b). 49

50 Determining whether debt consumer in nature or incurred with eye toward profit may be clear-cut, but other times debtor s pre-petition p liabilities do not fit squarely into either of these categories. EXAMPLE: The application of the means test is not so clear if the debtor s pre-petition obligations were limited to $100,000 in personal-income taxes and $50,000 owed on consumer credit cards because the income-tax liability was neither incurred with an eye toward profit, nor was it incurred for personal, family or household purposes. If profit-motive test not dispositive, the debt is not precluded from being deemed nonconsumer in nature. In re Westerberry, 215 F.3d at

51 Majority of courts that have considered issue have generally held that a tax liability is not incurred as part of a consumption activity but is involuntarily imposed in the course of earning income, and therefore is not considered consumer debt. See In re Brashers, 216 B.R. 59, (Bankr. N.D. Okla. 1998); see, e.g., In re Stovall, 209 B.R. 849, 854 (Bankr. E.D. Va. 1997); In re Dye, 190 B.R. 566, 567 (Bankr. N.D. Ill. 1995); In re Marshalek, 158 B.R. 704, 706 (Bankr. N.D. Ohio 1993); In re Greene, 157 B.R. 496, 497 (Bankr. S.D. Ga. 1993); Goldsby v. United States (In re Goldsby), 135 B.R. 611, (Bankr. E.D. Ark. 1992); In re Traub, 140 B.R. 286, 287 (Bankr. D.N.M. 1992); In re Reiter, 126 B.R. 961, 961 (Bankr. W.D. Tex. 1991); Harrison v. IRS (In re Harrison), 82 B.R. 557, 558 (Bankr. D. Col. 1987); Pressimone v. IRS (In re Pressimone), 39 B.R. 240, 244 (N.D.N.Y. 1984). 51

52 Almost all of the case law dealing with the issue has examined whether tax liabilities are consumer debts for purposes of the codebtor stay in chapter 13 cases under See In re Brashers, 216 B.R. at 60; In re Traub, 140 B.R. at However, since 101(8) is applicable to all sections of the Code, it applies to 707(b) as well when determining what constitutes consumer debt in a chapter 7 for means- test purposes. See In re Traub, 140 B.R. at

53 In In re Stovall, 209 B.R. 849 (Bankr. E.D. Va. 1997), the bankruptcy court in a chapter 13 case examined the issue of whether personal property taxes imposed on a debtor by reason of the ownership of consumer goods was a type of consumer debt. The court concluded that debt owed for personal property tax is not a type of consumer debt, even if the tax is imposed on property held for personal, family or household use. It is not the type of debt that is incurred that governs the determination of the nature of the tax liability, but rather the liability itself: It is an involuntary liability imposed by the government. 53

54 Another bankruptcy court in a chapter 13 case determined that an IRS lien for unpaid federal income taxes was not a consumer debt because it [was] not incurred in the course of a consumptive activity. In re Gault, 136 B.R. 736, 738 (Bankr. E.D. Tenn. 1991). 54

55 A handful of courts have addressed the issue of taxes and consumer debt in the context of a chapter 7. In In re Traub, 140 B.R. 286 (Bankr. D.N.M. 1992), the court held that income taxes were not consumer debts for the purposes of 707(b) and that money owed as a failure-to-pay penalty was also not consumer debt. Notwithstanding, the majority of the debtor s debts were still consumer in nature, and the case was dismissed after the court held that the granting of chapter 7 relief would have been substantial abuse. 55

56 More recently, a bankruptcy court in a chapter 7 case also classified a debt owed to the IRS as undisputed nonconsumer debt. In re Victoria, 389 B.R. 250, 252 (Bankr. M.D. Ala. 2008). The court further held that a proof of claim personally against the debtor by the IRS for unpaid corporate income taxes was also not consumer debt. Classifying these tax obligations as nonconsumer debt took the debtor outside the means test of 707(b)(2). 56

57 The only appellate court to render a holding on the issue of whether income tax liabilities are consumer debts is the Sixth Circuit Court of Appeals in In re Westberry, 215 F.3d 589 (6th Cir. 2000), which addressed whether the IRS could collect a tax obligation from a debtor s spouse in a chapter 13 case. In holding that an income tax debt was not a consumer debt, the court of appeals distinguished income tax debt from consumer debt in four ways: 57

58 1. The income tax debt was not voluntarily incurred on the part of the taxpayer. 2. The tax was incurred for a public purpose rather than a personal, family or household purpose. 3. The tax debt resulted from profit earning activities rather than from consumption 4. The taxation did not require or involve the extension of credit, which is a typical characteristic of consumer debt. The court concluded that the Code treats tax debts differently from consumer debts. It also noted that although the profitmotive test is not determinative of the issue of whether taxes constitute consumer debt, it does not prohibit other types of debt from falling outside consumer debt. 58

59 Although the Westerberry court held that federal income taxes were not consumer debts as defined by 101(8) and for purposes of 1301, other courts have indicated otherwise. The Fifth Circuit it Court of Appeals in In re Booth, 858 B.R (5th Cir. 1988), determined what debts should be classified as consumer debt in considering the dismissal of a debtor s bankruptcy case under 707(b). Although the court held that a loan secured by the debtor s residence was not a consumer debt, in dicta the court implied that the debt owed to the IRS was consumer debt. Similarly in dicta, a bankruptcy court in a chapter 7 case categorized tax debt owed to the IRS as consumer debt for purposes of 707(b). In re Bell, 65 B.R. 575, 576 (Bankr. E.D. Mich. 1986). 59

60 In In re Gentri, 185 B.R.368 (Bankr M.D. Fla. 1995), the court held that tax liabilities constituted consumer debt within the scope of 101(8) and for purposes of the substantial-abuse abuse provisions of 707(b). The debtors defaulted on their home mortgage loan, and the loan deficiency was forgiven by the lender. Subsequently, the debtors incurred tax liability for the forgiveness of the debt. The Gentri court treated the tax liability as consumer debt because absent the triggering event that was the forgiveness of the deficiency, the debt would have been consumer in nature. In addition, the debtor owed property taxes to the county tax collector for the residence and the court held that this also was consumer debt under 101(8) and for means-testing purposes under 707(b). 60

61 While hl it may appear that there is a split in authority, the majority of the bankruptcy courts have held that tax liabilities are not consumer debts in either chapter 7 or 13 cases. Although the Fifth Circuit s dicta suggests otherwise, the Sixth Circuit Westerberry case is the only appellate case to date to specifically rule that tax liabilities are nonconsumer in nature. 61

62 The Westerberry court s reasoning is rational and well thought-out: The income tax debt was not voluntarily incurred on the part of the taxpayer, the tax was incurred for a public purpose rather than a personal, family or household purpose, the tax debt resulted from earning activities for a profit rather than from consumption activities, and the taxation does not require or involve the extension of credit. It seems to follow that for purposes of applying the means test of 707(b), the case law seems to bear out that tax liabilities are considered nonconsumer debt. 62

63 Equitable Considerations BAPCPA also permits "other necessary expenses," which in some cases exceed IRS allowances: Health care costs; Health and disability insurance; Expenses for elderly, ill or disabled family member; Up to $1,500 per year per child for public or private elementary or secondary school; and Contributions to charity up to 15% of gross income. 63

64 Equitable Considerations Because the BAPCPA means test is used to determine what debtor could pay on nonpriority unsecured debts, the computation also deducts contractually scheduled payments to secured creditors for five years after petition date. For example, this may permit deduction of mortgage payments in excess of IRS housing allowance for purposes of the means test. 64

65 Equitable Considerations Conversion of Chapter 7 case to Chapter 11 or Chapter 13 will permit the discharge, but at the price of making monthly payments. Pre-BAPCPA, Chapter 13 plans usually required payments for 3 years. BAPCPA requires payments for 5 years if debtor's income is above the median income level for the state. 65

66 Chapter 7 vs. Chapter 13 Superdischarge provisions. Prior to BAPCPA, some taxes that were not dischargeable in Chapter 7 were dischargeable in Chapter 13: SFR assessments. Taxes for years with unfiled returns or filed less than two years before petition date. Taxes arising due to fraud. Taxes assessable but not assessed. Unfortunately, these superdischarge features of Chapter 13 were eliminated by the BAPCPA. 66

67 Chapter 7 vs. Chapter 13 But even after the BAPCPA, Chapter 13 still has some advantages over Chapter 7: Ability to pay priority taxes with monthly payments under the protection of the Court. No post-petition penalties, and no interest on unsecured, priority tax debts. Ability to discharge some debts even when Chapter 7 is unavailable due to means test. 67

68 Chapter 7 vs. Chapter 13 Disadvantages of Chapter 13: Who may be a debtor: Only someone with regular income; and with debts less than $360,475 unsecured, $1,081,400 secured. Monthly payments are required based on income and allowable living expenses. Must full pay priority debts for plan to be confirmed. 68

69 Contesting Tax Debts U.S. District Court or Claims Court. Prerequisite is full payment (Flora). Deals only with federal taxes. U.S. Bankruptcy Court. Court has authority to determine any tax. Put taxes at issue by filing objection to IRS proof of claim, or an adversary proceeding to determine amount and dischargeability of tax. 69

70 Contesting Tax Debts Judicial opportunities to contest tax liabilities: US U.S. Tax Court. No jurisdiction unless Petition filed within 90 days of Statutory Notice of Deficiency. Lacks jurisdiction over some kinds of taxes. Deals only with federal taxes. 70

71 Contesting Tax Debts Adversary proceeding is a lawsuit within a bankruptcy case, seeking affirmative relief. This can include determining the validity, priority, or extent of a lien, and determining the amount and dischargeability of a debt. 71

72 After the Discharge Tax problems often remaining after bankruptcy: Some taxes may survive the discharge (i.e. the in personam liability remains). Some taxes may have been secured by the pre-petition filing of tax liens (i.e. the in rem liability remains). 72

73 After the Discharge A valid federal tax lien survives a discharge. If IRS has properly filed a prepetition NFTL, and the lien is still valid (i.e., it was refiled correctly, if applicable) the lien survives the discharge. IRS may collect discharged taxes from property that is exempt from the estate, excluded from the estate, t or abandoned d by the trustee. t 73

74 After the Discharge IRS processing of case after discharge: Accounts remaining unpaid are reactivated, abated or reported as currently not collectible. Discharge relieves taxpayer of personal liability. But tax may still be collected from property (including exempt property) encumbered by a pre-bankruptcy p lien. SPf reviews collection potential and determines whether accounts should be abated. If there are no encumbered assets, taxes are abated and liens released. 74

75 After the Discharge Possible solutions for taxes surviving discharge: Second bankruptcy -- Chapter 7 can be followed by a Chapter 13 (after 4 years), or even another Chapter 7 (after 8 years). Installment agreement. Offer in compromise. Wait out statute of limitations (10 years from date of assessment, but extended by OIC, time in bankruptcy, CDP hearing requests, etc.). 75

76 Bankruptcy vs. OIC -- Treatment of Assets Offer in compromise: Retain assets. Pay 20% quick sale discount on hard assets, 100% of value of cash assets (special rules for IRAs, etc.). Chapter 7: Assets in excess of state exemptions are sold by trustee. Tax liens survive bankruptcy against pre-petition assets. Chapter 13: Retain assets. Must pay at least the value of non-exempt assets, plus the equity in property encumbered by liens. Five years to pay. 76

77 Bankruptcy vs. OIC -- Payment Options Offer in Compromise: Two options: Lump sum offer (payable over 5 months); or deferred payment offer (payable over 24 months). Chapter 7: Paid from (and to the extent of) debtor s assets. Unpaid nondischargeable taxes survive to be dealt with post-discharge. Chapter 13: Trustee determines ability to pay. Pay value of non-exempt assets, plus equity in property encumbered by FTL, over 5 years. 77

78 Bankruptcy vs. OIC Substitute te for Return (SFR) Offer in Compromise: May compromise -- (but IRS will often require filing of unfiled returns so taxpayer is in full compliance ). Bankruptcy: Nondischargeable (but note special BAPCPA provision for what constitutes a return). 78

79 Bankruptcy vs. OIC Late Filed Returns Offer in Compromise: May compromise. Bankruptcy: Dischargeable if petition filed 2 years after return is filed, 240 days after tax is assessed, and 3 years after due date. 79

80 Bankruptcy vs. OIC Non-filed Returns (w no SFR) Offer in Compromise: May not compromise until tax returns are filed and tax assessed. Bankruptcy: Nondischargeable. 80

81 Bankruptcy vs. OIC Fraudulent Returns Offer in Compromise: May compromise (but in some cases IRS may raise public policy argument). Bankruptcy: Nondischargeable. 81

82 Bankruptcy vs. OIC Trust Fund Taxes (100% Penalty) Offer in compromise: May compromise. (but note special rules evaluating offers in compromise from in business taxpayers). Bankruptcy: Nondischargeable. 82

83 Bankruptcy vs. OIC Enforced Collection Action Offer in Compromise: IRS may not levy or seize while offer is under consideration (or rejection is being appealed or litigated). Bankruptcy: BC 362 prevents enforcement action by IRS and other creditors. 83

84 Bankruptcy vs. OIC Taxpayer s Other Debts Offer in Compromise: Not resolved. Bankruptcy: Discharges all non-priority debts not excepted from discharge (though lien may remain on pre-petition assets). 84

85 Bankruptcy vs. OIC State Tax Obligations Offer in Compromise: Not settled (but separate offer in compromise with state may be available). Bankruptcy: Same rules as federal taxes, so that bankruptcy may resolve some or all state t taxes along with federal liabilities. 85

86 Bankruptcy vs. OIC Penalties Offer in Compromise: Included in offer and resolved upon acceptance and payment. Bankruptcy: Nonpecuniary loss penalties are discharged if event penalized is over 3 years old. 86

87 Bankruptcy vs. OIC Limitation on Amount of Debt Offer in Compromise: None. Chapter 7: None. Chapter 13: Debts cannot exceed limits: $360,475 of unsecured debt, and $1,081,400 of secured debt. 87

88 Bankruptcy vs. OIC Ideal Client for Each Approach Offer in Compromise: Taxpayer with large nondischargeable taxes, modest present income and future earning potential (on an individual and household basis), few assets, and a source of new cash with which to fund the offer in compromise. 88

89 Bankruptcy vs. OIC Ideal Client for Each Approach Chapter 7: Taxpayer with low income, or with high h income as long as the taxes and other nonconsumer debts exceed the consumer debt, few assets that would be includible in the bankruptcy estate, and large dischargeable tax and nontax debts. 89

90 Bankruptcy vs. OIC Ideal Client for Each Approach Chapter 13: Taxpayer with regular income, and with assets that would be excluded from the bankruptcy estate but included in the IRS s computation of ability to pay for purposes of an OIC. Taxpayer who is subject to the BAPCPA means test and cannot pass, and who is thus barred from using Chapter 7. 90

91 Securing tax information Complete information about taxes is essential. Don t rely on client or even client s accountant. The documents will be incomplete, recollections will be imperfect, and understanding of the relevant issues inadequate. IRS Practitioner Priority Service ( ). Local IRS Disclosure Office. 91

92 Securing tax information Obtain and review IRS account transcripts: Transcripts show chronological history of events posted to the IRS Integrated Document Retrieval System (IDRS) return due date, date filed, date assessed, SFRs, statutory notices of deficiency, payments, interest, penalties, appeals, collection waivers, innocent spouse claims, litigation holds, prior offers in compromise, etc. Each tax period is tracked in a separate module. 92

93 Securing tax information Reference materials: Internal Revenue Manual Bankruptcy Handbook. Found at IRM et seq. IRS Litigation Guideline Memoranda. BJ Haynes articles at 93

94 Taxation of Bankruptcy Estates The filing of a petition under any chapter of the Bankruptcy Code creates an estate. But only a petition for an individual in Chapter 7 or 11 (but not in Chapter 13) creates a separate taxable entity. The trustee or DIP of an individual estate must obtain an EIN, file returns, and pay any tax that t may be due if the estate has gross income that meets or exceeds the filing requirement. 94

95 Taxation of Bankruptcy Estates No separate taxable entity results from the bankruptcy of a partnership or corporation. However, the trustee must file all tax returns which h the partnership or corporation would have been required to file, and must pay all applicable taxes. 95

96 Taxation of Bankruptcy Estates IRC 1398(d) Election to Close Tax Year An individual debtor may elect to close his tax year as of the day before the petition is filed. IRC 1398(d) election must be made on or before due date of return for the short year ending on the day before the petition date. If election is made, debtor's tax year is divided into two short tax years. The first ends the day before the petition; the second begins on the petition date. Absent election, bankruptcy does not close the tax year of an individual debtor. 96

97 Taxation of Bankruptcy Estates IRC 1398(d) Election to Close Tax Year If election is made, the income tax for the first short year is a pre-petition debt, and can be paid from property of the estate. Since any such tax would be nondischargeable, the debtor would remain liable after the discharge if the tax is not paid from property of the estate. If election is not made, no part of the debtor's tax liability for the year in which the petition is filed is collectible from the estate, but rather would be collectible directly from the debtor. 97

98 Taxation of Bankruptcy Estates IRC 1398(d) Election to Close Tax Year The 1398(d) election to split the taxable year is available only in Chapter 7, not in Chapter 13. The election is also not available if the debtor has no non-exempt assets. [See IRC 1398(a) and (d)(2)(c)] 98

99 Taxation of Bankruptcy Estates Income and Deductions Gross income of the estate includes any of the debtor's income to which the estate is entitled. Gross income of the estate does not include amounts received or accrued by the debtor before the petition date. The estate may deduct any amount it pays as if the amount was paid by the debtor in carrying on the same trade, business, or activity in which the debtor was engaged. g 99

100 Taxation of Bankruptcy Estates Transfer of Debtor s Assets Bankruptcy law determines which assets become property of the estate. These assets are treated the same in the estate'ss hands as in the hands of the debtor. A transfer from the debtor to the estate is not treated as a disposition for tax purposes. Thus, the transfer does not result in recognition of gain or loss, recapture of deductions or credits, or acceleration of income or deductions. 100

101 Taxation of Bankruptcy Estates Transfer of Debtor s Assets When the estate is terminated, a transfer of assets back to the debtor is not treated as a disposition, and such transfer does not result in the recognition of gain or loss. A transfer back to the debtor by abandonment receives similar tax free treatment. 101

102 Taxation of Bankruptcy Estates Transfer of Tax Attributes tes On the first day of the debtor's tax year in which the petition is filed, the estate succeeds to the tax attributes listed in IRC 1398(g), including: 1) net operating loss carryovers, 2) carryovers of excess charitable contributions, 3) credit carryovers, 4) capital loss carryovers, 5) basis, holding period, and character of assets, 6) passive activity loss and credit carryovers, and 7) unused at-risk deductions. 102

103 Taxation of Bankruptcy Estates Transfer of Tax Attributes tes Tax attributes of the estate are reduced by any excluded cancellation of debt income. Form 982 (Reduction of Tax Attributes Due to Discharge of Indebtedness) is attached to the tax return of the estate for the year of the discharge. Tax attributes remaining when the case is closed by the Court revert to the debtor in that year. These tax attributes are not available for the taxpayer's use prior to the close of the case. 103

104 Taxation of Bankruptcy Estates Deduction of Administrative Expenses The estate t may deduct d administrative i ti expenses, including legal fees, court costs, and all other expense allowed under BC 503. If administrative expenses exceed the estate s gross income, the excess may be carried back three years and forward seven years. Administrative expenses can be carried only to a tax year of the estate, t and never to a tax year of the debtor. The carry back is first to the earliest possible year. 104

105 Taxation of Bankruptcy Estates Net Operating Loss Carrybacks If the estate has a net operating loss, separate from any administrative expense loss and from losses passing to the estate from the debtor, it can carry the loss back to its own earlier tax years as well as to the debtor's pre-petition tax years. However, an individual debtor may not carry back tax attributes tes arising in post-petition petition tax year to any pre-petition tax year. 105

106 Taxation of Bankruptcy Estates Changing Estate s Tax Year The estate may change its taxable year once without having to get approval from the IRS. This allows the trustee to close the estate s tax year early, before the anticipated termination of the estate, so that he can file a tax return for the short year and apply to the IRS for a BC 505(b) prompt determination of the estate's tax liability. 106

107 Bankruptcy Estates Prompt Determination Requests ests The trustee may request a prompt determination of any liability of the estate for any tax incurred during administration. (The estate should file all tax returns, including Form 1041 for an individual, and Forms 1120, 941 and 940 for a business.) Within 60 days, the IRS must notify the trustee if it has selected the return for audit. The notice will confirm receipt of the determination request and state whether the return is accepted as filed, or is to be examined. It must also state the full amount tdue, including interest tand penalties. 107

108 Bankruptcy Estates Prompt Determination Requests ests If the 60-day deadline is not met, amounts owed in excess of the tax shown on and paid with the return will be discharged as against the trustee, debtor, or a successor to the debtor, except for misrepresentation or fraud. The IRS is barred from collecting any additional amounts owed. However, even if the deadline is missed, it is still possible for the IRS to collect a deficiency from undistributed funds held by the estate. 108

109 Bankruptcy Estates Prompt Determination Requests ests Where a determination is sought, the debtor and the trustee will be discharged of liability upon: payment of the tax if IRS does not notify the trustee of an audit within 60 days; or if the IRS does not complete the audit within 180 days (subject to court extension for cause); payment of the tax as determined by the Bankruptcy Court; or payment of the tax as determined by the IRS. 109

110 Taxation of Bankruptcy Estates Claims for Refund If the trustee requests a refund, the Bankruptcy Court has the authority to determine the refund amount 120 days after the trustee s request. Absent a determination, the IRS may still deny the claim even after 120 days. But after 120 days the trustee may seek a determination of the estate s refund claim in the Bankruptcy Court (and thus may contest the IRS s determination). 110

111 Taxation of Bankruptcy Estates Claims for Refund A request for refund is deemed made if: the trustee files a claim for refund in response to the IRS s proof of claim; or the trustee files a tax return or amended return showing an overpayment. 111

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