Monthly Archives: October 2015

Can a Merchant Discharge Unpaid Sales Taxes by Filing Bankruptcy?

We all have paid sales taxes when purchasing consumer items.  But where does that money go?

In most states, a merchant selling consumer products is required to collect sales tax from customers and hold that money in trust for the government.  Periodically, the merchant is required to report the amount of sales taxes collected and to tender the tax money to the government.

However, some merchants fail to tender the money to the government when business is bad and use the trust fund money as a cash infusion to keep the business afloat.  It’s a terrible idea from a bankruptcy attorney’s point of view, but merchants struggling to keep their doors open sometimes grab any life-line they can reach.

Such was the case in Cooper v. Miss. Dep’t of Revenue (In re Cooper), 2015 Bankr. LEXIS 3261, (Bankr. S.D.MS 2015).  Cooper was audited by the Mississippi Department of Revenue for a three year period and assessed almost $60,000 in unpaid sales taxes.  MDOR filed a lien to secure its claim and started collection efforts against Cooper.

Two years later, Cooper responded by filing Chapter 13 bankruptcy and then initiated an adversary proceeding alleging the sales tax debt was dischargeable.  However, the court noted that Cooper failed to site any Bankruptcy Code sections or case law supporting Cooper’s position. MDOR filed a motion for summary judgment asserting that there are no factual issue in dispute and MDOR is entitled to a judgment that the sales tax debts are non-dischargeable.  MDOR’s claim had increased with interest to approximately $70,000.

The Court granted MDOR’s motion and held that the sales tax debts were non-dischargeable pursuant to 11 U.S.C. §§523(a)(1)(A) and  507(a)(8)(A).  The court’s reasoning for nondischargeability was limited to a one paragraph declaration.  Interestingly, MDOR did not allege that the taxes were nondischargeable pursuant to § 507(a)(8)(C), which would have been harder to discharge.  But MDOR’s attack on a  §507(a)(8)(A) basis opened a dischargeability door for Cooper to walk through, but Cooper failed to take advantage of this strategic opening and had to suffer the consequences of having $70,000 worth of tax debts rendered non-dischargeable.

Practice Pointer:   The taxpayer missed an opportunity to discharge the sales tax debt.  According to the Cooper court, the sales taxes were a §507(a)(8)(A) tax.  This type of debt could have been discharged if the taxpayer had waiting the required time periods set forth in 11 U.S.C. §§523(a)(1)(A) and  507(a)(8)(A).  Cooper should have considered before filing bankruptcy  the 3-year due date rule, 2-year filing date rule, and the 240-day assessment rule.  But Cooper failed to time the filing correctly, which resulted in Cooper not discharging the $70,000 claim.  Cooper should have made the investment and paid a little more to acquire expert legal advice.

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

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Can a Bankruptcy Trustee Force the IRS to Surrender Trust Fund Taxes Paid by a Bankruptcy Payroll Company?

It is not uncommon for a for-profit corporation to outsource payroll services to an independent payroll company (“Payroll Provider”) to help administer payroll tasks.  A corporation typically advance funds to the Payroll Provider near the end of a payroll cycle, which are in turn used by the Payroll Provider to pay wages to the corporation’s employees and pay corresponding trust fund obligations to the various taxing authorities.

But what happens when the Payroll Provider files bankruptcy within 90 days of paying trust fund obligations to the IRS?  The issue is one of “preferential transfer.”  This issue was addressed in Slobodian v. United States of America, 533 B.R. 126 (Bankr. M.D.PA 2015), where the Payroll Provider paid $32,297 to the IRS within the period 90 days prior to the Payroll Provider filing bankruptcy.

In Slobodian, The Chapter 7 trustee filed an adversary complaint against the IRS alleging that the IRS payment was a preferential transfer because it was made within 90 days of the bankruptcy filing.  The trustee sought disgorgement of the $32,297 so that the funds could be redistributed to all creditors according to their statutory rights.

The Slobodian court ruled that in order to disgorge a purportedly preferential transfer, a trustee must demonstrate a (1) transfer of an interest of the debtor in property (2) to or for the benefit of a creditor (3) for or on account of an antecedent debt owed by the debtor, and (4) made while the debtor was insolvent.  11 U.S.C. §547(b).

So the big issue for the Slobodian court to determine was whether the $32,297 payment constituted a “transfer of an interest of the debtor in property.”  The IRS argued that the Payroll Provider never possessed an interest in the property for preference action purposes, and instead held the transferred funds in trust, to be transmitted to the United States pursuant to the Payroll Provider’s payroll service agreement with the corporation that provided the funds to the Payroll Provider.  The IRS asserted that the funds were held in a special statutory trust for the United States pursuant to 26 U.S.C. §7501(a), which states “Whenever any person is required to collect or withhold any internal revenue tax from any other person and to pay over such tax to the United States, the amount of tax so collected or withheld shall be held to be a special fund in trust for the United States.”  The special trust applies to Social Security, Medicare, and income taxes that Congress requires employers to withhold from employees’ paychecks, commonly referred to as “trust-fund taxes.” Id. at 134, citing Begier v. Internal Revenue Service, 496 U.S. 53, 54 (1990).

The Slobodian court agreed with the IRS and found that corporation’s channeling of trust fund taxes through the third-party Payroll Provider did not dilute the protections of the 26 U.S.C. §7501(a) trust.  The corporation tendered the funds to the Payroll Provider which collected the funds pursuant to its payroll services agreement and withheld both trust fund and non-trust fund taxes from the collected funds before ultimately distributing employee paychecks.  Therefore, the Payroll Provider did not own an equitable interest in the property it held in trust for the corporation, and thus the $32,297 payment was not “property of the estate” for purposes of preferential transfers of 11 U.S.C. §547(b).

The IRS was allowed to retain the payment and the corporation received full credit for the trust fund payments.

Practice Pointer: Be careful when dealing with payroll providers.  Perform due diligence on the providers before tendering money to them.  Make sure the funds tendered by the corporation to the payroll service are made from a segregated trust fund account and not from the corporation’s general operating account.  The preferred method would be two separate payments being made to the payroll service: one payment for employees; and one payment for the taxing authorities.  This preferred method would buttress a corporation’s argument that the trust fund payments were tendered to the payroll service in trust as part of a 26 U.S.C. §7501(a) trust fund. It may not be “convenient” but it is following best practices.

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

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Don’t Trust the IRS’ Advice, it May be Wrong!

What recourse do taxpayers have if they wrongly rely upon the IRS’ bankruptcy advice?  None according to In re Brown, 533 B.R. 344 (Bankr. M.D. FL 2015).  There, taxpayers followed the IRS’ inaccurate bankruptcy advice that resulted in unwanted tax collections, including levies against the taxpayers’ bank accounts and tax refund offsets after the taxpayers’ bankruptcy case concluded.  The Brown court rejected the taxpayers’ theories of laches and estoppel to stop the IRS  because these equitable doctrines could not thwart the clear mandate of the U.S. Bankruptcy Code.  11 U.S.C. §101 et seq. The opinion did not state whether the taxpayers were represented by counsel at the time the IRS gave the advice or, if represented, why the taxpayers did not rely on contrary advice given by the taxpayers’ attorney.

Originally, the Brown taxpayers sought bankruptcy protection for relief from the IRS’ collection efforts initiated prior to the bankruptcy filing.  The taxpayers’ confirmed repayment plan, as amended, provided for the repayment of 100% of the IRS’ non-dischargeable priority tax claims and only a small percentage of the IRS’ non-priority unsecured claims relating to tax penalties (hereinafter, “Penalty Claims”).

Later, the taxpayers experienced problems making the plan payments.  The IRS recommended a strategy urging the taxpayer to file for a “hardship discharge” pursuant to 11 U.S.C. §1328(b) and then resolve the remaining priority debt issue outside of bankruptcy through an offer in compromise.  According to the IRS, this strategy would have allegedly discharged the Penalty Claim.  The taxpayers took the IRS’ advice and concluded the bankruptcy early by obtaining a hardship discharge.

The post-bankruptcy events did not go as planned.  The taxpayers’ offer in compromise was rejected by the IRS and the IRS sought to collect both the priority claim PLUS the Penalty Claim.  After the bank levied the taxpayers’ bank accounts and offset their tax refund, the taxpayers filed action in the bankruptcy court alleging the IRS violated the bankruptcy discharge injunction.

The Brown court had to determine if a hardship discharge under 11 U.S.C. §1328(b) eliminated the IRS’ Penalty Claim since the IRS encouraged the taxpayers to pursue a hardship discharge, and at no time indicated the IRS intended to collect on its Penalty Claim after the hardship discharge.

First, the Brown court understood that the hardship discharge of 11 U.S.C. §1328(b) is more limited in scope than the general discharge of 11 U.S.C. §1328(a).  Of particular importance was the discharge exception relating to tax penalties pursuant to 11 U.S.C. §523(a)(7). Unlike the general discharge of §1328(a) which eliminates tax penalties, the hardship discharge of §1328(b) does not discharge tax penalties relating to government claims for income taxes due within the three years prior to the bankruptcy filing.

Second, the Brown court found that the IRS’ inaccurate advice rendered prior to the entry of the hardship discharge did not affect the dischargeability of the IRS’ Penalty Claim.  The Penalty Claims remained non-discharged.  Therefore, the IRS was not violating the discharge injunction when it levied on the taxpayers’ bank accounts because the IRS’ debts were not discharged when the taxpayers received the §1328(b) hardship discharge.

Practice Pointer: Do not take the IRS’ advice on bankruptcy issues of law. Contact a qualified bankruptcy attorney with extensive experience in income tax dischargeability.  Taxpayers should follow the advice of experienced counsel and not the advice/strategy of the IRS.  Honest taxpayers who follow the IRS’ inaccurate advice could find themselves in deep trouble.  The old adage is true:  You get what you pay for; so don’t take free advice!

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

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Tax Debts are Dischargeable 3 Years After a Return Due Date Unless Tolled by a Prior Bankruptcy or Other Matter.

Income taxes are dischargeable in bankruptcy three years after the tax return “due date.” 11 U.S.C. §523(a)(1)(A) incorporating 11 U.S.C. §507(a)(8)(A)(i).  But that 3-year period can be extended or “tolled” if the taxing authority was prohibited from collecting against the taxpayer as a result of a pending bankruptcy case.  For example, consider a tax payer who files chapter 13 bankruptcy because he owes significant tax debts and seeks protection from the IRS’ collection efforts, liens, levies, etc. The tax debts owed prior to a bankruptcy filing are scheduled to be repaid in a chapter 13 bankruptcy case; the IRS would be prohibited from collecting against the taxpayer during the life of the chapter 13 because of the automatic stay protections granted to the taxpayer.  If the taxpayer does not complete the full repayment plan, then the case could be dismissed and the IRS would be afforded time to collect those prepetition tax debts, including the 3-year period, plus anytime the taxpayer was in bankruptcy, plus 90 days.  See 11 U.S.C. §507(a)(8)(*).

But what happens if the tax obligations related to tax years ending AFTER the chapter 13 bankruptcy case was filed?  That issue was address in Kolve v. IRS (In re Kolve), 459 B.R. 376 (Bankr. W.D.WI 2011).  In Kolve, a taxpayer’s prior chapter 13 bankruptcy case lasted more than two years.  During those two years, the taxpayer failed to pay the tax obligations coming due after the bankruptcy filing but while the case was still pending.  The prior bankruptcy case was ultimately dismissed and these postpetition tax debts were never paid.

The taxpayer waited just longer than three years after the dismissal of the chapter 13 bankruptcy case to file a chapter 7 bankruptcy case.  The taxpayer sought to discharge the taxes incurred after the filing of the prior bankruptcy case (but while the prior bankruptcy case was still pending).  The taxpayer argued a discharge was appropriate because the tax obligations related to tax returns whose “due date” was more than three years prior to the subsequent bankruptcy filing date. The IRS objected to the discharge stating that the 3-year “due date” period was tolled while the prior bankruptcy case was pending since the tax returns came due while the prior bankruptcy case was active.  The IRS cited the 90-day tolling provision of 11 U.S.C. §507(a)(8)(*).

The Kolve court ruled in favor of the taxpayer.  It found the tolling provision inapplicable because the IRS had not been prohibited by the automatic stay protections from collecting the tax obligations incurred while the prior bankruptcy case was pending. The court distinguished between tax obligations incurred prior to the original bankruptcy case (prepetition taxes) and the tax obligations incurred after the original case was filed (postpetition taxes).  The IRS was estopped from collecting prepetition taxes by the bankruptcy, but was not prohibited from collecting the postpetition taxes.  Therefore, the “tolling” provision that grants the IRS an additional 90 days was not applicable.  The tax debts were deemed dischargeable.

Practice Pointer:   The tolling period appears to be dependent upon the taxing authority being actually prohibited from collecting.  The mere existence of a bankruptcy case is not sufficient.  The taxing authority must be denied the right to exercise its collections rights, including garnishments, liens, and levies.

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

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Discharge Income Taxes 3 Years After the Due Date.

Taxpayers can discharge income tax obligations by filing bankruptcy three years after the tax return “due date.” 11 U.S.C. §523(a)(1)(A) incorporating 11 U.S.C. §507(a)(8)(A)(i).  The tax return “due date” is the date on or before which the tax return is required to be filed.  For IRS taxes, the filing due date is April 15th following the prior tax year, assuming that date is not a weekend or holiday.

However, the “due date” for bankruptcy purposes changes when a taxpayer requests and receives an automatic extension of the filing due date.  For example, a taxpayer can file IRS Form 4868 “Application for Automatic Extension of Time to File U.S. Individual Income Tax Return.”  This application extends the due date 6 months to October 15th.  In such a situation the “due date” for bankruptcy purposes would be October 15th — even if the taxpayer files the return between the April 15th original deadline and the October 15th extended deadline.  The date of filing is not at issue; the “due date” is the key issue for 11 U.S.C. §507(a)(8)(A)(i) purposes.

Similarly, the “due date” for state and local taxes could also be extended automatically even without the taxpayer submitting a request to the state and local taxing authorities.   Some states automatically extend the due date for the state tax returns if a taxpayer requests and receives an extension of the federal tax return due date.  Under these circumstances, the “due date” for bankruptcy purposes for those state and local taxing authorities would be the extended due date.

Practice Pointer:   Best practices requires a careful review and calculation of the tax return “due date” to determine if a tax obligation is dischargeable in bankruptcy. A matter of a single day could result in an otherwise dischargeable tax debt being rendered non-dischargeable.

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

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Can Income Taxes be Eliminated if the IRS Still Has the Right to Assess a Deficiency?

No, income taxes cannot be discharged or eliminated in bankruptcy if the taxing authority still has the right to assess a tax.  Section 523(a)(1)(A) of the Bankruptcy Code identifies certain types of income taxes that are non-dischargeable in bankruptcy by incorporating §507(a)(8)(A) of the Bankruptcy Code.  Section 507(a)(8)(A) excepts from discharge any income taxes that are assessed within 240 days of the bankruptcy filing, or are assessable under applicable non-bankruptcy law after the bankruptcy case is filed.

The US Court of Appeals for the Seventh Circuit addressed this issue in U.S. v. Frontone, 383 F.3d 656 (7th Cir. 2004).  In Frontone, a taxpayer had filed a tax return and paid the tax owed as required by the IRS Code.  However, the IRS made an error and wrongly tendered a tax refund to the taxpayer.  The IRS later realized its error and issued a supplemental assessment for the deficiency caused by the tax refund.  The IRS compounded the error by making another error—namely, issuing a supplemental assessment without issuing a notice of deficiency.

The taxpayer filed bankruptcy in an effort to discharge the tax debt caused by the tax refund.  The Frontone court denied the taxpayer’s quest for a discharge because the tax obligation was assessable at the time the bankruptcy case was filed. First, the court found that the IRS’ supplemental assessment was in error because it had not followed a “notice of deficiency.”  But that did not save the taxpayer because the court found that the IRS eventually filed the required notice of deficiency within the time period allowed as provided by the IRS Code (even if it was after the bankruptcy filing).  Therefore, since the notice of deficiency was finally issued correctly, the Frontone court found the tax refund obligation non-dischargeable because the tax debt was “assessable” on the date the bankruptcy case was filed.

Practice Pointer:   Best practices requires a careful analysis of the tax filing deadlines and the Bankruptcy Code’s statutory waiting periods.  Taxpayers must wait to file bankruptcy at least 240 days after the IRS assesses the tax, AND wait beyond the statutory assessment period if the IRS has not yet assessed a tax so that the tax becomes non-assessable.

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

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Taxpayers can discharge income tax liability relating to late-filed returns by filing Chapter 7 bankruptcy.

A Chapter 7 bankruptcy general discharge eliminates a debtor’s obligation to pay debts.  11 U.S.C. §727.  However, income tax debts relating to an unfiled tax return are excepted from the general discharge and survive the bankruptcy.  11 U.S.C. §523(a)(1)(B)(i).  The issue in Biggers was whether an IRS Form 1040 can be considered a “return” for bankruptcy purposes when filed after the due date and after the IRS unilaterally assessed a tax.

The Biggers court noted that courts across the country are divided regarding the issue of discharging tax obligations relating to late-filed tax returns.  Some courts have concluded that a late-filed tax return can never be a “return” for bankruptcy purposes solely because the return was filed after the tax filing deadline – even one day late.  See, e.g., In re Fahey, 779 F.3d 1 (1st Cir. 2015).  These courts rely on the Bankruptcy Code’s definition of “return” contained in 11 U.S.C. Section 523(a)(*), which states the term “return” means a return that satisfies the requirements of “applicable nonbankruptcy law”-including applicable filing requirements.

However, the Biggers court reached a different conclusion and rejected Fahey’s rational and held that a late-filed return can be deemed a “return” for bankruptcy purposes if it meets the definition of “return” as set forth in Beard v. Commissioner, 82 T.C. 766, 1984 WL 15573 (1984), affirmed 793 F.2d 139 (6th Cir. 1986).  The Beard test determining whether an IRS Form 1040 is a “return” has four prongs: (1) it must purport to be a return; (2) it must be executed under penalty of perjury; (3) it must contain sufficient data to allow calculation of tax; and (4) it must represent an honest and reasonable attempt to satisfy the requirements of the tax law.   

The Biggers court agreed with those decisions that define the phrase “applicable non-bankruptcy laws” of 11 U.S.C. Section 523(a)(*) as the pre-BAPCPA Beard test and found a Form 1040 is a “return” if it satisfies the Beard test. The court rejected the idea that the reference to “applicable non-bankruptcy laws” relates narrowly to the filing deadline imposed by the taxing authority per statute.

The Biggers court then applied the Beard test, noting that the taxpayers had filed multiple returns after the filing deadline and after the IRS had already assessed the tax.  The court found that the late-filed returns served no purpose on all but one return because the tax liability disclosed on the late-filed return was less than the amount assessed by the IRS and therefore did not “represent an honest and reasonable attempt to satisfy the requirements of the tax law,” as required by the fourth prong of the Beard test.  However, the court allowed the discharge of income tax relating to the one late-filed return that disclosed liability greater than the amount assessed by the IRS.  The Court allowed the discharge as to the tax liability that exceeded the IRS’ assessed liability that return.  Although not addressed in the opinion, it appears the Biggers court would have discharged all of the tax liability had the returns been filed after the filing deadline but before the IRS had assessed the tax.

When are Income Taxes Assessed by the Government?

Income taxes are dischargeable by filing bankruptcy if the taxpayer waits more than the amount of time set forth in the Bankruptcy Code.  One of the requirements is that the taxpayer must wait to file bankruptcy more than 240 days after the date the taxing authority “assesses” the tax.  See 11 U.S.C. §523(a)(1) incorporating §507(a)(8)(A)(ii).

But when are income taxes deemed “assessed” such that the 240-day clock starts ticking? This issue was addressed in Harnden v. United States of America (In re Harnden), Nos. 08-B-71909, 10-A-96039 (Bankr. N.D.IL 2011), where the IRS had audited the taxpayer and determined that the taxpayer had underreported his income by about $30,000.  The IRS sent the taxpayer Form 4549 (Income Tax Examination Changes) requesting that the taxpayer agree to the proposed increase in tax and waive any appeal rights.  The taxpayer signed the form in August of 2006, which stated “I give my consent to the immediate assessment and collection to any increase in tax and penalties.” The IRS, however, did not officially assess the tax until February of 2008.  The taxpayer filed the bankruptcy case in June of 2008, less than 240 days after the IRS had officially assessed the tax.

The Harnden court rejected the taxpayer’s argument that the IRS had effectively assessed the tax upon the taxpayer signing and returning the Form 4549 Income Tax Examination Changes.  The court found that neither the notice the IRS sent nor the taxpayer’s signature and return of the tax examination changes form constituted an “assessment” of the additional tax.

The Harnden court found that the assessment of federal income tax is “made by recording the liability of the taxpayer in the office of the Secretary [of the Treasury] in accordance with rules or regulations prescribed by the Secretary.” 26 U.S.C. §6203.  Those regulations delegate authority to “assessment officers” and state that the “assessment shall be made by an assessment officer signing the summary record of assessment. … The date of the assessment is the date the summary record is signed by an assessment officer.” 26 C.F.R. §301.6203-1.

Practice Pointer:   Best practices warrant obtaining proof from the taxing authority of the official assessment date.  For IRS debt, tax professionals must obtain copies of the IRS’ account transcript for each year that a taxpayer desires to discharge a tax obligation.  The tax transcript can assure counsel that the taxpayer has waited the appropriate time to pass the various time sensitive rules.

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

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Does a Bankruptcy Filing Stop the IRS from Levying Assets? 

Yes, filing bankruptcy immediately stops the IRS from levying assets or even threatening to levy assets while the bankruptcy case is pending.  Section 362 of the Bankruptcy Code provides that a bankruptcy filing immediately protects a taxpayer by an automatic injunction called the “automatic stay” from any act by a taxing authority to collect, assess, or recover a claim against the taxpayer that arose before the bankruptcy case was filed. 11 U.S.C. §362(a)(6). The conduct prohibited ranges from that of an informal nature, such as by telephone contact or by dunning letters, to more formal judicial and administrative proceedings.

In the IRS context, the automatic stay prohibits the IRS from sending a Notice of Intent to Levy and a Notice of Levy. However, the Bankruptcy Code does not prohibit all communications by the IRS.  Despite the fundamental importance of the automatic stay, Congress provided taxing authorities an exception to the automatic stay provision for “(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. See 11 U.S.C. §362(b)(9).

The §362(b)(9) exception has its own limitations and is narrowly construed.  The IRS may be permitted to make an assessment and a demand for payment. However, the IRS cannot couple that demand for payment with a Notice of Levy or other collection effort, or a Notice of Intent of Levy or other threat of a collection effort, including IRS pamphlets entitled “Understanding the [IRS] Collection Process (IRS Publication 954).

The limits of a §362(b)(9) exception was addressed recently in the non-IRS case In re Gonzalez, 532 B.R. 1 (D. PR 2015). The Gonzalez court had to determine if the Treasury Department of Puerto Rico violated the automatic stay by sending a debtor a “Final Notice” regarding the taxpayer’s prepetition income tax debt. That notice also included an assertion that the law empowers the taxing authority to use collection steps like wage garnishments and asset levies. The Gonzalez court rejected the taxing authority’s argument that such communications are excepted from the automatic stay by §362(b)(9).  Instead, the Gonzalez court ruled that the threat of collection efforts is outside the creditor protection of §362(b)(9) and is an automatic stay violation of 11 U.S.C. §362(a)(6).  The tax authority’s actions were enjoined and the violation subjected the taxing authority to sanctions, costs, and attorney’s fees.

PRACTICE POINTERS: A tax professional should recommend a taxpayer seek the advice of a bankruptcy attorney whenever the IRS or other taxing authorities are threatening collections action like levies and garnishments.  The automatic stay protections afforded by the Bankruptcy Code give taxpayers breathing room to orderly address the tax collection issues jointly with the tax professional and bankruptcy attorney.  The automatic stay stops the IRS from collecting, including levies and garnishments.

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

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Are Excise Taxes Dischargeable in Bankruptcy? 

Excise taxes assessed against an individual are dischargeable in a Chapter 7 case if the taxpayer waits three years to file bankruptcy.  The waiting period begins on the date of the transaction that incurs the excise tax if the taxpayer is not required to file a tax return reporting the excise tax.  However, the waiting period begins on the date of the tax return “due date” if the taxpayer is required to file a tax return reporting the excise tax transaction.

The excise tax is deemed a “priority” tax within the first three years of the waiting period pursuant to  11 U.S.C. §507(a)(8)(E) and rendered nondischargeable pursuant to 11 U.S.C. §523(a)(1)(A).  But the excise tax transforms into a “general unsecured” tax after the three year waiting and becomes dischargeable period pursuant to 11 U.S.C. §§727(a) and 1328(a).

So, the individual taxpayer who waits the three years can obtain a Chapter 7 discharge of the excise tax without paying any money to the taxing authority pursuant to 11 U.S.C. §727(a).  However, filing one day too early would cause the excise tax to be a non-dischargeable priority debt pursuant to 11 U.S.C. §523(a)(1)(A) incorporating 11 U.S.C. §507(a)(8)(E).

Similarly, the individual taxpayer who waits the three years can obtain a Chapter 13 discharge of the excise tax debt pursuant to 11 U.S.C. §1328(a) by paying only the percentage of the general unsecured debt required by the “liquidation analysis” of 11 U.S.C. §1325(a)(4).

Excise taxes assessed against a corporation are never dischargeable by filing Chapter 7 since corporations cannot receive a Chapter 7 discharge.  Similarly, corporations cannot receive a Chapter 13 discharge because they are not eligible to file Chapter 13.  However, a corporation could file a Chapter 11 case and pay less than the full amount of the excise tax if the corporation waits longer than the three year waiting period.

The dischargeability of an excise tax by an individual was addressed in In re Carpenter, 519 B.R. 811 (Bankr. D.MT 2014).  There, a corporation failed to pay required unemployment insurance taxes. The state taxing authority then assessed the tax against the corporate president as a “responsible party” because the president failed to cause the unemployment taxes to be paid.

The Carpenter court identified the issue as whether a corporate president’s personal liability for the corporate excise tax retains the status of “excise tax” when applied to the president individually.  The Court noted that all parties stipulated that the corporation’s obligation to pay the unemployment insurance tax was an “excise” tax. However, the president argued his tax obligation under the “responsible party” rule does not constitute an excise “tax” and is therefore not a priority debt.  Id. at 813.

Before ruling the court quoted Collier on Bankruptcy as stating the “first step in determining whether a claim is entitled to priority is determining whether the claim asserted by a governmental entity is a tax or is another type of obligation.”  4 Collier on Bankruptcy Sec 507.11[6].  The court determined that the obligation owed by the president as a “responsible party” was a tax.  Then, the court rejected the president’s argument and found that the president’s obligation to pay as a responsible party was an obligation to pay an “excise” tax and thus was a priority debt.  The logic of the opinion is somewhat confusing and could have been challenged on appeal.

PRACTICE POINTERS: A tax professional should analyze whether the obligation imposed by the government is a “tax” or merely a debt.  Any debt would be dischargeable in an individual Chapter 7 bankruptcy.  Any excise “tax” would be nondischargeable within the three year waiting period, but would be transformed into a dischargeable debt after the three year waiting period.

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The IRS Seized the Corporation’s Assets. Can a Corporation File Bankruptcy and Discharge Tax Debts? 

I’m often asked how a corporation can eliminate its tax debts.  Typically, the corporation has withheld taxes from its employees’ paychecks but has not tendered these “trust fund taxes” to the IRS or state taxing authority.  These withheld funds are referred to as “trust fund taxes” because the employer withheld the money “in trust” for the benefit of the IRS or other taxing authority.

An employer who is struggling financially uses the trust fund taxes as a source of hard currency, much like it would if granted a bank loan.  An employer hopes the use of the trust fund taxes would defuse a business crisis or at least keep the business afloat until brighter days (entrepreneurs always see a brighter tomorrow).  The problem is the IRS is not a lender and did not voluntarily give the employer the money —and certainly has not granted the employer authorization to use the trust fund taxes.

The IRS is typically aggressive in collecting the trust fund taxes.  The IRS can intercept tax refunds, lien, levy, seize, and exercise other collection tactics.  Seizure of the corporation’s asset could terminate the business.  For example, what would a restaurant owner do if the president arrived at the restaurant one morning to find the IRS had seized all the tables, chairs, refrigerators, freezers, etc.? Panic of course!

So what is the corporation to do?  Call its lawyer of course!  But there is only so much a lawyer can do in such an emergency.

The corporation is generally not in a position to repay the IRS the full amount of the trust fund taxes in a quick lump-sum payment so that the assets are returned.  Lawyers can contact the IRS and try to negotiate an installment agreement or an offer-in-compromise— but that takes time and the IRS would be in no hurry to relieve the taxpayer’s pressure by returning the assets.  An emergency bank loan would be nice, but that is not realistic because of the pending tax obligation and the fact that the restaurant is not operating since the IRS seized the tables, chairs, refrigerators, freezers, etc.

So bankruptcy becomes the obvious solution.  Chapter 13 is not available because the tax debt is owed by the corporation and Chapter 13 is available only to individuals.  Chapter 11 is a great option. Filing the Chapter 11 bankruptcy case would grant the corporation with the “automatic stay” protections of the US Bankruptcy Code.  The attorney would contact the IRS to negotiate a return of the assets for the company’s promise to pay adequate protections payments to the IRS going forward.  If negotiations are unsuccessful, then the court should rush to the courthouse to file an adversary proceeding to force the IRS to return the assets… again, the company would have to provide the IRS adequate protection.  But at least the company could return to regular business operations.

Some clients ask if the taxes could be discharged by filing Chapter 7 bankruptcy without the need to pay any adequate protection payment to the IRS. The answer is NO.  That strategy was tried by a convenience store operating in Senatobia, Mississippi in the case of In re Sarfani, Inc., 527 B.R. 241 (Bankr. N.D.MS 2015).  In Sarfani, the company attempted to discharge unpaid sales taxes collected from customers as “trust fund” taxes.  The court rejected the company’s attempt to discharge the taxes because Sarfani, Inc. was a corporation and Chapter 7 bankruptcy discharges are only available to individuals (human) and not corporation, partnerships, LLCs, LLPs, trusts, etc.  11 U.S.C. §727(a)(1).  So, Chapter 11 would be the best bet.

PRACTICE POINTERS: The best tax planning is advanced tax planning. Bankruptcy lawyers are frequently contacted in emergencies after the IRS collectors have struck and struck hard—shuttering a business.  The IRS can be agreeable if the company negotiates before the issue comes to a boil.  But once the IRS collectors have taken action a company would typically need court intervention and the bankruptcy protections to survive.  How long can a company survive that is shuttered?  NOT LONG!  Customers find competitors, suppliers and vendors get frightened, and employees quit and find other jobs.  Immediate Chapter 11 bankruptcy protection would be warranted.

For follow-up questions, contact attorney Robert V. Schaller by clicking here.

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