Category Archives: 3-Year Due Date Rule

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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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.

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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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