Category Archives: Chapter 13

What Affect Does a Bankruptcy Filing Have Upon an Illinois Real Estate Tax Sale?

The date a bankruptcy case is filed determines a lot.  The filing of the bankruptcy case triggers the implementation of the “automatic stay” provisions of the U.S. Bankruptcy Code.  11 U.S.C. §362(a).  The stay enjoins creditors from taking action to collect debts owed by the debtor.

But how does the automatic stay affect the sale of real estate taxes in Illinois?  The real estate tax sale is actually a multi-step process.  So, the effect of bankruptcy filing depends on the status of the tax sale and whether the buyer is aware of the bankruptcy filing.

An Illinois real estate tax sale has three parts and the bankruptcy case can be filed before or after these parts.  The first part is the tax sale by the county taxing authority and the purchase by a tax buyer.  The buyer tenders money to the taxing authority.  A bankruptcy filing prior to the sale blocks the county from selling the taxes.  Any sale in violation of the automatic stay would be void.

The second part relates to the redemption period assuming the taxes were sold prior to any bankruptcy case.  A bankruptcy filing during the redemption period would not void the sale. However, a bankruptcy filing could effectively extend the redemption period if the homeowner establishes a repayment plan, like a Chapter 13 repayment plan.  The bankruptcy filing does not actually “extend” the redemption period, but it has the same effect.  The redemption period would not expire and the tax buyer would not be allowed to petition the circuit court for a tax deed during a chapter 13 repayment plan if that plan provides for the repayment of the sold taxes.

The third part of the tax sale relates to the petition of the circuit court for the issuance of a tax deed.  A bankruptcy filing after the issuance of the tax deed would not affect the homeowner’s rights because the homeowner would have already lost all legal rights to the property prior to the bankruptcy filing.  In general, a bankruptcy filing stops future action against the bankruptcy filer and preserves the status quo; a bankruptcy filing does not reverse a tax sale or the issuance of a tax deed.

But the bankruptcy court in In re Wilson, 536 B.R. 218 (Bankr. N.D.IL 2015)(Black, J.) had to decide what impact a bankruptcy filing had upon the issuance of a tax deed by an Illinois circuit court when the issuance occurred AFTER a bankruptcy filing but WITHOUT the tax buyer knowing a bankruptcy case was filed.  There, the tax buyer was never informed of the bankruptcy case until after the circuit court had issued the deed.  Both the debtor and the mortgage lender knew of the bankruptcy filing; neither notified the tax buyer.  Consequently, the tax buyer never filed a motion to “lift or remove” the automatic stay prior to petition the circuit court for the tax deed— a motion that the court would have certainly granted.

The Wilson tax buyer filed a motion to “annul” the automatic stay pursuant to 11 U.S.C. §362(d) after the buyer discovered the bankruptcy filing.  The buyer stated that the buyer had no knowledge of the bankruptcy filing prior to the tax deed issuance despite taking steps to investigate.  The court noted that it would be inequitable to punish the tax buyer who acted in good faith while helping the mortgage lender who failed repeatedly to notify the buyer of the bankruptcy filing.  The Wilson court conducted an exhaustive study of the equities between the parties before granting the tax buyer’s motion to annul the automatic stay.  The court also noted that the battle was between the tax buyer and the mortgage lender with the homeowner taking no position.

Practice Pointer:   People who file bankruptcy should make efforts to notify ALL creditors and people who hold adverse interests in any property of the bankruptcy filer.

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

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How Does a Bankruptcy Filing Affect the Sale of Delinquent Real Estate Taxes?

An owner of real property receives protection from creditors immediately upon filing a bankruptcy case pursuant to 11 U.S.C. §362(a), which provides an “automatic stay” or injunction against creditors’ actions against the owner and the owner’s property.  As to real property, the automatic stay prohibits mortgage lenders from foreclosing on delinquent mortgage notes, and it prohibits governmental taxing authorities from selling any delinquent real estate taxes without leave of court.

An order granting relief from the automatic stay is typically granted in a bankruptcy case if the secured party is not receiving adequate protection, or the owner has no equity in the property and the property is not necessary for an effective reorganization. See 11 U.S.C. §362(d).

But what do taxing authorities do about delinquent taxes when a homeowner files bankruptcy?  It depends when the bankruptcy case was filed in relation to the sale of the delinquent taxes.  First, let’s assume a sale is imminent but did not occur prior to the bankruptcy filing, then let’s assume a sale occurred prior to the bankruptcy filing.

Imminent Sale:  The filing of a bankruptcy case automatically prohibits the sale of the delinquent real estate taxes.  In a Chapter 7 case, the taxing authority typically stands-down and postpones the tax sale  until after the bankruptcy case is concluded.  The taxing authority could file a motion to lift the automatic stay to allow the tax sale, but typically does not file such a motion because of the cost to do so.  A Chapter 7 case typically lasts only 100 days or so.  Thereafter, the taxing authority thereafter conducts the tax sale.

A Chapter 13 case is different because it could last 5 years.  The filing of the Chapter 13 stays the sale of the delinquent real estate taxes just like a Chapter 7 filing.  However, the owner of the real estate must make a decision whether the owner wants to retain the real property or surrender it.  If surrendering the real estate, the owner’s Chapter 13 plan should expressly provide for the surrender of the real estate pursuant to 11 U.S.C. §1325(a)(5)(C) and treat any secured creditor’s deficiency claim as an “unsecured” claim by reason of the surrender.  If retaining the real estate, then the owner’s Chapter 13 plan should provide to cure mortgage arrearage and maintain the mortgage payments, and provide for the full repayment with interest of any delinquent real estate taxes.

Post Sale: The issues are more complicated when a real estate owner files a bankruptcy case after the delinquent real estate taxes have already been sold.  Some states allow an owner to “redeem” the sold real estate taxes within a certain statutory time period.  The Bankruptcy Code allows a Chapter 7 trustee to exercise the homeowner’s redemption rights by paying the delinquent taxes (plus interest) provided the bankruptcy case was filed prior to the redemption period expiring.  Similarly, the Chapter 13 bankruptcy laws allow the home owner to repay the sold real estate taxes over the 5 year period provided the bankruptcy case was filed prior to the redemption period expiring.  Unfortunately, a homeowner cannot save real estate sold for delinquent real estate taxes by filing bankruptcy after the redemption period has expired.

Violating the Automatic Stay:  Sometimes a real estate tax buyer who properly purchased delinquent real estate taxes unknowingly violates the automatic stay by foreclosing a homeowner’s equity of redemption despite a bankruptcy filing.  Such was the case in In re McCrimmon 536 B. R. 374 (Bankr. D.MD. 2015). The tax purchaser bought the delinquent real estate taxes before the homeowner filed bankruptcy.  There was no automatic stay violation at the time of purchase because the bankruptcy case had not yet been filed.  Maryland law required the tax purchaser to give certain notice to the property owner and lienholders at least two months prior to filing an action to foreclose the right of redemption.  The tax purchaser conducted a title search and gave proper notice to the owner and known lienholders prior to filing the foreclosure action in the county court.

Later, the McCrimmon homeowner filed bankruptcy but failed to provide any notice to the real estate tax purchaser.  Subsequently, the tax purchaser filed suit in the county court and foreclosed the homeowner’s right of redemption in accordance with Maryland law.  The mortgage lender objected to the tax purchaser’s foreclosure because it violated the Bankruptcy Code’s automatic stay protections because the foreclosure occurred after the bankruptcy filing and without leave of the bankruptcy court.

The tax purchaser filed a motion to “annul” the automatic stay.  The McCrimmon court granted the tax purchaser’s motion because: (1) the tax purchaser was not noticed and had no actual or constructive knowledge of the bankruptcy filing; (2) the court would have granted a motion to lift the automatic stay had the tax purchaser filed such a motion prior to the foreclosure sale; and (3) the equities favor the tax purchaser because the financial loss to the purchaser by denying the motion to annul far outweigh the financial loss to the mortgage lender by granting the motion to annul.  Therefore, the court annulled the automatic stay so that it had no effect upon the tax purchaser’s foreclosing of the homeowner’s right of redemption.

Practice Pointer:  An individual who files bankruptcy should give notice of the bankruptcy filing to all creditors, including a real estate tax purchaser.  Creditors who violate the automatic stay protections could “annul” the stay if the equities are in their favor.  This is a factual determination.  Annulling the automatic stay would not have occurred in the McCrimmon case had the tax purchaser been given notice of the bankruptcy case and chose to ignore that notice.

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

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Can a Taxpayer Discharge Loan Debt Incurred to Pay an Otherwise Non-Dischargeable Tax Debt?

Yes and no, depending on what type of bankruptcy case is filed.  Sometimes a taxpayer has a tax debt that the taxpayer cannot afford to pay, but it cannot be discharged in bankruptcy because of the dischargeability prohibition of 11 U.S.C. §523(a)(1).  So, one strategy is for that taxpayer to obtain a bank loan to acquire capital and then tender the bank loan funds to the taxing authority to pay off the tax debt.  Then, that taxpayer files bankruptcy in an attempt to discharge the non-tax bank debt.

Such a taxpayer who files chapter 13 bankruptcy would have an easy time discharging the bank debt as long as the taxpayer waits a sufficient period of time.  The Bankruptcy Code does not expressly prohibit the Chapter 13 discharge of debts incurred to pay non-dischargeable tax debts.  However, an immediate bankruptcy filing after acquiring the bank loan would trigger issues of bad faith and fraud with a bank alleging the taxpayer had no intention of ever repaying the bank loan.  See 11 U.S.C. §§523(a)(2) or (a)(4). So a taxpayer should wait a period of time before filing bankruptcy, and make the required monthly payments on the loan until the bankruptcy filing to show good faith and act as a prophylactic.

A taxpayer who files chapter 7 bankruptcy would be out of luck and find non-dischargeable pursuant to 11 U.S.C. §§523(a)(14) or (a)(14A) the bank debt incurred to pay off the tax debt.  These Bankruptcy Code sections except from Chapter 7 discharge debt incurred to pay a non-dischargeable tax owed to the United States or any other governmental unit.

These issues were addressed in Brown v. Link (In re Link), 2015 Bankr. LEXIS 3248 (Bankr. E.D.MO 2015).  In Link, a restaurant seller owed delinquent state sales tax at the time the restaurant was sold.  The seller sold the business to the buyer (and the buyer ultimately filed Chapter 7 bankruptcy) for an amount sufficient to pay the seller’s state sales tax obligation.  The buyer did not have sufficient capital so the buyer secured a loan.  The lender tendered funds to the buyer in the form of three checks: (1) a check made payable to the state sales taxing authority in the exact amount of the sales tax debt owed by the seller; (2) a check made payable to the state sales taxing authority in an amount the buyer was required to pay the state taxing authority as a bond for prospective sales taxes; and (3) a check made payable to the buyer for additional capital. Ultimately the restaurant failed and the buyer filed bankruptcy seeking to discharge the loan provided by the lender that had been used to pay money to the state sales taxing authority.

The first issue the Link court had to address was whether the 11 U.S.C. §523(a)(14A) non-dischargeability exception applied to loans incurred to pay tax debts owed by someone other than the person filing bankruptcy.  In Link, this issue related to the buyer’s loan incurred to pay the state sales tax owed by the seller.  The Link court held that the 11 U.S.C. §523(a)(14A) non-dischargeability exception applied to the payment of all non-dischargeable tax debts and was not limited to just the tax debts owed by the person filing bankruptcy.  Therefore, the buyer’s loan was deemed non-dischargeable because the court found a direct connection between the loan incurred and the immediate application of those funds to seller’s tax obligations.

The second issue the Link court had to address was whether the 11 U.S.C. §523(a)(14A) non-dischargeability exception applied to loans incurred to pay a bond for prospective sales taxes.  The court found that buyer’s use of the loan to pay the sales tax bond resulted in the loan being rendered non-dischargeable.  This issue appears more complicated than the first issue and the court’s analysis is debatable.  The Link court interpreted expansively the non-dischargeability statute’s language of “a tax required to be collected or withheld and for which the debtor is liable in whatever capacity.” 11 U.S.C. §523(a)(1) incorporating 11 U.S.C. §507(a)(8)(C).  This interpretation appears to be overly expansive and subject to an appellate attack because the buyer’s bond was not a “tax,” but merely collateral to be used by the state sales taxing authority in the event the buyer fails to pay to the taxing authority the required sales tax in the future.  If the buyer pays the appropriate sales taxes in the future, then the bond would be returned to the buyer.  As such, the bond may be interpreted by an appellate panel as not “a tax required to be collected or withheld and for which the debtor is liable in whatever capacity.”  11 U.S.C. §523(a)(1) incorporating 11 U.S.C. §507(a)(8)(C).  Under this alternative interpretation, the loan proceeds used to pay the bond would not be deemed a payment of a “tax” and would therefore be dischargeable. But, the buyer never appealed the decision so the issue has to wait for another case.

Practice Pointer:   A taxpayer should file Chapter 13 bankruptcy instead of Chapter 7 bankruptcy if that taxpayer is attempting to discharge a loan incurred to pay otherwise non-dischargeable taxes owed to the IRS or another taxing authority.  Chapter 7 is a poor choice.  Instead, a Chapter 13 bankruptcy with a limited dividend to unsecured creditors would be a better strategy.

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

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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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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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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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How Does “Innocent Spouse Relief” Protect Taxpayers From IRS Levies and Collections?

Taxpayers who file joint IRS 1040 tax returns are jointly and severally liable for the full tax liability no matter how much or how little they contribute to the total tax.  That liability is not affected by divorce.  Sure, a divorce court could order one party to pay all or part of the joint tax debt, but such an order does not change the fact that each spouse is jointly and severally liable to the IRS.  The IRS can pursue collections against either or both taxpayers no matter how the divorce court shifts responsibility between the joint filers.

What options are available to an ex-wife if the prior years’ joint tax liability really resulted from extraordinarily large income produced by the ex-husband and the ex-husband now refuses or is unable to pay the taxes? You should consider “innocent spouse relief” offered by the IRS pursuant to 26 U.S.C. §6015?

Tax professional must be able to distinguish between two separate scenarios that may offer “innocent spouse relief” to the ex-wife: one good, and one bad.

The good scenario relates to a situation where a tax return was never filed or the filed return understated the true tax liability.  That scenario causes the IRS to assess a tax for the never filed return or assess a tax deficiency for the understated portion of the tax liability.  Section 6015 of the Internal Revenue Code grants the IRS authority to eliminate the assessed tax deficiency under the “innocent spouse relief” program when the innocent spouse had no knowledge of the understatement and had no reason to know of the understatement.  A perfect example is a wife of a self-employed home-remodeler and the wife has no involvement with the business and no knowledge that the home-remodeler underestimated the tax liability on the joint tax return.

The bad scenario relates to a situation where a tax return was properly filed and did NOT understate the tax liability on the return; the tax liability exists because the taxpayers did not save sufficient funds to pay the tax liability.  That was the scenario in In re Mikels, 524 B.R. 805 (Bankr. S.D. IN 2015).  In Mikels, an ex-spouse applied to the IRS for innocent tax relief for several years.  Some of those years related to years no returns were ever filed, and other years related to years where the innocent spouse failed to pay the taxes that were properly reported on the returns.

The spouse in Mikels sought innocent spouse relief from the IRS before filing bankruptcy.  The IRS granted the innocent spouse relief as to the tax years when no tax return was filed and the IRS had assessed the tax deficiency. However, the IRS denied innocent spouse relief for the tax years that the tax return properly reported the tax liability.

The Mikels spouse filed bankruptcy and objected to the IRS’ proof of claim seeking payment for the properly reported tax liability.  The Mikels court overruled the spouse’s objection and allowed the IRS’ claim for the tax liability relating to the properly reported tax years.  The court ruled that “innocent spouse relief” is only available pursuant to 26 U.S.C. §6015 when the IRS assesses a tax deficiency and such relief is not available when the taxpayers merely fail to pay the tax.

PRACTICE POINTERS: Innocent spouse relief is a great tool for ex-spouses who were deceived by their self-employed ex-spouses who underreported net income and concomitantly underreported the total tax liability.  However, the tax professional must be able to spot when the IRS will grant such relief and when it won’t.  The simple rule is no relief when the tax was reported accurately, and relief may be available it the tax was underreported and the ex-spouse had no knowledge of the underreporting.

For follow-up questions, contact attorney Robert V. Schaller by clicking here.
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How Long Does a Bankruptcy Filing Stay on My Credit Report?

Some people say a bankruptcy filing stays on the credit record for 7 years and other say 10 years.  Who is right?  This issue was addressed by the U.S. Court of Appeals for the Seventh Circuit in Childress v. Experian Information Solutions, Inc., 790 F.3d 745 (7th Cir. 2015).  In Childress, the court found the Fair Credit Reporting Act requires a reporting agency to purge bankruptcy records 10 years after the bankruptcy filing date, but noted that the credit-reporting agencies voluntarily purge them after seven years instead.  Id. at 746-747.

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

Are IRS Tax Liens Removed by Filing Bankruptcy?

An IRS lien can be eliminated in a Chapter 13 bankruptcy case, but tax liens cannot be avoided by filing a Chapter 7 bankruptcy case.

A taxpayer unsuccessfully attempted to avoid the IRS’ tax liens by filing chapter 7.  In U.S. v Parker, 578 Fed.Appx. 669 (9th Cir. 2014), the court found that a chapter 7 case discharged the taxpayer of personal liability for old taxes, but the prepetition tax liens on the taxpayer’s property remained enforceable after the discharge—citing the Supreme Court’s decision in Dewsnup v. Timm, 502 U.S. 410 (1992).

Practice Pointers: A Chapter 7 bankruptcy case is designed to eliminate personal liability, but not the lien against real estate or personal property.  A chapter 13 case would be a better strategy if the goal is to strip or avoid a lien.

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

What is the Effect of an IRS Lien During Bankruptcy?

This issue was addressed in In re Nomellini, 534 B.R. 166 (Bankr. N.D.CA 2015).  In Nomellini, a taxpayer filed a chapter 13 bankruptcy and listed the value of his allegedly underwater real property at $950,000 with a mortgage lien of $980,000. Taxpayer also listed personal property of $10,000.  The IRS accepted the valuations and filed a proof of claim consisting of a $10,000 secured claim and a $204,000 unsecured claim.  The chapter 13 plan stated that the “valuations shown above will be binding unless a timely objection to confirmation is filed.”  No objections were filed and the plan was confirmed.  The IRS ultimately was paid $10,000 for the secured claim.

Later, but before the plan was completed and discharge entered, the taxpayer sold the home for $2,175,000, which resulted in a $1,000,000 surplus after the mortgage obligation was paid in full.  The taxpayer argued that the IRS was only entitled to the $10,000 provided in the plan and that the IRS was limited by the confirmed plan and did not enjoy the rights of its lien.

The court phrased the issue as whether, under the provisions of the confirmed plan, the IRS was entitled to any of the proceeds of the sale of taxpayer’s real property based on the federal tax lien recorded, when the IRS has already been paid the full amount of its allowed secured claim as set forth in the confirmed plan.

The Nomellini court rejected the taxpayer’s argument believing the confirmed plan only affected the IRS’ “claim” against taxpayer and did not affect the IRS’ in rem rights established by the tax lien.  The court held that the IRS’ lien was not affected by the plan confirmation and the IRS had a valid lien against the property at the time of the sale because taxpayer never stripped or modified the IRS lien.

Practice Pointers: Taxpayer should have been more strategic.  Taxpayer should have filed a Rule 3012 motion to value the real estate soon after filing bankruptcy.  The IRS apparently would have agreed with the taxpayer’s valuation of the real estate.  Alternatively, taxpayer could have filed an adversary proceeding against the IRS and sought a valuation within the adversary and an order declaring the lien void upon issuance of the discharge.  Then, taxpayer should have paid off the case and received the discharge prior to selling the property.  Upon discharge, the IRS’ lien would have been void because the underlying debt would have been discharged. Thereafter, taxpayer could have sold the real property and kept the $1,000,000 surplus and paid nothing more to the IRS.

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

Can an IRS Tax Lien be Eliminated or Reduced by Filing Bankruptcy?

The IRS has the statutory right to record a Notice of Federal Tax Lien against a taxpayer’s home, other real estate, and personal property.  See 26 U.S.C. §6323. Such a lien provides the IRS with the right to a taxpayer’s assets superior to any later recorded junior liens.  In the event of liquidation, the IRS would be paid in full prior to any junior lienholders receiving any money.

A taxpayer attempted to eliminate/void the IRS’ lien by filing Chapter 13 bankruptcy in Ryan v. United States, 725 F.3d 623 (7th Cir. 2013).  In Ryan, taxpayer failed to file taxes for the years 2006 thru 2010.  The IRS responded by filing a Notice of Federal Tax Lien against taxpayer’s real property and personal property. Subsequently, taxpayer lost his home for delinquent real estate taxes and did not own a bank account or vehicle when he filed bankruptcy.  In fact, debtor’s total assets were worth only $1,625 as of the bankruptcy filing date.

Taxpayer attempted to reduce the tax lien to the asset value of $1,625.  Taxpayer alleged that §506(a) allows a taxpayer to bifurcate the IRS’ claim between a secured claim component to the extent of any assets and an unsecured claim component for the remaining debt.  Then, taxpayer asserted that §506(d) of the Bankruptcy Code allowed a taxpayer to “stripdown” the lien to the value of the property, citing 11 U.S.C. §506(d).  The IRS agreed with the bifurcation, but objected to the lien being voided and argued that §506(d) does not authorize the bankruptcy court to void the federal tax lien to the extend it exceeded the value of the assets.

The Ryan court looked for guidance in the U.S. Supreme Court’s decision in Dewsnup v. Timm, 502 U.S. 410 (1992).  In Dewsnup, the Supreme Court considered the proper interpretation of §506, and held that §§506(a) and 506(d) did not have to be read together, and that the term “allowed secured claim” in §506(d) was not defined by reference to §506(a). Instead, the Court determined that, consistent with preCode rules that liens pass through bankruptcy unaffected, the term “allowed secured claim” in §506(d) means a claim that is, first, allowed under §502 and, second, secured by a lien enforceable under state law, without regard to whether that claim would have been deemed secured or unsecured under §506(a).

Therefore, the Ryan court found that the IRS’ claim was secured by a lien enforceable under state law, and then held that the IRS’ claim could NOT be stripped down pursuant to §506(d). However, the Ryan court noted in dicta that the IRS’ claim could be stripped down pursuant to other sections of the Bankruptcy Code, including 11 U.S.C. §1325.

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

Who Has the Burden of Proof in a Tax Dischargeability Dispute Relating to Fraudulent Returns or Willful Attempt to Evade Paying Taxes?

Certain tax liabilities can be discharged in bankruptcy provided they are not excepted from discharge pursuant to 11 U.S.C. §523.  Section 523(a)(1)(C) excepts from discharge any tax debt “with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.”

Taxpayers or the IRS can file an adversary proceeding in bankruptcy court seeking an order determining whether the taxpayer’s tax obligations are discharged.  The factual question in these cases is whether  a taxpayer filed a fraudulent return or willfully attempted to evade or defeat a tax.

Who has the burden of proof: the taxpayer or IRS?  That issue was addressed in In re Looft, 553 B.R. 910 (Bankr. N.D.GA 2015), citing Griffith v. United States (In re Griffith), 206 F. 3d 1389, 1396 (11th Cir. 2000). The Looft court found that the burden of proof is on the government to prove nondischargeability by a preponderance of the evidence. Exceptions to discharge are strictly construed in favor of the debtor.  In determining whether the government has met its burden, the court considers the totality of the circumstances.

Practice Pointers: The taxing authority has the burden of proof, but the analysis is fact intensive.  The bankruptcy court would be given wide discretion in determining whether the government met its burden.

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

Can a Taxpayer “Strip Off” an IRS Lien From a Home by Filing Chapter 7?

Did you say Chapter 7 or Chapter 13?  It makes a difference.  Keep reading…

It is not uncommon for a taxpayer’s home to be “underwater,” meaning the fair market value (FMV) of a taxpayer’s home is less than the amount owed on the senior mortgage loan. Sometimes a taxpayer with an underwater home fails to pay income taxes, causing the IRS to file a Notice of Tax Lien against a taxpayer’s property with the Recorder of Deeds for the county in which the real property is located.  This lien gives public notice of a “secret lien” that previously existed pursuant to 26 U.S.C. §6321, which attached automatically to all of a taxpayer’s property and rights to property, both real and personal, upon assessment.

These taxpayers are prevented from filing Chapter 7 bankruptcy and “stripping down” the tax lien value from the full face amount of the tax obligation to the amount that would be recoverable after the senior liens are paid in full.  The U.S. Supreme Court rejected any attempt to “strip down” a lien in a Chapter 7 bankruptcy case in Dewsnup v. Timm. Until recently, the Supreme Court had not decided whether a lien could be “stripped off” in a Chapter 7 case.

So a clever taxpayer in In re Blackburn, 525 B.R. 153 (Bankr. N.D.FL 2015) attempted to reclassify an otherwise impermissible “strip down” of a tax lien into a “strip off” by arguing the IRS’ tax liens were divisible between real property and personal property.  If divisible, the taxpayer argued, then the tax lien could be “stripped off” as to the real property while preserving the tax lien as to the personal property.

The Blackburn court stated the issue as whether the IRS tax liens were divisible. The court ruled that the IRS tax liens were NOT divisible.  Therefore, the IRS’ claim was partially secured by the personal property.  The fact that there is no equity in the taxpayer’s real property over and above the senior mortgage did not render the IRS’ tax lien totally unsecured.  The IRS’ tax lien remained, at least in part, secured by the taxpayer’s personal property.  Consequently, the court rejected the taxpayer’s attempt to “strip off” the tax lien finding the taxpayer was actually attempting to “strip down” the tax lien, which was prohibited by the US Supreme Court in Dewsnup v. Timm.

Practice Pointers:  A taxpayer should attempt to file a Chapter 13 case instead of a Chapter 7 case if the taxpayer’s goal is to “strip down” a tax lien.  It is permissible to both “strip down” and “strip off” a tax lien in Chapter 13 bankruptcy cases.

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

Must All Tax Returns be Filed Prior to Filing Bankruptcy?

A common question asked by tax professionals is whether an individual taxpayer is eligible to file Chapter 13 bankruptcy if that taxpayer has failed to file any IRS 1040 tax returns. The quick answer is a taxpayer is eligible to file bankruptcy even if that taxpayer has unfiled tax returns. However, a longer answer provides more guidance.

The US Bankruptcy Code does NOT require a taxpayer to be in compliance with all filing requirements as of the day the bankruptcy petition is filed. The taxpayer has time after the bankruptcy case is filed to tender to the IRS any missing tax returns. Section 1308(a) of the Bankruptcy Code, 11 U.S.C. §1308(a), requires a taxpayer to file all tax returns for the four years prior to the bankruptcy filing date; the submission deadline is not identified by statute as a certain number of days after the bankruptcy case is filed. Instead, the deadline is set as no later than the day before the Section 341 meeting of creditors, which is approximately 30-45 days after the bankruptcy case is filed.

Therefore, a taxpayer can file bankruptcy for immediate protection from creditors even though that taxpayer is delinquent on tax filings on the bankruptcy filing date. But the Court, trustee, and creditors will be watching closely to determine if the taxpayer files the missing IRS tax returns prior to the deadline of one day before the Section 341 meeting of creditors. Some trustees will refuse to conduct the Section 341 meeting of creditors if the returns have not been filed. Other trustees could conduct the meeting despite objections from the creditors.

The taxpayer’s bankruptcy case is in jeopardy if the taxpayer fails to file the missing tax returns before the bankruptcy deadline. The case is subject to dismissal if the deadline is missed. That was the case in In re Mohamed, 523 B.R. 287, 290 (D.D.C. 2014). In Mohamed, the taxpayer filed bankruptcy in October of 2013 even though the taxpayer had never filed the 2012 tax return. The Chapter 13 trustee moved to dismiss the case because the taxpayer had failed to file the missing tax return before the bankruptcy deadline. At trial, the taxpayer’s witness stated that the 2012 tax return was filed, but the witness had no proof of filing and could not remember whether the return was filed prior to the bankruptcy deadline. On the other hand, the trustee testified that the taxpayer himself had admitted at the Section 341 meeting of creditors that the 2012 tax return was never filed. Also, the trustee introduced into evidence the IRS’ proof of claim that stated the 2012 tax return was never filed.

The bankruptcy court repeated that the taxpayer was required to file all tax returns for the past four years no later than the day before the Section 341 meeting of creditors. Then, the court found that the taxpayer did not timely submit the 2012 tax return and that the court was therefore required to dismiss the bankruptcy case pursuant to 11 U.S.C. §521(e)(2)(B) and §1307(e). The taxpayer appealed. The appellate court affirmed the bankruptcy court’s ruling and dismissed the bankruptcy case.

Best practices: File all unfiled tax returns before filing the bankruptcy case. If emergency protection from creditors is required, then a bankruptcy case should be filed to obtain an injunction against the creditors. But, the taxpayer and the tax professional must strive to file the missing tax returns as quickly as possible after the bankruptcy case and prior to the deadline of one day before the Section 341 meeting of creditors.

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