Category Archives: Sales Tax

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.

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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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