The treatment of tax claims in bankruptcy proceedings is an attempt to reconcile two conflicting policies. The first policy concerns the government’s interest in collecting taxes. The second policy concerns the fresh start that bankruptcy is to give honest debtors. Under the Bankruptcy Code, a debtor’s ability to discharge any tax debt is based upon the classification of that particular tax debt.
Characterization of Tax Claims
A tax claim can be characterized as a:
- trust fund tax,
- secured claim,
- administrative tax claim,
- priority tax claim, or
- general unsecured claim.
The debtor holds trust fund taxes, which have been collected by the debtor from third parties, in trust for the appropriate taxing authority. The amounts held in trust are not property of the debtor or of the bankruptcy estate. The taxing authority will have a priority tax claim if the debtor failed to collect and/or remit a trust fund tax to the appropriate taxing authority.
Secured claims are claims that are secured by a lien on the debtor’s property. A claim is secured to the extent of the value of the property securing the claim.
Administrative tax claims consist of taxes that have accrued during the pendency of the bankruptcy. The Bankruptcy Code accords administrative status to any tax that is incurred by the estate with two exceptions.
Priority tax claim status is granted to certain allowed unsecured claims of governmental units.
General unsecured tax claims are taxes that are not entitled to secured or administrative tax claim status. Generally, these are old claims that are not entitled to qualify for priority tax claim status.
Dischargeability of Tax Claims in Bankruptcy
Taxes may be discharged in bankruptcy either through liquidation or reorganization. In a liquidation proceeding, the taxes of an individual may be discharged. Taxes may also be discharged pursuant to a Chapter 11 plan. Discharges under Chapter 13 are available to individual wage earners upon the confirmation of a plan of reorganization. Certain tax liabilities may be discharged under Chapter 13 that are not otherwise dischargeable. Also, under Chapter 13, creditors must file a proof of claim with the Bankruptcy Court. However, a governmental unit is not required to file a request for payment of an administrative expense for a tax or a tax penalty as a condition to allowance of an administrative expense.
Whether taxes are priority tax claims or general unsecured claims determines their dischargeability. A priority claim is nondischargeable. A taxpayer must file a tax return in order to get a discharge of the tax liability. Taxes are nondischargeable if the debtor files a fraudulent return or willfully attempts to defeat taxes. Fraud includes activities such as submitting false withholding statements for the purpose of eliminating withholding and failing to report embezzlement income. Willful attempts to evade or defeat tax liabilities include concealing assets and failing to file returns or to pay taxes over an extended period. Federal tax liens are not discharged even if the underlying taxes are discharged.