Tax Claims in Bankruptcy

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.

Dischargeability Determination

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.

Nondischargeable Debts in Bankruptcy

Dischargeable debts are those debts that can be discharged through bankruptcy proceedings. Certain debts cannot be discharged through a bankruptcy proceeding.

In a Chapter 7 bankruptcy, nondischargeable debts cannot be discharged at all, and in a Chapter 13 bankruptcy, these debts remain even after the repayment plan is completed.

Common Nondischargeable Debts

The following claims are generally found to be nondischargeable:

  • Alimony, child support, and any debts in the nature of support
  • Student loans, unless repayment would cause undue hardship
  • Court-ordered restitution owed to either a court or a victim
  • Debts not listed on the bankruptcy petition
  • Some property settlements
  • Certain fines or penalties
  • Debts incurred from driving under the influence of alcohol or drugs
  • Most federal, state, and local taxes and any money borrowed on a credit card to pay those taxes
  • Fees imposed by a court for the filing of a case, motion, complaint, appeal, or for other costs and expenses assessed with such filing
  • Debts that could not be discharged in a prior bankruptcy that was dismissed due to fraud or misfeasance
  • Debts for purchases of more than $ 1,225 in luxury goods or services or cash advances within 60 days of filing for bankruptcy
  • Credit card purchases made within 60 days of filing for Chapter 7 bankruptcy.

Adversary Proceeding to Get Nondischargeable Debts Discharged

To get any of the above debts discharged, a debtor needs to file a Complaint to Determine Dischargeability of a Debt with the bankruptcy court and must show, in court, that the debt is not covered by the general rules that state these debts are not dischargeable. This is considered an adversary proceeding.

Dischargeable Debts Unless Objected to by Creditor

The following four categories of debts are discharged unless a creditor objects to dischargeability:

  • Debts incurred on the basis of fraudulent acts
  • Debts from willful or malicious injury to another or their property, including assault, battery, false imprisonment, libel, and slander
  • Debts from larceny, breach of trust, or embezzlement
  • Debts arising out of a marital settlement agreement or divorce decree that are not otherwise automatically nondischargeable as support or alimony.

For More Help

You can read more about bankruptcy and contact our bankruptcy team for more help on the Allen Turner Law Bankruptcy site.

Employment of Professionals

July 2014 Newsletter

Employment of Professionals
The Bankruptcy Code governs a trustee’s or debtor in possession’s employment of attorneys, accountants, appraisers, auctioneers and other professional persons to represent or assist in carrying out duties under the Bankruptcy Code. Generally, the trustee or debtor in possession had broad latitude in the selection of professional persons to be employed. The Bankruptcy Code authorizes the employment of professional persons only to the extent that such persons do not hold or represent an interest adverse to the estate.
The Bankruptcy Code requires that the trustee file with the court an application specifying the facts demonstrating the necessity for the employment, the name of the person to be employed, the reasons for the selection, the professional services to be rendered, and any arrangement for compensation. The application for employment as well as an accompanying verified statement of the professional person to be employed must set forth all known connections of the applicant or professional person with the debtor, creditors, any other party in interest, their respective attorneys and accountants, the United States Trustee, or any person employed by the United States Trustee. However, a person will not be ineligible for employment as a professional solely because the person was an investment banker for a security of the debtor, or was an attorney, director, officer, or employee of such investment banker.
An application for employment must be filed with the court prior to performance of services by the professional sought to be employed. Failure to obtain prior court approval may result in a denial of fees for any pre-approval services.
The determinative question in approving the employment of a professional person is whether it is reasonably necessary in the administration of the estate to have professional persons, such as attorneys or accountants, employed. An attorney for a trustee should not be employed unless the attorney’s special professional skills are necessary for the protection and benefit of the estate or will further the aims of the case. The court makes this determination, and a refusal to approve the employment should not be interfered with on appeal in the absence of an abuse of discretion. Nevertheless, the actual selection of attorneys or other professional persons rests with the trustee.
An attorney, accountant, or other professional person may be employed only to perform professional services. Attorneys and accountants may not be employed and will not be compensated for services that the Bankruptcy Code identifies as administrative duties of a trustee. Professionals may not assume the duties of a trustee and then claim compensation for performing legal, accounting, or other professional services.

Contested Matters

June 2014 Newsletter

Contested Matters
Whenever there is an actual dispute, other than an adversary proceeding, before the bankruptcy court, the litigation to resolve that dispute is a contested matter. For example, the filing of an objection to a proof of claim, to a claim of exemption, or to a disclosure statement creates a dispute that is a contested matter. Even when an objection is not formally required, there may be a dispute. If a party in interest opposes the amount of compensation sought by a professional, there is a dispute that is a contested matter.
Adversary proceedings and contested matters are methods of handling disputes that may arise during a bankruptcy case. An adversary proceeding is basically a civil trial within the context of a bankruptcy case. It is initiated by a complaint, requires a filing fee, and follows rules much like the Federal Rules of Civil Procedure. Contested matters are more informal. Motions initiate contested matters, and most do not require a filing fee. The Bankruptcy Rules establish the types of disputes that fall into each category. Contested matters include objections to sales of the debtor’s property. Alternative dispute resolution is also available in some bankruptcy courts.
In a contested matter in a case under the Bankruptcy Code relief is to be requested by motion. Reasonable notice and opportunity for hearing is to be afforded the party against whom relief is sought. No response is required unless the court orders an answer to a motion.

Chapter 12 Hardship Discharge

May 2014 Newsletter

Chapter 12 Hardship Discharge
A family farmer may be excused from completing payments under a plan of reorganization if payments under the plan are not completed due to circumstances for which the family farmer cannot be held accountable and other statutory criteria have been met..
Grant of Discharge of All Unsecured Debts in Plan
The bankruptcy court may grant the debtor a discharge of all unsecured debts provided for in the plan or disallowed by the court, with the exception of those types of debts which are excepted from discharge, if the court finds that such circumstances exist and that unsecured creditors already have received at least what they would have received if the debtor’s estate had been liquidated under Chapter 7 of the Bankruptcy Code.
Illness that Precludes Employment may Serve as Basis for Discharge
Injury or illness that precludes employment sufficient to fund even a modified plan may serve as the basis for a discharge. This type of discharge is often referred to as a “hardship discharge.” A Chapter 12 hardship discharge may only be granted if the unsecured creditors have received at least as much as they would have received through a Chapter 7 liquidation and if modification of the plan is not feasible.