ALI-ABA
Bankruptcy Abuse Prevention and Consumer Protection Act of 2005
Summary of Tax Provisions
Carl M. Jenks
Jones Day
New York and Cleveland
I. Introduction
In every bankruptcy case in which the debtor is liable for pre-petition taxes, there is an
inherent tension among giving the debtor a “fresh start”, affording private creditors an
appropriate recovery, and allowing the fisc to collect what it is owed. Congress itself expressly
acknowledged this tension more than 25 years ago in connection with the enactment of the
Bankruptcy Act of 1978:
In a broad sense, the goals of rehabilitating debtors and giving equal treatment to
private voluntary creditors must be balanced with the interests of governmental tax
authorities who, if unpaid taxes exist, are also creditors in the proceeding. . . .
A three-way tension thus exists among (1) general creditors, who should not have
the funds available for payment of debts exhausted by an excessive accumulation of taxes
for past years; (2) the debtor, whose “fresh start” should likewise not be burdened with
such an accumulation; and (3) the tax collector, who should not lose taxes which he has
not had reasonable time to collect or which the law has restrained him from collecting.1
Many of the tax-related provisions contained in the Bankruptcy Abuse Prevention and
Consumer Protection Act of 2005 (“BAPCPA” or “the Act”) and summarized herein resulted
from the participation of the Department of Justice, the Internal Revenue Service (“IRS”), and
the National Association of Attorneys General in the work of the National Bankruptcy Review
Commission in the mid-Nineties.2 Not surprisingly, these governmental representatives were
largely focused on eliminating the frustrations that their agencies faced when the bankruptcy
system made it difficult for them to collect taxes to which they asserted they were entitled.3 As a
1
S. Rep. No. 95-989, at 13-14 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5799-5800. See generally
Jenks, “The Tax Collector in Bankruptcy Court: The Government's Uneasy Role as Creditor in Bankruptcy,” 71
Taxes 847, 847-48 (1993).
2
See Asofsky and McKenzie, Report of the ABA Tax Section Task Force on the Tax Recommendations of
the National Bankruptcy Review Commission ¶ 6, reprinted in 97 TNT 90-22 (May 9, 1997) (hereinafter Report of
the ABA Tax Section Task Force).
3
Id.
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result, the basic effect of the tax provisions in the Act is to adjust the “three-way tension”
between debtors, general creditors, and taxing authorities in favor of the government.
II. Ad Valorem Taxes and Liens
Subordination of Ad Valorem Taxes. The general rule in Chapter 7 liquidations is that,
when property is sold, the claims of secured creditors must be satisfied before any payment is
made to priority or general unsecured creditors.4 Under present law, however, there is an
important exception to this general rule: secured tax claims are subordinated to the payment of
administrative and certain other priority claims set forth in Section 507 of the Bankruptcy Code,
thereby allowing the trustee to “step into the shoes” of the holder of the tax lien claim.5 Under
the Act, this subordination will not apply to liens securing claims for ad valorem real and
personal property taxes, but these taxes would still be paid after certain wage and employee
benefit plan claims. New rules governing payment priorities, expense recoveries, and the
trustee’s duty to exhaust the estate’s unencumbered assets are mandated in cases where the
downgrading rule continues to apply. BAPCPA § 701(a).
Commentary. The most common type of tax lien subject to subordination under present
law is the state or local lien for real property taxes.6 The policy behind subordination is the
belief that the taxing authorities should not recover until administrative and other priority claims
have been paid.7 The changes made by the Act to Section 724 reverse that result, and will in
some cases have a dramatic and negative impact on the recoveries obtained by holders of
administrative and other priority claims (other than those wage and employee benefit plan claims
that will retain their superiority to tax liens under the new law). State and local taxing
jurisdictions, which have long argued (uniformly in vain) that Section 724(b) was an
unconstitutional violation of their Tenth Amendment rights,8 have finally prevailed by statutory
amendment.
Jurisdiction to Determine Ad Valorem Taxes. Under present law, the bankruptcy court
has broad jurisdiction to determine the amount of any tax, provided that the tax had not actually
been determined by a judicial or administrative tribunal of competent jurisdiction before the
commencement of the case.9 Under the Act, that jurisdiction will not extend to ad valorem real
4
Id. at ¶ 40. See generally Section 724(b)(1). All “Section” references are to the Bankruptcy Code unless
otherwise indicated.
5
See generally 6 Collier on Bankruptcy ¶ 724.03 (15th ed. rev. 2005). Section 724(b) applies only to
Chapter 7 cases; there is no comparable provision applicable to Chapters 11, 12 or 13. Id. Subordination of tax
liens in Chapter 7 cases has been a fixture of the law for more than 65 years. See Report of the ABA Tax Section
Task Force ¶ 43 & n.18.
6
See 6 Collier on Bankruptcy ¶ 724.03[1A] (15th ed. rev. 2005). Most of the cases applying Section
724(b) have involved the subordination of pre-petition tax liens, but in at least one case the provision has been held
to subordinate a tax lien that arose post-petition. See Wasden v. City of Savannah (In re Owens), 208 B.R. 750
(Bankr. S.D. Ga. 1996). See generally 6 Collier on Bankruptcy ¶ 724.03[1A] (15th ed. rev. 2005).
7
See Report of the ABA Tax Section Task Force ¶ 43.
8
See 6 Collier on Bankruptcy ¶ 724.03[2] & n.8 (collecting cases) (15th ed. rev. 2005).
9
Section 505(a).
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or personal property taxes if the period of limitations for contesting the tax has expired under
applicable non-bankruptcy law. BAPCPA § 701(b).
Commentary. Section 505(a) of the Bankruptcy Code confers extremely broad authority
on the bankruptcy court to determine any unpaid tax liability of the debtor that has not been
contested before or adjudicated by a judicial or administrative tribunal before the debtor filed for
bankruptcy.10 In particular, there is nothing in Section 505(a) that expressly prohibits debtors
from contesting in bankruptcy court tax liabilities (especially real property or ad valorem tax
claims) that arose many years ago and with respect to which the debtor never filed timely
objection.11 The state and local taxing jurisdictions have occasionally argued that there is an
unwritten, equitable time limitation on debtor actions to contest stale property tax claims under
Section 505(a), but the bankruptcy courts have generally been unreceptive to these arguments. 12
The effect of BAPCPA § 701(b) is to reverse this result, but only with respect to ad valorem
taxes. Under the Act, if the liability became fixed and the debtor's time to contest it outside of
bankruptcy court had expired by the time of the filing, the debtor may not contest the liability in
bankruptcy.
Creation of Property Tax Liens. Under present law, the automatic stay does not
prevent the creation of property tax liens for taxes becoming due after the filing of the petition. 13
The Act will extend this principle to a “special tax or special assessment.” BAPCPA § 1225.
Avoidance of Statutory Liens Prohibited. Under present law, the trustee is given lien
avoidance rights of a hypothetical bona fide purchaser, whether or not such a purchaser exists.14
The Act will make this provision inapplicable to federal tax liens arising under Section 6321 of
the Internal Revenue Code (“I.R.C.”). BAPCPA § 711. This provision arguably does no more
than codify existing law.15
10
See generally Jenks, Ridgway, and Purnell, 790 T.M., Corporate Bankruptcy (2004) (hereinafter
Corporate Bankruptcy) at A-82 et seq.
11
See generally 15 Collier on Bankruptcy ¶ TX5.04[2][a] (15th ed. rev. 2005).
12
See, e.g., Custom Distrib. Servs., Inc. v. City of Perth Amboy (In re Custom Distrib. Servs., Inc.), 216
B.R. 136 (Bankr. D. N.J. 1997).
13
See generally 3 Collier on Bankruptcy ¶ 362.05[17] (15th ed. rev. 2005).
14
Section 545(2).
15
I.R.C. § 6321 provides that, “[i]f any person liable to pay any tax neglects or refuses to pay the same
after demand, the amount [of that tax plus various enumerated costs associated with it] . . . shall be a lien in favor of
the United States upon all property and rights to property . . . belonging to such person.” I.R.C. § 6323 limits the
reach of this lien by making it invalid against any “purchaser”. I.R.C. § 6323(h)(6) then defines “purchaser” to
mean “a person who, for adequate and full consideration in money or money's worth, acquires an interest (other than
a lien or security interest) in property which is valid under local law against subsequent purchasers without actual
notice.” The lien avoidance power given to the trustee by Section 545(2) is that of “a bona fide purchaser that
purchases such property at the time of the commencement of the case, whether or not such a purchaser exists.” The
courts have generally held that the lien avoidance right given to the trustee does not allow a trustee to avoid a tax
lien by invoking I.R.C. § 6323. See, e.g., United States v. Hunter (In re Walter), 45 F.3d 1023 (6th Cir. 1995) (since
“bona fide purchaser” standard lower than “adequate and full consideration in money or money's worth” standard,
trustee cannot avoid liens under I.R.C. § 6323). See generally Report of the ABA Tax Section Task Force ¶¶ 329-44.
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III. Priority and Subordination of Taxes
Priority Status of Straddle-Year Tax Claims. Several U.S. Court of Appeals panels
have held that the income tax liability of a corporate debtor for the year of bankruptcy filing (the
“Straddle Year”) must be bifurcated into a pre-petition component and an administrative expense
component, notwithstanding that the filing of a petition does not terminate the corporate debtor's
taxable year.16 The Act amends Section 507(a)(8) governing the priority of taxes to provide that
income and gross receipts taxes for Straddle Years are post-petition administrative expense
claims that must be paid in full in the ordinary course, rather than pre-petition priority claims that
are not payable until emergence (and may at that point be subject to the deferred payment rules
of Section 1129(a)(9)(C)). BAPCPA § 705.
Commentary. Under prior law, it was not clear whether income and gross receipts taxes
for Straddle Years should be treated partly as pre-petition priority claims or entirely as postpetition administrative claims.17 The IRS position, and that of some states, was that the entire
period was post-petition because the debtor's liability for the tax did not arise until the last day of
the tax year. Debtors generally argued that taxes associated with the Straddle Year should be
bifurcated into pre- and post-petition portions, with only the post-petition portion having
administrative status, and most courts agreed.18 After studying the issue, the National
Bankruptcy Review Commission recommended that Congress amend Section 507 so that
Straddle Year taxes would be treated entirely as administrative period expenses but corporate
debtors would have an election to close the Straddle Year as of the date of the filing, thereby
effectively bifurcating the Straddle Year. The IRS and the Department of Justice argued that the
bifurcation cases should be overruled, primarily because of fears that significant tax revenue
might be lost if taxing authorities had to comply with the earlier bar dates associated with prepetition claims.19 The amendment to Section 507(a)(8) contained in the BAPCPA is clearly
intended to follow the government's position on this issue and to overrule the bifurcation cases,
although the technical draftsmanship of the amendment may have left something to be desired.20
The change should, on balance, be neutral or even helpful to most large corporate debtors, at
least if one takes administrative convenience and expense into account. The principal advantage
of bifurcation was to increase the taxes eligible for deferred payment, since most bankruptcy
plans call for payment in full of priority as well as administrative tax claims. As noted below,
under the bill the deferral period has been shortened and the cost of deferral potentially
increased. Treating the entire straddle year as a post-petition tax period is also much simpler
administratively. Debtors do not need to allocate their income and deductions between the preand post-petition tax portion of the filing year, or defend the decision to bifurcate when
challenged on audit.
16
See Report of the ABA Tax Section Task Force ¶¶ 469-73.
17
See generally Corporate Bankruptcy at A-34 et seq.
18
Id.
19
See Report of the ABA Tax Section Task Force ¶ 474. Interestingly, the ABA Tax Section Task Force
was unable to reach a consensus on this issue and therefore made no recommendation on it either way. See Report
of the ABA Tax Section Task Force ¶¶ 476-81.
20
See Corporate Bankruptcy at A-38 et. seq. (failure to amend Section 503(b)(1)(B) to make clear that prepetition Straddle Year taxes are “incurred by the estate” leaves open the bizarre and unintended possibility that such
taxes are neither pre-petition priority claims nor administrative period claims).
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Priority Status of Stale Tax Claims. Under present law, a claim for income taxes of a
debtor receives priority status if the return in respect of such tax is due, including extensions,
after three years before the date of the filing of the petition.21 Courts have generally, but not
uniformly, held that the three-year period is tolled during the period when a stay against
collection is in effect during a prior bankruptcy case of the debtor.22 Under the Act, the threeyear period is tolled during the stay period of the prior case plus 90 days. In addition, under
present law, a claim for income taxes of a debtor receives priority status if it was assessed within
240 days before the filing of the petition.23 That 240-day period is also tolled during the period
an offer in compromise was pending plus 30 days, if made within 240 days after the
assessment.24 Under the Act, the tolling will apply to the period when an offer in compromise is
actually in effect plus 30 days, and during the time a prior bankruptcy case is in effect plus 90
days.25 Finally, under present law, the 240-day assessment safe harbor is not tolled during other
periods during which a taxing authority is precluded from taking action. Under the Act, tolling
will apply during any period when a taxing authority is prohibited from collecting a tax as a
result of a request by a debtor for a hearing and an appeal of any collection action taken or
proposed against the debtor. BAPCPA § 705.
Commentary. It is unusual for the existing time requirements set forth in Section
507(a)(8)(A)(ii) to cause a pre-petition tax claim against a corporate debtor to lose its priority
status, because old tax claims that fail to meet the time requirements set forth in (A)(ii) generally
continue to qualify for priority status under the entirely parallel route set forth in (A)(iii), which
requires that the tax not be assessed prior to the petition but that it be assessable after that date.26
As a result, these changes to Section 507(a)(8)(A)(ii) should be of importance to corporate
debtors only in very limited circumstances.
Priority Status of Property Taxes. Under present law, priority status applies to
property taxes “assessed” before the commencement of the case and last payable without penalty
after one year before the date of the filing of the petition.27 Confusion arises because the term
“assess” has a different meaning under state and local ad valorem real property tax laws than
under other tax laws.28 The Act will substitute the word “incurred” for the word “assessed” in
the case of such taxes. BAPCPA § 706.
21
Section 507(a)(8)(A)(i).
22
Compare In re Waugh, 109 F.3d 489 (8th Cir. 1997) (time periods in Section 507(a)(8)(A)(i) suspended
during prior bankruptcy); In re Taylor, 81 F.3d 20 (3d Cir. 1996) (same); Montoya v. United States (In re Montoya),
965 F.2d 554 (7th Cir. 1992) (same) with Quenzer v. United States (In re Quenzer), 19 F.3d 163 (5th Cir. 1993)
(plain language of statute requires contrary outcome). See Report of the ABA Tax Section Task Force
¶ 223 & n.107.
23
Section 507(a)(8)(A)(ii).
24
Id.
25
See Report of the Tax Section Task Force ¶¶ 247-61 for a detailed discussion of the background to this
change.
26
See generally Corporate Bankruptcy at A-34 et seq. See also id. at n.315 (collecting cases holding that
(A)(iii) is independent of (A)(ii)).
27
Section 507(a)(8)(B).
28
See generally Corporate Bankruptcy at A-39 et seq.
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Tardily Filed Priority Tax Claims. Under present law, priority claims are entitled to
distribution in Chapter 7 even if tardily filed, provided they are filed before the trustee
commences distribution.29 Under the Act, if the trustee mails to creditors a summary of his final
report prior to commencing distribution, a late-filed priority claim must be filed within ten days
after the mailing of that summary. BAPCPA § 713.
IV. Determination and Payment of Taxes
Request for Determination of Taxes. Under Section 505(b) of the Bankruptcy Code, a
trustee or debtor in possession may seek a prompt determination of the debtor's liability for
administrative expense taxes.30 In order to invoke this procedure, the debtor submits a tax return
and a request for determination of tax to the governmental unit charged with responsibility for
collecting the tax in question. If the governmental unit does not notify the debtor within 60 days
that the return has been selected for examination, or complete such an examination within 180
days of the request, the debtor is generally discharged from liability for that tax.31 It has not
always been clear to debtors seeking to invoke Section 505(b) what procedures should be
followed in notifying the taxing authority.32 Under the Act, taxing authorities may register with
the clerk of the bankruptcy court an address for service of requests and describe where further
information concerning additional requirements may be found. If a taxing authority fails to do
so, the trustee may serve the request at the address for filing a tax return or protest with the
applicable taxing authority. BAPCPA § 703.
Rate of Interest on Tax Claims. Present law is silent on the applicable rate of interest
on tax claims when such interest is allowed. Under Section 1129(a)(9)(C), if a Chapter 11 debtor
avails itself of the privilege of deferring payment of tax claims, the payments must have a
29
See 6 Collier on Bankruptcy ¶ 726.02[1] (15th ed. rev. 2005).
30
See generally Corporate Bankruptcy at A-85 et seq. Section 505(b) by its terms applies to all taxing
jurisdictions, not just the IRS. There is of course an issue under Seminole Tribe and its progeny as to whether and
under what circumstances a bankruptcy court can determine the amount of a contested state tax. See generally
Seminole Tribe v. Florida, 517 U.S. 44 (1996); 15 Collier on Bankruptcy ¶ TX12.02 (15th ed. rev. 2005). For
example, in In re Lake Worth Generation, LLC, 318 B.R. 894 (Bankr. S.D. Fla. 2004), a Florida bankruptcy court
barred the county tax authority from asserting sovereign immunity as a defense to a debtor's request for
redetermination of taxes. The debtor's property was sold through the Section 363(f) process in the bankruptcy court,
and the lien that the county taxing authority had against the debtor's property attached to and followed the proceeds
of the sale. As a result, according to the Lake Worth court, the bankruptcy court had continuing exclusive
jurisdiction over the proceeds, or the “res”, because it had exclusive jurisdiction over the debtor's estate and
therefore the debtor could request that the bankruptcy court determine the amount of tax liability owed on the sale in
spite of the state's argument that its sovereign immunity was thereby being infringed.
31
Section 505(b). See generally 15 Collier on Bankruptcy ¶ TX5.04[3][b] (15th ed. rev. 2005).
32
The IRS has prescribed detailed rules as to the manner and content of notifying it of the request for a
Section 505(b) determination. See Rev. Proc. 81-17, 1981-1 C.B. 688. Nevertheless, there are several reported
cases in which taxpayers failed to follow those procedures properly, and disputes subsequently arose over whether
the notice given was adequate to meet the requirements of Section 505(b). See, e.g., In re Flaherty, 169 B.R. 267
(Bankr. D. N.H. 1994) (filing request with initial tax return not sufficient; request must be filed with special
procedures unit of District Director); United States v. Leonard (In re Carie Corp.), 128 B.R. 266 (D. Alaska 1989)
(notice deemed given where request filed at IRS Service Center where debtor's tax returns usually filed). See
generally Henderson and Goldring, Tax Planning for Troubled Corporations § 1011 & n.2 (collecting cases) (2005
ed.); Report of the ABA Tax Section Task Force ¶ 172.
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present value equal to the allowed amount of the claim. New Section 511 provides that the
interest rate paid on pre-petition and administrative period tax claims (as well as the interest rate
applied to deferred payments made under Section 1129(a)(9)(C)) shall be the applicable rate
under non-bankruptcy law. (In the case of a confirmed plan, the interest rate in effect as of
confirmation may be used, rather than the variable rate called for by some state tax laws.)
BAPCPA § 704.
Commentary. This provision will generally increase the rate of interest that debtors pay
on oversecured pre-petition tax claims or deferred tax payments made after emergence.
Although the prior case law on point was divided, many courts had held that the rate determined
under non-bankruptcy law (typically the state rate of interest on secured property taxes) was
generally not controlling, and that the court should instead look to some combination of market
rates, the generally lower federal statutory or judgment rates, or rates determined by the
bankruptcy court exercising its discretion.33 Note also that the enactment of new Section 511
would appear to circumscribe the impact of the U.S. Supreme Court's decision in Till v. SCS
Credit Corp.,34 where at least the Court plurality suggested in dictum that the so-called primeplus method (pursuant to which the national prime rate is treated as the starting spot and is
augmented as necessary to account for the nonpayment risk posed by the debtor's particular
financial position) should be applied to deferred payments under Section 1129(a)(9)(C).
No Discharge of Fraudulent Taxes in Chapter 13. Under present law, individuals who
file under Chapter 7 face a different set of rules with respect to the discharge of taxes than
individuals who file under Chapter 13. First, in order for income taxes to be discharged in a
Chapter 7 case, the individual must have filed returns with respect to the taxes whose discharge
is being sought and must have done so in timely fashion to the extent that the taxes in question
arose in the last two years prior to bankruptcy.35 By contrast, in a Chapter 13 case taxes can be
discharged without any return being filed at all.36 Second, a taxpayer who files a fraudulent
return or willfully attempts to evade or defeat a tax cannot discharge that tax in a Chapter 7
case,37 but the same is not the case in Chapter 13.38 Under the Act, the Chapter 13 rules will be
largely conformed to those in Chapter 7, with the consequence that this “superdischarge” result
will no longer be applicable to taxes owed by Chapter 13 debtors who fail to file, file late, or file
fraudulently. BAPCPA § 707.
No Discharge of Fraudulent Taxes in Chapter 11. Under present law, confirmation of
a plan of reorganization discharges a corporate debtor from all debts, except when the plan is a
liquidating plan.39 Under the Act, a corporation will not be discharged from a tax or a customs
33
See generally Corporate Bankruptcy at A-25 et seq. (discussing case law on the rate of interest
applicable to oversecured pre-petition property taxes), and A-87 et seq. (discussing case law on the rate of interest
applicable to deferred tax payments in the Section 1129(a)(9)(C) context).
34
541 U.S. 465, 124 S. Ct. 1951 (2004).
35
See Section 523(a)(1)(B).
36
See Sections 1322(a)(2) and 1328(a). See Report of the ABA Tax Section Task Force ¶ 136.
37
See Section 523(a)(1)(C).
38
See Section 1322(a)(2). See Report of the ABA Tax Section Task Force ¶ 137.
39
See 15 Collier on Bankruptcy ¶ TX1.08[10] (15th ed. rev. 2005).
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duty with respect to which the debtor made a fraudulent return or willfully attempted in any
manner to evade or defeat the tax or duty. BAPCPA § 708.
Stay of Tax Court Proceedings. Under present law, the filing of a petition operates as a
stay against the commencement or continuation of a proceeding before the United States Tax
Court concerning the debtor.40 Literally read, this stay would apply even to a post-petition year
over which the bankruptcy court has no jurisdiction.41 Under the Act, the stay will apply to a
corporate debtor's tax liability for any period that is subject to the bankruptcy court’s jurisdiction
and to an individual debtor's pre-petition tax liability. BAPCPA § 709.
Deferred Payment of Priority Taxes. Under present law, a Chapter 11 debtor's prepetition liability for unsecured priority taxes may be spread over a period ending not later than
six years from the date of assessment of the tax, provided that the taxing authority receives
payments having a value not less than the allowed amount of the claim.42 Under the Act, the
deferred amounts must consist of “regular” installment payments in cash, must not extend
beyond five years from the date of the order for relief (i.e., normally the petition date), and the
taxing authority must be treated not less favorably than the most favored non-priority unsecured
claimant other than a convenience class (the “most-favored-unsecured-creditor” requirement).
These provisions will also apply with respect to secured tax claims. BAPCPA § 710.
Commentary. The change to the period over which deferred tax payments can be made
will drastically shorten the actual deferral period in many major corporate bankruptcies. Under
prior law (where the six-year time period began to run on the date of assessment), it was very
common for reorganized debtors to have a full six years from the date of emergence to pay prepetition taxes, because the date of assessment would typically have been delayed throughout the
case.43 Once the provisions of the BAPCPA become effective, however, the new five-year
period will begin on the petition date. This will mean that, in major cases in which the debtor is
in bankruptcy for several years, the deferral benefit conferred by Section 1129(a)(9) will dwindle
or even disappear entirely.44 And the debtor's new-found ability to defer payment of not only
40
Section 362(a)(8).
41
See generally 15 Collier on Bankruptcy ¶ TX1.04 (15th ed. rev. 2005).
42
Section 1129(a)(9)(C).
43
While this result may seem contrary to the 1994 amendment to the Bankruptcy Code allowing
assessment of taxes during the case, the operation of parallel provisions in the Internal Revenue Code normally
prevents IRS assessment from taking place prior to emergence. See Corporate Bankruptcy at A-88.
44
Indeed, the most-favored-unsecured-creditor requirement could at least literally be interpreted as
prohibiting any deferral of payment of pre-petition priority taxes, since in the typical corporate bankruptcy
unsecured creditors are paid in cash on (or very shortly after) the effective date. If this interpretation were adopted,
Section 1129(a)(9)(C) would be effectively read out of the statute. The legislative history is silent on the question
(see H.R. Rep. No. 109-31, pt. 1, at 102 (2005)), but it seems clear from contemporaneous commentary that the
intent of the most-favored-unsecured-creditor requirement is simply to require that the taxing authority be paid the
same percentage of its claim at the same time that the unsecured creditors are paid. “In other words, if the holders of
unsecured claims are receiving 25 percent recoveries in quarterly installments over the first two years, then the
priority tax claims must receive at least a 25 percent recovery in quarterly installments over the first two years; the
75 percent balance then will be paid over the next four years in accordance with the plan.” Report of the ABA Tax
Section Task Force ¶ 157. Note that the Task Force's example implicitly assumed that the payout period for tax
claims would be the six years from assessment called for under current law, rather than the five years from date of
filing that will apply under the Act.
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unsecured taxes but secured taxes as well may turn out to be the bankruptcy equivalent of giving
away ice in the wintertime: because secured tax claims will earn interest during the case (and
because after the BAPCPA becomes effective that interest will be computed at the fairly high
rates specified in state tax codes), many debtors will discover that it is cheaper to seek
permission to pay its secured tax obligations during the administrative period to stop the interest
meter from running, even though as a theoretical matter that means foregoing the possibility of
paying off the secured tax obligations over a several-year period after emergence under Section
1129(a)(9).
Payment of Taxes in the Conduct of Business. Under present law, it is not clear that all
post-petition taxes must be paid when due.45 The Act makes a number of changes in existing law
in an effort to make it clear that current payment is required. First, the Act inserts language in
Section 960 of Title 2846 providing that any taxes that must be paid pursuant to Section 960 are
due “on or before the due date of the tax under applicable nonbankruptcy law,” unless (a) the tax
is a property tax secured by a lien against property that is abandoned promptly after the lien
attaches, (b) payment of the tax is excused by an express provision of Title 11, or (c) in a
Chapter 7 case the tax was either not incurred by the trustee or the bankruptcy court issues an
order prior to the due date of the tax finding that the estate is probably administratively insolvent.
Second, the Act amends Section 503(b)(1)(B)(i) of the Bankruptcy Act to clarify that postpetition ad valorem taxes qualify as administrative expenses.47 Third, the Act makes it
45
See Report of the ABA Tax Section Task Force ¶ 433 et seq. (timing of payment of administrative claims
within discretion of bankruptcy judge; extraordinary administrative expenses appear payable only pursuant to
creditor's request for payment; timing of payment may affect present value or even face amount of recovery).
46
Title 28 covers the Judiciary and Judicial Procedure; Section 960 is part of Chapter 57 of that title, which
is entitled “General Provisions Applicable to Court Officers and Employees.” Section 960 was enacted in 1934 in
response to a federal court decision holding that, pursuant to the so-called intergovernmental tax immunity doctrine,
a federal court-appointed bankruptcy receiver was not liable for a state sales tax on motor fuel. See generally H.R.
Rep. No. 73-1138 (1934). Prior to its amendment by the Act, Section 960 read as follows: “Any officers or agents
conducting any business under authority of a United States court shall be subject to all Federal, State and local taxes
applicable to such business to the same extent as if it were conducted by an individual or a corporation.” (Although
the language of Section 960 is limited to officers and agents of the United States, it has been construed as applying
to debtors in possession as well. See In re Samuel Chapman, Inc., 394 F.2d 340 (2d Cir. 1968).) Until the U.S.
Supreme Court resolved the issue in 1989, the courts had split on whether bankruptcy trustees were required to pay
taxes in connection with liquidations, with some courts holding that payment was not required because the language
of Section 960 was limited to circumstances in which the company in bankruptcy or receivership was “conducting
any business”. Compare In re Hatfield Constr. Co., 494 F.2d 1179 (5th Cir. 1974) (sales tax can be imposed on
liquidation sale); In re Leavy, 85 F.2d 25 (2d Cir. 1936) (same), with In re Cusato Bros. Int'l, Inc., 750 F.2d 887
(11th Cir. 1985) (bankruptcy trustee not liable for excise taxes), cert. denied sub nom. Florida v. Great American
Bank, 472 U.S. 1010 (1985). The Supreme Court concluded that Section 960 was best read as indicating a
Congressional purpose to facilitate the enforcement of state tax laws, and refused to find an implied prohibition on
taxing liquidations in the statute's focus on “conducting any business”. California State Bd. of Equalization v.
Sierra Summit, Inc., 490 U.S. 844 (1989). In light of this case law history, it is perhaps ironic that Section 712 of
the Act is entitled “Payment of Taxes in the Conduct of Business”) (emphasis added).
47
Prior to the enactment of Section 362(b)(18) as part of the Bankruptcy Reform Act of 1994, a majority of
courts had held that the automatic stay prohibited local taxing authorities from creating or perfecting a statutory lien
for ad valorem taxes that became due after the petition date. See 15 Collier on Bankruptcy ¶ TX4.04[8] (15th ed.
rev. 2005). Once Section 362(b)(18) -- which permits such a lien to be created or perfected -- was on the books, a
new question arose in the pre-BAPCPA case law: would an ad valorem tax that would otherwise qualify as an
administrative expense lose that status precisely because it was now supported by a lien on real property? In at least
some cases, the courts doggedly so held, thereby undoing in part the benefits bestowed on the local taxing
authorities by the addition of Section 362(b)(18) to the Bankruptcy Code. See, e.g., In re Sylvia Dev. Corp., 178
B.R. 96 (Bankr. D. Md. 1995). Other cases frustrated local taxing authorities by holding that, where property
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unnecessary for taxing authorities to file a request for payment before a post-petition tax
qualifies as an allowed administrative expense. And fourth, the Act clarifies that state taxes -including ad valorem property taxes -- can qualify for treatment as secured claims under Section
506, even though they do not arise from any agreement.48 BAPCPA § 712.
Discharge of the Estate's Liability for Unpaid Taxes. Under present law, following a
request for a prompt assessment of taxes made by the trustee and upon payment of the tax shown
on the return, if a taxing authority does not timely respond or audit the return, the trustee, the
debtor, and any successor to the debtor are discharged from any tax liability in excess of the tax
paid.49 Some cases have held that this discharge does not apply to the “estate,” so that a taxing
authority may participate in the distribution in respect of late-claimed taxes.50 Under the Act, the
estate will also receive the benefit of the discharge when the taxing authority does not comply
with Section 505(b) procedures. BAPCPA § 715.
V. Filing of Tax Returns
Income Tax Returns Prepared by Tax Authorities. Under present law, an individual
may not receive a discharge in Chapter 7 in respect of a tax for which a return, if required, has
not been filed.51 Under the Act, a return will include a written stipulation to a judgment or a
final order entered by a non-bankruptcy tribunal and a return based upon information supplied by
the taxpayer and signed by him, but prepared by a taxing authority pursuant to Section 6020(a)
of the Internal Revenue Code or similar state or local law. It will not include a substitute return
under Section 6020(b) of the Code, which is not a full return, but merely a predicate for
assessment. BAPCPA § 714.
Requirement to File Tax Returns to Confirm Chapter 13 Plans. Under present law, a
debtor is entitled to the benefits of Chapter 13 notwithstanding that he has unfiled returns
outstanding.52 Under the Act, the debtor will be required to have filed tax returns for the four
(continued…)
subject to a tax lien was abandoned by the debtor, the underlying real property tax had not been “incurred” by the
estate, which caused the tax to fail to qualify as an administrative expense under Section 503(b)(1)(B). See, e.g., In
re Carolina Triangle Ltd. P’ship, 166 B.R. 411 (9th Cir. BAP 1994). During the process of drafting what has
become the BAPCPA, local taxing authorities argued that these results were improper and unfair, and that the
attachment of a lien (or the classification of real property taxes as in rem under local law) should not result in
otherwise-eligible ad valorem taxes losing their administrative expense status. See Report of the ABA Tax Section
Task Force ¶ 440. BAPCPA § 712(b) accomplishes this result by inserting in Section 503(b) after “any tax” the
phrase “whether secured or unsecured, including property taxes for which liability is in rem, in personam, or both.”
48
This statutory change can be viewed as extending the holding in United States v. Ron Pair Enters., Inc.,
489 U.S. 235 (1989), that under Section 506(b) a governmental claimant should recover interest post-petition if its
claim is oversecured, despite the fact that the statutory language on its face seems to limit the awarding of interest to
situations in which there is a consensual agreement between the creditor and the debtor.
49
Section 505(b). For more background, see the more extended discussion of Section 505(b) in connection
with BAPCPA § 703, supra text accompanying notes 30-32.
50
See, e.g., In re Fondiller, 125 B.R. 805 (N.D. Cal. 1991); In re Rode, 119 B.R. 697 (Bankr. E.D. Mo.
1990); Kellogg v. United States (In re West Texas Mktg. Corp.), 54 F.3d 1194 (5th Cir. 1995). See generally Report
of the ABA Tax Section Task Force ¶¶ 493-99.
51
See 15 Collier on Bankruptcy ¶ TX4.02[2] (15th ed. rev. 2005).
52
See generally H.R. Rep. No. 109-31, pt. 1. at 104 (2005).
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taxable years immediately preceding the filing of the petition. Limited extensions will be
permitted, during which the trustee will hold open the first meeting of creditors. Conversion or
dismissal will result from failure to file within the extended periods. BAPCPA § 716.
Dismissal for Failure to Timely File Tax Returns. Under present law, a debtor may
continue to exercise the right to reorganize under bankruptcy protection notwithstanding the
failure to file post-petition tax returns.53 Under the Act, a debtor who fails to file post-petition
returns may, on request of a taxing authority, have his case converted or dismissed. BAPCPA
§ 720.
Providing Requested Tax Documents to the Court. Under the Act, the court may not
grant an individual a Chapter 7 discharge or confirm the Chapter 11 or Chapter 13 plan of an
individual unless requested tax documents have been filed with the court. The court must retain
such documents for three years, subject to extension in the event of an audit or enforcement
action. BAPCPA § 1228.
VI. Miscellaneous Tax Provisions
Standards for Tax Disclosure. Under present law, prior to solicitation of acceptances
for a Chapter 11 plan, a proponent must submit and have approved by the court a disclosure
statement containing adequate information.54 The Bankruptcy Code does not specify what
constitutes adequate information as to the tax consequences of the plan.55 Under the Act, the
disclosure statement will be required to contain a discussion of the potential material federal tax
consequences to the debtor and a hypothetical investor typical of the holders of claims or
interests in the case. BAPCPA § 717.
Commentary. This change in the language of Section 1125 should have little if any
impact on well-counseled debtors. It has been standard procedure for many years to include a
lengthy and detailed federal tax consequences section in every disclosure statement,56 and as a
result it is hard to see what impact the new language can have, other than simply memorializing
in the statute what has long been normal practice. It is perhaps comforting to know that
Congress has limited its required tax disclosure to federal tax matters, thereby confirming
industry practice of generally ignoring state and foreign tax consequences in the disclosure
statement, except under unusual circumstances.
Setoff of Tax Refunds. Outside of bankruptcy, the IRS is generally permitted to set off
refunds owed to a taxpayer against unpaid taxes owed by that taxpayer.57 Current bankruptcy
law preserves the government's right of setoff with respect to pre-petition taxes but prevents the
53
See generally Henderson and Goldring, Tax Planning for Troubled Corporations § 1006.2 (2005 ed.).
54
Section 1125(b).
55
See generally Report of the ABA Tax Section Task Force ¶¶ 572-85.
56
See generally Corporate Bankruptcy at A-139 et seq.
57
See I.R.C. §§ 6402(a) & 6411(b). See generally Corporate Bankruptcy at A-66 et seq.
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taxing authority from exercising that right while the automatic stay is in place.58 Under the Act,
setoffs will generally be permitted if setoff would have been permitted outside bankruptcy and if
the taxable periods giving rise to both the overpayment and the deficiency are pre-petition. If
setoff is not permitted under nonbankruptcy law because of a contest over the amount or legality
of the deficiency, the taxing authority will be permitted to hold the refund pending resolution of
the contest, unless the court grants adequate protection. BAPCPA § 718.
Commentary. This provision will eliminate the existing procedural requirement that
taxing authorities -- just like any other creditor -- seek bankruptcy court approval before prepetition setoffs can take place, even though outside bankruptcy such setoffs are generally
permitted. This change may be seen as codifying the Seventh Circuit's decision in Pettibone,
which had generally been thought to be contrary to prevailing bankruptcy law.59 It is also hard to
articulate the policy reason why the normal setoff rules applicable to other creditors should not
apply to governmental tax claims.60
Special Provisions Related to the Treatment of State and Local Taxes. Present
Section 346 of the Bankruptcy Code contains a series of detailed provisions that mandate a
uniform outcome at the state and local level with respect to a variety of bankruptcy tax matters,
both substantive and procedural. For example, Section 346(g)(1)(C) provides that, for state and
local tax purposes, neither gain nor loss shall be recognized on a transfer that qualifies as a
bankruptcy reorganization for federal income tax purposes.61 Similarly, Section 346(j) provides
a comprehensive series of rules governing the state and local tax consequences of discharge of
indebtedness in bankruptcy. Other, more specialized tax rules appear in Chapter 762 and Chapter
11.63 Under the Act, Section 346 is completely rewritten, and the provisions previously housed
in Section 728 and Sections 1146(a) and (b) are largely transferred to Section 346. Among other
things, the new rules require uniformity among federal, state, and local tax administrative rules
by (a) preventing a bankruptcy filing from resulting in the creation of a new taxable estate (or the
termination of the debtor's taxable year) for federal purposes but not for state and local purposes
(or vice versa), (b) conforming the federal, state, and local tax consequences of property transfers
from the debtor to the estate (or vice versa), (c) preventing state or local tax from being imposed
on discharge of indebtedness income unless that income is also subject to tax under the Internal
Revenue Code, and (d) generally requiring states and localities to reduce tax attributes to reflect
58
See Sections 553 and 362(a)(7). Nevertheless, standing orders or local rules in some bankruptcy courts
permit setoffs of tax deficiencies and overpayments without court order in certain circumstances.
59
Pettibone Corp. v. United States, 34 F.3d 536 (7th Cir. 1994). See generally Corporate Bankruptcy at
A-66 & n.624.
60
See, e.g., Report of the ABA Tax Section Task Force ¶ 168 (“The notice and hearing requirements
[associated with the automatic stay] are essential to protect the rights of the other creditors that may be entitled to
the funds under the priority rules contained in section 507. If the IRS is permitted to automatically setoff a refund
against a tax liability, the other creditors will not be aware of the setoff and will not have a forum to protest the
setoff.”) (emphasis in original).
61
See generally Henderson and Goldring, Tax Planning for Troubled Corporations § 1103.1 (2005 ed.); 15
Collier on Bankruptcy ¶ TX12.03[2][b] (15th ed. rev. 2005).
62
See Section 728. See generally 15 Collier on Bankruptcy ¶ TX12.01 (15th ed. rev. 2005).
63
See Section 1146. See generally 15 Collier on Bankruptcy ¶ TX12.01 (15th ed. rev. 2005).
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untaxed discharge of indebtedness income following the same rules applicable for federal
purposes. BAPCPA § 719.
Commentary. Current Section 346, while designed to achieve the important federal
goals of uniform tax treatment across all states and non-interference by the states in federal tax
planning, became over the years a source of interpretational confusion. Several of the most
important provisions in Section 346 were tied in one way or another to provisions of the Internal
Revenue Code that had long ago been repealed, thereby making it extremely difficult to know
what those provisions might mean today.64 Other provisions posed nettlesome difficulties of
interpretation when applied to new fact patterns.65 New Section 346 is both simpler and more
effective than its predecessor. Instead of laying out detailed tax rules for the states and localities
to follow, it relies on simpler cross-references to federal law that should help keep the two more
closely in sync. Although the validity and enforceability of Section 346 itself may be thought to
be open to some question in light of the sovereign immunity issues raised by several recent
Supreme Court decisions,66 the new version of Section 346 is a significant improvement over the
old one.
Treatment of Fuel Tax Claims. Section 501 of the Bankruptcy Code is amended to
provide that a claim arising from the liability of a debtor for fuel use tax may be filed by the base
jurisdiction designated pursuant to the International Fuel Tax Agreement and, if so filed, shall be
allowed as a single claim. BAPCPA § 702.
VII. Effective Date
The provisions of the bill are generally effective on October 17, 2005, the date that is 180
days after the date of enactment, but only with respect to cases filed after that effective date.
BAPCPA § 1501.
Commentary. Commentators have suggested that the delayed effective date of the bill
will cause a flood of bankruptcy filings by individuals who think they would be disadvantaged
by the bill's changes. The same is not likely to happen in the corporate area merely as a result of
the tax changes made by the bill. Although on balance those changes will be harmful to most
corporate debtors, the detriment does not appear to be significant enough in the typical case to
affect the timing of filing. Since the bill's provisions will not apply to cases filed before the
effective date, bankruptcy tax practitioners will for many years to come be practicing in two
parallel universes: applying the old rules to cases filed before the effective date, and the new
rules to cases filed thereafter. It would not be particularly surprising, however, if courts
64
See, e.g., Henderson and Goldring, Tax Planning for Troubled Corporations § 1103.1 (2005 ed.)
(puzzling over current significance of the Section 346 cross-reference to I.R.C. § 371, repealed in 1980).
65
See, e.g., Jenks, “Tax Attributes in Bankruptcy,” 592 PLI/Tax 981, 1027 n.26 (technical issues of
statutory construction in applying Section 346(g)(1)(C) to so-called Bruno's transaction “extremely complex”; entire
area “murky”). See generally Section 346(a) (not clear what impact phrase “but subject to the Internal Revenue
Code of 1986” meant to have on rest of statute).
66
See, e.g., Seminole Tribe v. Florida, 517 U.S. 44 (1996); Fed. Mar. Comm’n v. South Carolina Ports
Auth., 533 U.S. 743 (2002).
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interpreting and applying old law post-effective date were influenced in their decisions by the
contents of the new law.
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