James I. Shepard

Bankruptcy Tax Consultant

National Bankruptcy Review Commission

2682 W. Dovewood Lane

Fresno, California 93711-2518

Tele. (209) 435-8996 Fax (209) 436-8808

1. Introduction.

Thank you for inviting me to speak today. It was an honor to be appointed to serve on the National Bankruptcy Review Commission and to have the opportunity to seek improvements in the manner in which the rights and interests of the American people who do not file bankruptcy are treated under the Bankruptcy Code. The Commission's attempt to revise bankruptcy laws easily leads one to the conclusion that bankruptcy has grown too important to entrust to those who work within the bankruptcy industry, those who profit from the bankruptcy system--the drafting of bankruptcy laws should not be left to those who have a vested interest in the implementation of those laws, either creditors or debtors.

1. Bankruptcy is a Big Business.

In contemplating bankruptcy reform legislation, I would hope that the members of Congress keep in mind that there are only two things in bankruptcy for the players in the system, the lawyers and other professionals, money and power--the Bankruptcy Code and courts provide the power and the system provides the money--if the law expands the power, the lawyers will find the money. The recently released statistics on case filings in 1997 has produced some interesting inferences. If the debtors' lawyers who filed the 54,027 business cases in 1997 received (or will receive) an average of $25,000 in fees, a conservative estimate according to most bankruptcy judges, that group received (or will receive) a total of over $1.35 billion dollars. If the consumer debtors' lawyers received an average of $1,000 for each of their 1,350,118 cases, a reasonable estimate, that group received over $1.35 billion dollars, for a total of approximately $2.7 billion dollars paid to the debtors' lawyers. Assuming that the creditors' lawyers were paid just a third of that amount and adding in the accountants, turn-around specialists and other hangers-on, bankruptcy is easily a $5 billion dollar-a-year industry, at the expense of the American public; and these figures don't include any of the costs of the judicial system or the costs of administering the cases, nor do they account for any of the debt that is discharged. The numbers point to a conclusion which is entirely inescapable, bankruptcy is a big business for lawyers and other professionals.

1. The Proper Role of the Bankruptcy Courts and Bankruptcy Law.

Further, it must be recognized that bankruptcy courts cannot function as a "court of all social ills," real or perceived. Section 105(a) of the Bankruptcy Code--which, in the words of Judge Robert Ginsberg, who also served on the Bankruptcy Review Commission, is the "Last Bastion of a Desperate Lawyer"--is not the authority for a court to rewrite nonbankruptcy law according to the court's perception of whether or not the law should apply to the case at hand and the result it seeks. Bankruptcy judges must be discouraged from rendering result oriented decisions, those where the Bankruptcy Code is read in a manner never contemplated by Congress; such judicial legislation creates law that was not intended and invades the province of Congress. The Bankruptcy Code cannot be the source of omnipotent power, staving off the demands of creditors and rewriting law to suit the needs of every individual debtor, nor can every small business owner with a fervent hope of survival and a burning desire to profit be allowed to remain sheltered in that hospice of dying businesses, Chapter 11, until all assets are wasted and the list of creditors is longer than before. Where the courts have strayed from Congressional intent Congress must establish clear limitations and definitions to redirect not only the "rogue" judges but the majority of our judges who are intelligent and well meaning, but often are given liberty to create law because the Code is vague.

It should not be necessary to remind this panel that Congress and the United States Government must serve all the citizens of this country, not just the debtors and creditors, but, more importantly, the 260 million people who did not file bankruptcy in 1997. It must be remembered that the Bankruptcy process is but one function of government, a substructure within the panoply of governments, state, federal and local, which must provide for all citizens. Governments are unique not only as creditors but because of the function of government. Private creditors generally can not mimic a government--private creditors do not have the obligations of government, nor do they have the concomitant powers of government; consider, for instance, the exercise of the police power, the power to impose a tax, the states' duty to administer federally mandated programs, the need for revenue to provide for essential government services, and the obligation to perform regulatory functions for the protection of all the people. Consider also that governments are generally ex post facto, involuntary creditors. When performing strictly governmental functions, as opposed to acting as a lender or supplying utilities, for instance, government agencies do not have the ability to take actions available in the private sector. Governments are not able to restrict their activities to a particular geographic area or segment of the population nor can they withhold police or fire protection merely because taxes have not been paid. Any state or local government can, however, be required to protect the rights of the public in any bankruptcy court in the country. Public policy dictates that the public be protected from the unreasonable costs of bankruptcy and the burdens of overly complex rules and laws.

The Constitution states that Congress shall "establish uniform laws on the subject of bankruptcies throughout the United States"--that bankruptcy law will be federal law to achieve uniformity as a part of the regulation of commerce--and to prevent fraud where debtors may have relocated property in other states. The Federalist No. 42, at 217 (James Madison) (Garry Wills ed., 1982). The Constitution also imposes the obligation upon the sovereign to provide the functions of government for all the people; to pay for those functions the Constitution also gives the sovereign the power of taxation. Taxation is the cost of citizenship which we all must pay--the sovereign may tax anything it deems necessary and may also determine the extent of any relief from such taxes which it sees proper; to be fair, however, taxes must be imposed uniformly, relief from that charge can only be granted as may specifically and sparingly be provided within the confines of the law. The citizen accepts the privileges and benefits of citizenship, exercises the rights and powers granted thereby, and must accept the duties and obligations imposed in exchange. In order for government to function and to avoid anarchy these duties and obligations are not to be lightly taken nor readily excused. Society has a right to expect that citizens will respect the rules of acceptable behavior and will share the cost of government. The payment of taxes may limit the fresh start but that is as the public interest requires.

While the goals of the Bankruptcy Code are understandable and appropriate, the creation of special laws and procedures, loop-holes and "gotcha" provisions, which are not in furtherance of the legitimate goals of the Code can only be destructive of the fundamental proposition of taxation enunciated at the time of the adoption of the Bankruptcy Code which holds that,

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.

Since tax authorities are creditors of practically every taxpayer, another important element is that tax collection rules for bankruptcy cases have a direct impact on the integrity of the Federal, State and local tax systems. These tax systems, generally based on voluntary assessment, works [sic] to the extent that the majority of taxpayers think they are fair. This presumption of fairness is an asset which should be protected and not jeopardized by permitting taxpayers to use bankruptcy as a means of improperly avoiding their tax debts. To the extent that debtors in a bankruptcy are freed from paying their tax liabilities, the burden of making up the revenues thus lost must be shifted to other taxpayers.

S. Rep. No. 989, 95th Cong., 2d Sess. 13-14 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5799-5800; as quoted in In re Conston, Inc., 181 B.R. 769 (D. Del. 1995). This statement is still a valid precept for those who are considering changes in bankruptcy law.

1. The Work of the National Bankruptcy Review Commission.

My primary goal, during the initial stages of the National Bankruptcy Review Commission, was to advance proposals which I viewed as necessary to protect the integrity of our tax system. Being a tax lawyer and tax practitioner, I was very concerned about what I saw as the development of rules for the determination and collection of taxes unique to the bankruptcy court, that a body of law and procedure was being developed under which uniformity and consistency with nonbankruptcy tax law is being lost. The Commission heard substantial testimony from numerous tax authorities describing their difficulties, for instance, in timely asserting claims or in being able to even determine that a claim existed; a substantial problem exists where debtors may have not filed returns. Every government representative that appeared before the Commission described major difficulties in being made aware of the mere filing of a case in sufficient time to protect the rights of the public; thus, not just one, but two provisions of the bill propose changes in the Code that will make changes necessary to remedy the deficiencies in ensuring that the parties receive meaningful notice.

The Commission appointed a Tax Advisory Committee, made up of tax professionals and educators, knowledgeable in the special circumstances of bankruptcy, who reviewed over 100 specific suggestions for changes in tax and/or bankruptcy law and submitted their report recommending the adoption of over 30 "consensus" proposals. The National Bankruptcy Review Commission, in turn, unanimously adopted those proposals, many of which are reflected in the bill.

Unfortunately time did not permit the Commission to resolve a large number of other extremely important problems. For instance, a proposal was made which would have resolved the problems created by the Supreme Court's decision in the case of Energy Resources without overruling the thrust of the decision, that bankruptcy courts may approve the allocation of payments under a plan of reorganization under certain circumstances, but which would have protected the government's right to collect taxes. The Tax Advisory Committee briefly discussed the matter but found it too controversial to act upon; a Working Subgroup of the Commission addressed the problem and suggested a compromise solution but the issue was never presented to the full Commission for its consideration. I would hope that Congress would recognize the benefit of that compromise proposal and enact such a law.

Other very important proposals were adopted by the Commission but which are not found in the bill, proposals which must be submitted to the Committee on Ways and Means because they would amend the Internal Revenue Code.

1. Overview of the Tax Provisions of the bill.

The bill does not enlarge the rights of the tax authority, but eliminates certain loopholes and opportunities to manipulate the Code which prevent the tax authority from protecting the public's rights and interests. Consider, for instance, that the commencement of a bankruptcy case imposes the most powerful injunction provided by law without the opportunity for a prior hearing, the stay of proceedings under 11 U.S.C. § 362. All that is necessary is to sign and file a form and pay a fee. This stay of proceedings is available to all debtors regardless of the merits of their case and enjoins, among other things, nearly all actions pursuant to state, federal or local law related to the debtor or the estate, including the collection of taxes, many aspects of the regulation of business, and the licensing and enforcement activities of most regulatory agencies. Together with the court's equitable jurisdiction under 11 U.S.C. § 105(a) debtors have a formidable array of tools with which to achieve results and obtain benefits not available through any other means. The effect of this immense power is the ability of a bankruptcy court to stop the world from turning, as we know it. All too often, under current law, debtors and their lawyers are able to manipulate the various provisions of the Code to take advantage of this power and obtain results not intended by Congress.

The bill includes several comprehensive provisions designed to improve the efficiency and fairness with which tax matters are handled in bankruptcy. At the present there are a number of instances in the Bankruptcy Code where either the language is vague or the procedure imposed is inherently unfair or incomplete. In other instances, procedures which work for creditors, generally, are ill-suited for governmental agencies, particularly tax authorities. A primary focus of the provisions of the bill is to eliminate numerous instances where a tax authority is put at a decided disadvantage arising from lack of clarity in the Code, resulting in substantial litigation over the effect of a prior bankruptcy case, for instance, which prevents the collection of taxes which the Bankruptcy Code otherwise permits. Other changes would clarify the obligations of a trustee when filing returns on behalf of the estate, as well as the rights of a tax authority to assert claims in respect of such returns. The bill would also enhance the fairness of the treatment of debtors and creditors by imposing a greater degree of parity among the chapters and by establishing a fixed rate of interest, reducing litigation related to plans of reorganizations.

1. Comments on the Tax Provisions of H.R. 3150.



1. Sec. 501--The Protection of State and Local Tax Revenue.

The bill amends the Bankruptcy Code to increase local revenues derived from ad valorem property taxes, i.e., taxes assessed based on the value of property. Currently, under Bankruptcy Code § 724(b)(2), ad valorem tax dollars intended for use by local governments to provide police protection, fire protection and schools are being siphoned off to pay the lawyers and other professionals who drove a failed Chapter 11 case into conversion to Chapter 7.

As section 724(b) was originally enacted, Congress sought to guarantee the payment of only the costs of administration in a chapter 7 case and small wage claims by resort to the tax revenue represented by the tax liens on only personal property. The statute has since been significantly expanded beyond its original scope to allow an ever-increasing number of unsecured priority claimants to invade valid and properly perfected liens on both personal and real property. Further, as administrative claimants, the lawyers and other professionals with unpaid fees arising from employment in a failed chapter 11 case are entitled to be paid from tax revenues. Because state law usually provides that a lien securing ad valorem property taxes "primes" all other consensual and nonconsensual liens, the application of section 724(b) invariably causes the administrative and other priority claims to be paid from tax revenues otherwise destined for essential public purposes, e.g,, schools and police and fire protection.

Bankruptcy judges now admit they are seeing numerous "fee driven" Chapter 11 cases--lawyers and other professionals for failing and failed businesses simply cannot be subsidized with the taxpayers' money. Why should the taxpayers subsidize the lawyers for a failed case when the numbers of cases that are converted to Chapter 7 or are dismissed are alarmingly high--the number of debtors that successfully complete their plan is dismally low.

1. Sec. 502--Enforcement of Child and Spousal Support.

To ensure that debtors will not be able to escape such obligations, the bill subjects exempt property to claims for child and spousal support.

1. Sec. 503--Provide Effective Notice to State, Local and Federal Government Agencies.

Governmental units, whether state, local or federal, should not lose their rights against the debtor or the bankruptcy estate in a case because of the debtor's failure to provide notice reasonably calculated to reach the proper representatives of the government and identify the nature of the obligation for which notice is provided. Without a reasonably targeted notice requirement under the Bankruptcy Code one can continue to expect state, federal and local governments to experience substantial difficulties because of the large and diffuse nature of governmental units and the difficulty they have in identifying claims and interests in the bankruptcy case.

The Commission considered no less than three proposals related to ensuring that the government was provided proper timely notice in all cases. The Tax Advisory Committee established by the Commission to review proposals related to tax problems in bankruptcy unanimously adopted a proposal which was then unanimously adopted by the Commission stressing the importance of enacting procedures for giving proper notice to government representatives. The proposal adopted by the Commission states that, "There is a consensus that the government should not lose its rights against the debtor or the bankruptcy estate in a bankruptcy case because of the debtor's failure to provide notice reasonably calculated to reach the proper representatives of the government." Report of the National Bankruptcy Review Commission 949 (Oct. 20, 1997). The bill provides that notice to governmental units must be reasonably calculated to reach the proper representatives of the government and must reasonably identify the debtor. Improved notice will enhance the fairness and efficiency of the bankruptcy process--it will reduce inadvertent violations of the automatic stay, reduce costs associated with the bankruptcy case, and reduce delay by eliminating litigation in regard to the efficacy of notices.

1. Sec. 504--Notice of Request for a Determination of Taxes.

Section 505(b) of the Bankruptcy Code permits a trustee to request a prompt audit of the income tax returns filed on behalf of the estate from a taxing authority. If the taxing authority fails to respond within sixty days to the request, the trustee is discharged from liability for any taxes beyond the taxes shown on the return. Presently, the Internal Revenue Service has directed that section 505(b) requests be filed with the local District Director. Nonetheless, some courts have held that a trustee may ignore the IRS directive. Because governmental units are entitled to timely and reasonable notice in the bankruptcy process if their right to assert an administrative expense claim is to be barred, the bill provides that rules be established under which a governmental unit may designate the manner and location to which a request for a prompt audit be sent.

1. Sec. 505--Provide a Fixed Rate of Interest on Tax Claims.

The Bankruptcy Code does not specify the interest rate to which tax claims are entitled, requiring litigation in almost every court to determine a market rate or some other rate of interest to be applied and while the Federal statutory rate is relevant it is not binding. Litigating the issue of what the appropriate rate of interest should be wastes valuable judicial resources. Therefore, the bill amends the Bankruptcy Code to provide that where a governmental unit, state, local or federal, is entitled to receive interest on its claim, the fixed federal deficiency rate under section 6621(a)(2), as in effect on the date of confirmation of the plan, of the Internal Revenue Code should be applied, without reference to the compounding requirement otherwise applicable to Federal taxes.

1. Sec. 506--Tolling of Priority of Tax Claim Time Periods.

The Bankruptcy Code identifies several tax claims as priority or as nondischargeable by reference to certain time limits, e.g., taxes due for taxable years ending within three years of the filing of the petition are priority claims under section 507(a)(8) of the Bankruptcy Code and nondischargeable under section 523(a)(1). Currently it is not clear whether the filing of a prior bankruptcy case tolled the running of these time periods in a subsequent case, where, for instance, the debtor has filed successive bankruptcy petitions--if not, the debtor is able to prevent collection of the tax while sheltered by the stay of proceedings in one or more cases before discharging the tax in a subsequent bankruptcy case. The bill provides that in the event of successive bankruptcy filings, the relevant time periods specified in section 507(a)(8) shall be suspended during the period in which a governmental unit was prohibited from pursuing a claim by reason of the prior case. A debtor should not be entitled to stay the collection of a tax by filing a bankruptcy petition and then benefit from the pendency of the abortive case by reducing or eliminating the time in which the government's tax claims would otherwise have been entitled to priority, or altering the nondischargeability of a tax. Clarification of the law will eliminate unnecessary litigation and provide uniformity.

1. Sec. 507--Assessment Defined.

Some confusion has surrounded the use of the term "assessment" in the Bankruptcy Code when used in reference to state and local taxing authorities. The Bankruptcy Code was drafted in reliance of federal tax law terms and concepts. Unfortunately, those terms and concepts do not always comport with state and local procedures or law. Some state and local taxing authorities, for instance, have no assessment procedure whatsoever; some taxes are self-assessed. A provision in the bill will resolve this problem by providing a universal definition of assessment with respect to State or local tax collections, regardless whether conventional "assessment" procedures are employed.

1. Sec. 508--Discharge of Fraudulent and Other Taxes in Chapter 13 Cases.

Currently, Chapter 13 debtors are able to discharge their tax obligations arising from fraudulent returns, willful attempts to evade, and late and unfiled returns; taxes which are not dischargeable in cases filed under any other chapter of the Code. Not only are such taxes dischargeable in a Chapter 13 case, there is no requirement that they be paid in full as a condition of confirmation of the plan, as are priority tax claims--taxes owed in respect of fraud and unfiled returns are treated as general, unsecured claims and are discharged after completion of the payments under the plan. If the plan "provides for" a tax, even though the amount stated is clearly wrong, the tax authority may be bound by the plan and unable to collect the proper amount due.

The rationale for not providing parallel treatment of priority taxes and taxes excepted from discharge was to benefit creditors, but was not intended to let the debtor benefit from his or her misdeeds. These provisions of law serve as motivation for Chapter 13 debtors to file deceptive plans which "provide for" the payment of tax claims by stating that the amount of taxes owed is "zero" or a minimal amount and to obfuscate notice to the tax authority in hopes that it will be delayed so that the tax authority will be unable to timely file a proof of claim for the correct amount due. As the law is applied, tax authorities often are required to search every Chapter 13 petition filed in an attempt to discover if they might have a claim for an outstanding tax; where returns have not been filed it is nearly impossible to timely file a proof of claim.

Taxes due to fraud or that have been evaded, or those for which the debtor has never filed returns do not deserve special, lenient treatment; it is unfair to honest taxpayers to allow debtors to escape such taxes. Thus the bill provides that tax obligations arising from fraudulent returns, willful attempts to evade, and late and unfiled returns shall be nondischargeable in Chapter 13 cases. The bill does not alter the current rules for priority--the other creditors are not affected, but the debtor will not be able to take advantage of his or her fraud or dilatory behavior.

1. Sec. 509--Discharge of Fraudulent Taxes in Chapter 11 Cases.

Currently the confirmation of a Chapter 11 plan of reorganization discharges the debtor from any debt that arose before the date of confirmation, but does not discharge an individual debtor from taxes which arose because of fraudulent returns or an attempt to evade taxes. The discharge of corporate debtors, by contrast, is not restricted, taxes due to fraud and evasion are discharged. Both bankruptcy and tax policy dictate that corporate owners and management should not receive an undeserved benefit from their misdeeds and that this loophole be closed. The bill provides, therefore, that corporations may not discharge such taxes in Chapter 11 cases, the same as individuals.

1. Sec. 510. The Stay of Tax Proceedings.

Section 362(a)(8) of the Bankruptcy Code stays the commencement and continuation of a proceeding before the United States Tax Court concerning the debtor. A Tax Court decision held that this section stays the commencement or continuation of a proceeding involving an individual debtor's postpetition tax liabilities, even though such taxes are not an administrative expense of the estate. The bill overrules the Tax Court's decision in Halpern v. Commissioner, 96 T.C. 895 (1991), and provides that decisions in tax matters may be appealed without violating the automatic stay.

1. Sec. 511--Requiring Periodic Payment of Taxes in Chapter 11 Cases.

The bill provides that secured tax claims which, but for their secured status, would otherwise be payable as priority claims, shall be paid in the same manner as if the claims were merely priority and that all tax claims be paid in regular installments over the life of the plan. Currently Chapter 11 debtors are permitted to pay both secured and unsecured tax claims according to whatever plan the court approves. In some cases courts have approved plans providing no payments on tax claims until the end of the plan, thus placing the public revenue at risk and favoring other creditors in the all to often event that the plan fails. In other cases courts have permitted debtors to pay secured tax claims in much the same manner as a consensual lender's debt secured by a mortgage, over a period far in excess of the time permitted by law for the payment of taxes. Given that a tax claim becomes secured only after the taxpayer fails to pay the tax and that any tax obligation protected by a lien may be immediately collected, the "stretch-out" of such taxes under a plan of reorganization is the forced public financing of the debtor's business and is contrary to good bankruptcy policy.

1. Sec. 512--The Avoidance of Statutory Tax Liens Prohibited.

The bill provides that a trustee is not a "hypothetical purchaser" for purposes of avoiding certain tax liens. Section 6323 of the Internal Revenue Code provides protection to certain purchasers of property even after a notice of federal tax lien has been filed in accordance with federal tax law. A"purchaser" is defined as a person who, for adequate consideration, acquires an interest (other than a lien or security interest) in property, which is valid under local law against subsequent purchasers without notice. Applicable purchases include securities, motor vehicles, personal property purchased at retail, and personal property purchased at casual sales. Section 545(2) of the Bankruptcy Code permits a trustee to avoid a tax lien that is either not perfected or not enforceable at the time of the filing of the petition against a bona fide purchaser, "whether or not such purchaser exists." Trustees and debtors in possession have attempted to employ section 545(2) to avoid tax liens on the basis that the trustee or debtor steps into the shoes of the hypothetical bona fide purchaser entitled to superpriority under the Internal Revenue Code. The purpose of the exceptions in the Internal Revenue Code is to facilitate the flow of these goods in commerce and should not be used to displace an otherwise valid lien for the protection of the public revenue. Applying §545(2) to tax liens may result in an unintended windfall to the debtor.

1. Sec. 513--Provide Course of Business Status for Administrative Taxes.

The Judicial Code, title 28 of the United States Code provides that bankruptcy estates are subject to all state, local and federal taxes. Because governmental units are creditors in the vast majority of bankruptcy cases, however, taxing authorities often have difficulty obtaining payment of the taxes owed by a bankruptcy estate. The problem is particularly pronounced in smaller Chapter 11 cases where cash-short debtors-in-possession frequently default on tax paying obligations in favor of paying legal fees, salaries or trade creditors.

Currently taxing authorities can be required to file a request for payment of an administrative expense tax under 11 U.S.C. § 503(a), the same as lawyers and other professionals seeking approval of their fees; a procedure is provided under 11 U.S.C. § 505(b) for the determination of the estate's taxes. In at least one case, a bankruptcy court held that a request for payment was a mere notice and that the taxing authority was required to file a motion to obtain payment. The purpose of section 503(a) is to provide the mechanism by which administrative creditors, lawyers and other professionals, may be paid for their services to the estate, after court review and approval. Inasmuch as taxes are more like the usual and normal expenses payable in the ordinary course of the debtor's business it makes no sense to burden governmental authorities with the task of filing a request for payment, particularly when the Code already provides the trustee with a procedure to determine the propriety of any such tax. The bill makes it clear that the taxes incurred by a bankruptcy estate are a course of business expense and eliminates the need to make a request to pay taxes that are entitled to payment as an administrative expense.

1. Sec. 514--Clarify the Treatment of Tardily Filed Priority Tax Claims.

In Chapter 7 cases, section 726(a)(1) of the Bankruptcy Code allows a tardily filed claim for a priority tax if the claim is "filed before the date on which the trustee commences distribution," but does not specify when that event occurs, whether it is the date when the court approves the final report and accounting of the trustee, the date the checks are mailed or when the trustee's final report is sent to the United States Trustee for approval. The bill makes a housekeeping amendment designed to minimize future litigation that may arise from a literal reading of the statute by amending section 726(a)(1) to provide that a tardily filed claim must be filed before "the date on which the court approves the final report and accounting of the trustee."

1. Sec. 515--Clarify the Definition of a Return.

Section 523(a)(1)B) of the Bankruptcy Code provides that taxes which are excepted from the debtor's discharge include those where the debtor has failed to file a return, but does not define a "return" or provide guidance as to the treatment of the various returns taxing authorities are permitted to make on behalf of delinquent taxpayers. The bill makes it clear that substitute returns made by taxing authorities, with the co-operation of the debtor and signed by the debtor, are included in the definition of a return.

1. Sec. 516--The Discharge of the Estate's Liability for Unpaid Taxes.

Section 505(b) of the Code provides that on the request for a determination of the tax by the taxing authority, the trustee, debtor, and any successor to the debtor are discharged from any tax liability other than that reflected on the return, unless the taxing authority notifies the taxpayer that the return will be examined. Courts have held, however, that this discharge of liability for additional tax does not apply to the estate, even though the trustee is the representative of the estate and even though logic suggests that the estate should be included in the provision providing for the discharge of tax liabilities, consistent with Congressional intent for providing for expedited audits and speedy, final determination of tax liabilities in bankruptcy. The bill makes it clear that the estate is discharged from any liability for additional taxes if the taxing authority fails to pursue its rights to assert additional taxes due as provided in the Code.

1. Sec. 517--Requirement to File Tax Returns to Confirm Chapter 13 Plans.

In a Chapter 13 plan, the debtor is required to provide for the full payment of all claims entitled to priority, including taxes which have not been assessed but are still assessable. Where the debtor has failed to file a return the taxing authority has no practical means of determining the correct amount of its claim. In some cases, the taxing authority has attempted to protect the public interest by filing estimated claims in all cases where the debtors have "open" years, a monumental task given the volume of Chapter 13 filings. The practice of filing estimated, "place holding" proofs of claim for periods for which no returns have been filed creates a number of problems for tax authorities, debtors and courts. Some courts have directed tax authorities to file claims labeled as estimates to protect their position, while other courts have sanctioned tax authorities for filing incorrect estimates--tax authorities are in a "no-win" situation when they must rely on estimated proofs of claim. To avoid such difficulties, the bill requires that Chapter 13 debtors file all returns which are due for the six taxable years ending before the petition in bankruptcy.

1. Sec. 518--Standards for Tax Disclosure in Chapter 11 Cases.

The bill amends section 1125(b) of the Bankruptcy Code to require a discussion of the potential material federal and state tax consequences of the plan to the debtor and any entity created pursuant to the plan, and a discussion of the potential material federal tax consequences of the plan to a hypothetical investor typical of the holders of claims or interests. A Chapter 11 plan's tax consequences represent an important aspect of the plan. The failure to discuss the potential tax consequences of a plan of reorganization in the disclosure statement can result in seriously misleading creditor constituencies and other parties in interest about the plan's economic effects.

1. Sec. 519--Burden of Proof in Tax Matters.

The Bankruptcy Code does not require that either the debtor or the taxing authority sustain the burden of proof in regard to tax claims, whether the debtor must sustain the ultimate burden, the rule in nonbankruptcy tax matters, or whether the taxing authority has the burden, consistent with the treatment of other bankruptcy claims, generally. To resolve the conflict among judicial decisions, which have ruled favorably on both sides of the issue, and to establish consistency with the treatment of tax determinations outside of bankruptcy, the bill simply provides that the burden of proof in regard to tax claims shall be the same as in nonbankruptcy tax determinations, regardless of what that rule may be.

The National Bankruptcy Review Commission recommended that the burden of proof in tax matters in bankruptcy court be placed on the debtor.

The government's position as a tax creditor in a claims contest is different from other creditors in a normal debtor-creditor relationship. It is generally the debtor or the debtor-in-possession who has access to all of the relevant records, information and knowledge required to substantiate or contest the validity of a tax claim. . . . To the extent one creditor is prevented from being able to prove its claim due to lack of information, other creditors benefit to the detriment of that creditor. The Recommendation is designed to protect tax creditors from that result.

Report of the National Bankruptcy Review Commission 816 (Oct. 20, 1997).

1. Sec. 520--Setoff of Tax Refunds.

After a consumer files a petition in bankruptcy, a taxing authority is required to seek relief from the automatic stay on a case-by-case basis if it wants to offset a refund of prepetition taxes against a claim for prepetition taxes, even if the claim is not disputed. The cost to the government of prosecuting often uncontested and routine motions as a prerequisite to enforcing an undisputed, mutual obligation is substantial. Because the interest and penalties which may continue to accrue are often nondischargeable, the inability to promptly apply income tax refunds against tax claims can cause individual debtors undue hardship. Thus the bill grants taxing authorities the ability to setoff an income tax refund that arose prepetition against an undisputed income tax liability which similarly arose prepetition.

1. Conclusion.

We may not like paying taxes and we may not even like the tax system as it presently stands, but as citizens and tax payers we have a duty to try to make the system work until it is changed. We also have a duty to seek changes in the tax system which allow it to function properly and to seek changes in other laws which unduly impede the governmental process and impose unwarranted risks or burdens on those outside the bankruptcy system. In short, if the system doesn't work, from your perspective, if it doesn't do what you believe it should do or if, in your opinion, it treats some too harshly, seek to change the system, don't corrupt it and, most importantly, don't advocate the creation or maintenance of loopholes, such as those which presently exist in the Bankruptcy Code, which those who are undeserving can exploit; don't seek to maintain rules and procedures which impose undue complexity and unreasonable burdens on the parties and which frustrate the ability of those who are charged with performing essential government services from doing their duty under laws designed to protect all the people; and do what you can to discourage those who would foster such rules and requirements which increase the cost of government, a cost which we all must pay, and make it nearly impossible for government to serve all the people.

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