Judiciary HomepageWRITTEN STATEMENT OF PAUL H. ASOFSKY
For presentation to the Subcommittee on Commercial and Administrative Law of the Committee on the Judiciary of the United States House of Representatives.
March 18, 1998
Introduction
My name is Paul H. Asofsky. I am a partner in the law firm of Weil, Gotshal & Manges, LLP, resident in its Houston office. I have practiced tax law for more than thirty years, during most of which time I have devoted significant attention to the tax consequences of bankruptcy cases in general and Chapter 11 reorganizations in particular. I have been privileged to serve on and to chair committees of many bar associations and law improvement groups whose jurisdiction includes the tax consequences of bankruptcy. I am appearing today as an individual and not on behalf of any of those organizations, because not all of them have completed their analysis and recommendations with respect to the tax consequences of H.R. 3150. Although I will have something to say about the particulars of some of the provisions contained in this bill, my principal emphasis today will be upon the legislative process and the importance of a more extensive study by this committee of the tax aspects of the Commission's work.
The substantive and procedural tax aspects of bankruptcy cases, both individual and corporate, are badly in need of revision. Part of the problem lies in the peculiar position that "bankruptcy tax" occupies. The problem is that on the one hand, bankruptcy lawyers as a group do not understand tax, and many of them have little patience for it. They consider tax to be a specialty practiced by tax lawyers and accountants, and so when tax problems arise in bankruptcy, many bankruptcy practitioners instinctively look elsewhere hoping to find the requisite expertise. On the other hand, tax lawyers suffer from a similar myopia. They spend their professional careers dealing with clients whose problems grow out of economic success rather than failure, and they deal with the Internal Revenue Service and state and local tax bureaucracies through familiar procedures designed to resolve tax controversies in a deliberative fashion. When bankruptcy strikes, these professionals must often deal with different bureaucracies at the federal and local levels and must seek ultimate resolution in the bankruptcy court, a tribunal which is unfamiliar to most tax lawyers.
Governmental taxing authorities suffer similar culture shock when dealing with taxpayers under the jurisdiction of the bankruptcy court. On the one hand, routine procedures for the assessment and collection of tax may be barred by the automatic stay. On the other hand, these taxing authorities often find it hard to adapt to statutes and rules requiring creditors to proceed in an expedited fashion to file their claims and resolve their disputes.
1978 Bankruptcy Code Tax Provisions
At the time of the enactment of the Bankruptcy Code in 1978, there was little statutory and regulatory guidance to give directions to debtors, creditors and governmental agencies. The first bankruptcy commission made a comprehensive attempt to rationalize these substantive rules and procedures and many new principles found their way into H.R. 8200, which formed the basis for current Title 11 of the United States Code. Many of these rules were well intentioned, but they were not grounded in widespread experience and scholarship. More important, jurisdictional disputes arose between the tax writing committees of the Congress and the judiciary committees. Chairman Ullman of the Ways and Means Committee insisted on sequential referral of the tax provisions to the Ways and Means Committee as a condition for ultimate floor consideration. In an effort to enact a comprehensive statute after many years of study and hearings without delay that would arise from Ways and Means consideration, the tax provisions were effectively stripped from the bill insofar as they related to the federal government. This was accomplished by inserting the words "state or local" before the word "tax" in many places where it was to appear in the Bankruptcy Code. The theory apparently was that although Ways and Means could claim initial jurisdiction over matters relating to federal taxes, the assessment and collection of state taxes in bankruptcy was initially a matter for the Judiciary Committee. Thus, the Bankruptcy Code as initially enacted contained substantive and procedural rules applicable to state and local taxes while parallel provisions dealing with federal taxes were left for future consideration. That consideration led, after additional years of study and hearings, to the Bankruptcy Tax Act of 1980, which produced a comprehensive set of federal rules to be applied in bankruptcy. Unfortunately, no effort was ever made to harmonize the federal tax provisions of the Bankruptcy Code with the state and local ones. The many discontinuities thus created are troublesome. For example, under Section 346 of the Bankruptcy Code, when an individual files a bankruptcy case under Chapter 7 or 11, his taxable year is terminated on that date. The purpose of this rule is to permit any tax liability arising in the prepetition portion of the filing year to be considered a liability of the bankruptcy estate (even though it may be non-dischargeable) so that estate assets can be used to pay such a tax, which is likely to be a priority. The draftsmen of the Bankruptcy Tax Act approached the same issue in a different way. They provided that the debtor's taxable year would not end unless he made an election. When such an election was made, the debtor's taxable year would be terminated on the day prior to the filing of the bankruptcy petition. The following anomalous results could occur as a result of the lack of parallelism between Section 346 of the Bankruptcy Code and Section 1398 of the Internal Revenue Code: If the debtor failed to timely make the federal election, he would be in the unfortunate position of having a full taxable year for federal income tax purposes, no portion of the liability for which would be a prepetition tax payable out of the assets of the bankruptcy estate. On the other hand, for state and local tax purposes, the debtor's taxable year would be divided in two. Most state income tax laws are designed to begin consideration with the debtor's federal taxable income for the full tax period, but this is not possible in the case of a debtor who fails to make the federal election. Even in the case of a debtor who makes the election, there is the minor glitch in that the federal taxable period will end on the day before the filing of the bankruptcy petition, and the taxable year for state and local tax purposes will end on the date the petition is filed, once again resulting in a lack of parallelism. There is no one who would argue that such disparate treatment is warranted as a matter of policy. All agree that it is a historical error.
A similar anomaly was created when Congress enacted Chapter 12 as part of the Bankruptcy Judges, United States Trustees, and Family Farmer Bankruptcy Act of 1986. Under Chapter 12, for state and local tax purposes, the filing of a Chapter 12 petition creates a separate tax paying, tax reporting entity in the person of the bankruptcy estate, similar to a case under Chapter 7 and Chapter 11, but different from a case under Chapter 13, where no separate estate is created and a debtor reports and pays tax upon all of his income, whether prepetition or postpetition. At the time of the enactment of Chapter 12, no amendment was made to the Internal Revenue Code. As a result, a Chapter 12 family farmer finds himself in the anomalous position that income arising during the pendency of the case is reported on his personal return for federal income tax purposes, but is reported on an estate return for state and local tax purposes. Once again, every practitioner and scholar who has considered this question has concluded that there should be parallel treatment for federal and state and local tax purposes, and most of those, whether representing the government or the taxpayer, have concluded that the present federal rule, not the present state and local rule, is a more rationale rule that should form the basis for the uniform treatment.
The foregoing two examples are but the most irrational of the differences between federal tax treatment on the one hand, and state and local on the other. There are at least twenty others, and all of these differences should be reconciled.
Wholly aside from the problems created by the statutory inconsistencies, twenty years of experience has shown that there are many provisions of the Bankruptcy Code that have simply not worked well in practice, either because they have been abused or because the statute does not suggest a ready solution to an issue. The result is often conflicting decisions of numerous bankruptcy courts. There is an overwhelming public interest in the uniform application of tax laws regardless of the residence of a taxpayer. When these conflicts arise, there should be a way of eliminating them.
National Bankruptcy Review Commission Tax Process
The National Bankruptcy Review Commission early recognized that taxes would be an important part of its mission, notwithstanding the arcane nature of some of the issues. Because it was important to draw on many perspectives in order to improve the workings of the tax law in the bankruptcy area, the Commission appointed an informal advisory committee (the "Advisory Committee") to help it sift and winnow the issues. The Advisory Committee consisted of four private practitioners, of whom I was privileged to be one. It also contained four experienced tax experts from the federal and state governments. Finally, it contained two professors with national reputations for expertise in the bankruptcy tax area. One of them, Professor Jack Williams of Georgia State College of Law, was designated to chair the Advisory Committee.
The Advisory Committee held many meetings and telephone conferences over a six-month period and produced a comprehensive report to the Commission. Notwithstanding the differing perspectives from which its members viewed the tax problems that arise in bankruptcy, the Advisory Committee was able to come up with more than thirty consensus recommendations for changes in the Bankruptcy Code and the Internal Revenue Code. With a single exception dealing with the payment of trust fund taxes in Chapter 9 municipal bankruptcies, the Commission endorsed all of these consensus recommendations either by a single vote incorporating them by reference or by specific consideration of the item. Among these consensus proposals were a lengthy series of amendments to various sections of the Bankruptcy Code designed to end the lack of parallelism between the federal and state tax proposals described above.
As might be expected, the members of the Advisory Committee had disagreements, some of them intense, as to many proposals put before it. Perhaps these disagreements resulted from the differing perspectives brought to bear by the Advisory Committee members. Nevertheless, in each of these cases, the Advisory Committee took a vote on each item at the request of the Commission and the votes of the individual members were recorded.
The Advisory Committee's work product was set forth in a lengthy report delivered to the Commission in August, 1997 and that report is contained within the larger Commission report. In the community at large, the work of the Advisory Committee was widely praised for addressing real problems in the administration of bankruptcy cases, even where controversial proposals continue to give rise to disagreement. The Commission clearly hoped that the Advisory Committee's work would form the basis for legislation that would be part of a comprehensive bankruptcy statute.
The Challenge to This Committee
Inexplicably, H.R. 3150 merely scratches the surface of the Advisory Committee's work and thus fails to take advantage of the great deal of work and expertise put at the service of the Congress by the Advisory Committee. There seems to be no reason why the Judiciary Committee should not include each and every one of the consensus recommendations, and especially the state/federal conformity provisions, in this piece of legislation.
Equally important, this Committee should not ignore the other tax issues debated before the Advisory Committee just because the Advisory Committee was unable to reach a consensus. The Advisory Committee agreed that all of these proposals were important. Government and private representatives may hold strongly-felt differing views on these proposals, but they all agree that Congress should address them.
This Committee should take up the following additional matters:
Whether the six-year deferral period for payment of priority taxes in Section 1129(a)(9)(C) of the Bankruptcy Code should run from the date of the order for relief, rather than from the date of assessment. The Advisory Committee and the Commission adopted this proposal as part of a comprehensive amendment of Section 1129(a)(9)(C).
Whether the bankruptcy court should be given authority to issue a declaratory judgment concerning the tax consequences of a plan of reorganization. Section 1146(c) of the Bankruptcy Code presently provides for such a declaratory judgment in the case of state and local taxes, but does not contain a similar provision with respect to federal taxes. The Commission proposed granting such authority in a divided vote.
Whether the tax liability of a corporate debtor should be divided into a prepetition liability and a postpetition liability for the year in which a petition is filed. Two court of appeals cases hold that the liability should be bifurcated without the necessity of filing two sets of returns. The Commission adopted a compromise proposal pursuant to which a petition year liability would not generally be divided and would thus be treated in its entirety as an administrative expense, but under the Commission proposal, a corporate taxpayer would be given an election to terminate its taxable year on the date prior to the filing of the bankruptcy petition. This would preserve the substance of the court of appeals decisions, while giving a clear signal to governmental taxing authorities that there may be a separate liability for a prepetition period against which they would have to file a proof of claim.
Whether tax penalties not attributable to pecuniary losses would be subordinated in Chapter 11. The Commission voted to subordinate prepetition penalties, thus restoring the law to that declared by various courts of appeals prior to overruling by the Supreme Court of the United States in 1996. Neither the Commission nor the Advisory Committee took a position on whether the same rule should apply to postpetition penalties.
Whether the Bankruptcy Code and the Internal Revenue Code should be amended to make clear that a trustee of a partnership has a duty to file partnership tax returns. The Advisory Committee and the Commission both adopted such a recommendation.
Whether there should be added as grounds for conversion or dismissal in Chapters 11, 12 and 13 cases the failure to file prepetition returns, the failure to file postpetition tax returns and the failure to file postpetition returns and pay postpetition taxes. The Advisory Committee in a divided vote recommended such a provision, but the Commission did not take any action on it.
Whether the Bankruptcy Code should be amended to make clear that on a default under a confirmed plan the taxing authority retains the rights of a governmental authority collecting taxes, and is not relegated to default remedies under the plan. The Advisory Committee recommended such a proposal in a divided vote, but the Commission did not act on it.
Whether Section 508(a)(8)(A)(iii) should be clarified so that priority status will be denied for taxes attributable to fraudulent and unfiled returns only when the taxing authority's ability to assess those taxes results solely from the taxpayer's fraud or failure to file. The proposal would provide priority status to those tax claims still assessable at the time of filing of the petition for reasons that are totally unrelated to the debtor's failure to file. The Advisory Committee adopted this proposal in a divided vote, but the Commission did not act on it.
Whether the Bankruptcy Code should be amended to make clear that the term "willfully attempt in any manner to evade or defeat . . . tax" requires a showing by a taxing authority in the bankruptcy case of an affirmative act or acts of misconduct and a state of mind requirement. In a divided vote, the Advisory Committee recommended this proposal but the Commission did not act on it.
Whether in a Chapter 13 case where the tax authority elects, under Section 1305 of the Bankruptcy Code, to file a claim for postpetition taxes, interest on such claim will nevertheless be allowable, notwithstanding that it is otherwise generally treated as a prepetition claim. The Advisory Committee made such a recommendation by a divided vote, but the Commission did not act on it.
Whether the amount of a tax authority's secured claim determined under Section 506 excludes the value of property exempt from levy. The Advisory Committee adopted such a recommendation by a divided vote, but the Commission did not act on it.
All of the foregoing proposals are important to the administration of the tax laws. In the view of this writer, the Committee should take up each and every one of the foregoing proposals and reach a policy decision as to whether legislative action is needed and take such action where indicated.
In addition to all of the foregoing, there were a number of proposals considered by the Advisory Committee that were not adopted, or were rejected by a divided vote. It would be appropriate for this Committee to look into some of those proposals to determine whether congressional action is in fact needed.
Finally, there were a number of items considered by the Advisory Committee and the Commission that involve amendments to the Internal Revenue Code, not the Bankruptcy Code. Although such amendments are not within the jurisdiction of this Committee, this Committee should notify the Ways and Means Committee of the Commission's and the Advisory Committee's actions and ask the Ways and Means Committee to study them. These include:
The tax consequences of abandonment of estate property to an individual debtor.
Net operating loss carryovers of debtor corporations experiencing a change of ownership in Chapter 11.
The date by which a debtor must make an election under Section 1398(d)(2) of the Internal Revenue Code in an involuntary case.
The application of alternative minimum tax rates and capital gains rates to bankruptcy estates.
The treatment of compensation paid by a bankruptcy estate to an individual debtor.
The availability of Internal Revenue Code exclusions for gain on the sale of a personal residence to a bankruptcy trustee.
The tax treatment of satisfaction of a non-recourse debt with estate property.
The date on which attribute reduction takes place under Section 108(b) of the Internal Revenue Code when there is a discharge of indebtedness.
It is the essence of my testimony that if the Congress is to undertake comprehensive Bankruptcy Code revision, it should do so comprehensively by addressing all of the tax provisions that were presented to and acted upon by the Advisory Committee and the Commission. There is a compelling need for the Congress to do so. In attacking this problem, this Committee has before it the product of hard work and mature consideration by the members of the Advisory Committee. By considering the Advisory Committee recommendations and coming to an independent judgment, this Committee will perform an important public service.
Specific Tax Provisions of H.R. 3150
Of course, the Committee now has before it, and intends to act upon, nineteen discrete tax proposals that appear in Article 5 of H.R. 3150. Although my personal views on each of these discrete provisions is not the most important part of this statement, I will humbly give the Committee the benefit of these views. My real hope is that the Committee will solicit the views of the Internal Revenue Service, the Department of Justice, state taxing authorities, and the many bar associations and law improvement groups interested in the subject matter that now have the tax provisions of H.R. 3150 under consideration.
Section 501 of the Bill attempts to deal with two concerns of local school districts as to the effect of Chapter 7 bankruptcy filings on their ad valorem property tax claims. The proposal represents a classic problem of balancing the needs of the bankruptcy system and the needs of taxing authorities.
One portion of Section 501 of the Bill would amend Section 724(b) of the Bankruptcy Code, which now effectively treats secured tax claims as priority tax claims under Section 507(a) of the Bankruptcy Code, thus moving the associated liabilities below administrative expenses, wages and other higher priority claims. Section 724 has a long history, but is based upon two important considerations. First, Congress decided that the bankruptcy process should be financed to the maximum extent possible out of the assets of bankruptcy estates and should not be a burden on the taxpayers of the United States generally. Second, Congress decided that although taxing authorities may need statutory liens as a collection device against the delinquent taxpayer, the mere placement of a statutory lien upon a debtor's property should not elevate a tax claim above the priority which it would normally have under Section 507. The Bill would restore fully-secured status to such tax claims in bankruptcy in the case of ad valorem real or personal property taxes. The apparent reason for this is the argument of state and local tax authorities that the downgrading of tax liens in bankruptcy has an adverse effect upon the revenue collections of local school districts that are dependent upon such taxes to finance their systems. This argument was first made in hearings before the Judiciary Committee of the United States Senate in connection with Senator Grassley's Investment of Education Act of 1997. Yet, a perusal of the testimony and exhibits submitted in connection with that hearing indicates that the school districts have utterly failed to demonstrate that this is a real problem. In fact, a lengthy exhibit submitted in connection with one school district witness's testimony shows only one case in which the operation of Section 724(b) of the Bankruptcy Code reduced the revenue collections of the local school board.
In addition, the actual proposal contained in the Bill appears to go far beyond what is needed to solve the supposed problem. On its face, the Bill applies to ad valorem personal as well as real property taxes. Under most state laws, the liens attributable to ad valorem personal property taxes are not valid as against bona fide purchasers, and therefore, would be avoidable by a trustee under Section 545(2) of the Bankruptcy Code. Thus, ad valorem personal property taxes should be deleted from the proposed amendments in all events.
The second branch of Section 501 of the Bill would withdraw jurisdiction from the bankruptcy court to redetermine the value of real or personal property subject to ad valorem taxes if the applicable period for contesting or redetermining that amount had otherwise expired. While there is surface appeal to this proposal, this Committee must take into account the unfair effect that it would have upon innocent third parties. Chapter 7 debtors often have little incentive to contest property tax valuations because of the fact that they have no equity in the property. Therefore, they may allow the time period for exercising their right to contest such valuations to go by because they cannot benefit from the expense of making such a contest. The creditors are the only real parties in interest, and, prior to bankruptcy, they would have no standing to make the contest themselves. Giving the bankruptcy court the right to determine the proper amount of the tax if it has not been previously contested in an appropriate non-bankruptcy forum insures a fair distribution of estate assets between taxing authorities and other innocent creditors.
Section 502 of the Bill appears to contain a drafting error, as the statutory language proposed would appear properly to substitute for, rather than add to, the present statutory language. If so, it is not clear what the proposal seeks to accomplish. In any event, the title of the section is clearly misleading as the subject matter goes beyond child and spousal support. Clarification is badly needed.
Section 503 of the Bill contains some detailed requirements as to the form and content of notices required to be made to governmental units. Clearly, there are some problems to be addressed here, but this is one of those situations where the proposed cure is worse than the disease. The actual operation of the bankruptcy system has for many years been governed by rules promulgated from time to time by the Advisory Committee on Bankruptcy Rules of the Judicial Conference (the "Rules Committee"). Congress has long left the rule-making authority to this eminent body of bankruptcy scholars, which by general acclaim has done its job well.
The Commission understood that there may be instances in which unscrupulous debtors may try to hide the ball from taxing and other governmental authorities by mailing notices to addresses calculated not to reach the agency having jurisdiction over the subject matter. An example sometimes used, but probably never resorted to in practice, would be a notice of potential tax liabilities to the Internal Revenue Service addressed to Bill Clinton at the White House. It is not conceivable that any bankruptcy judge would grant a discharge to a debtor who notified the government of a potential tax liability in such a manner. What the government is entitled to is notice sent to a person having jurisdiction over the subject matter with a content reasonably calculated to apprise the government of the nature of its potential claim. Before the Advisory Committee, the Justice Department submitted just such a package of rules that included notice requirements. The Advisory Committee, after negotiating some protective changes, approved these rules proposals unanimously and passed them along with a recommendation to the Commission, which also approved them. The Commission, however, transmitted its recommendation not to the Congress, but to the Rules Committee, where it belonged. Congress should deal with this problem by a resolution directing the Rules Committee to act. What Congress might, and should, do is to provide that every district should create a registry where governmental taxing authorities may file an address for sending notice of tax claims for cases pending within that district. Presumably, the Rules Committee would then direct that notices be sent to that address once such a filing has been made. This would enable a debtor acting with reasonable diligence and in good faith to make the required filing. The problem today is that an honest debtor filing a case in, let's say, Texas, and knowing that he may owe a tax to a local taxing district in Missouri, might send a notice to a central office of a taxing authority in Missouri without knowing that the taxing agency has issued an announcement requiring the filing at a specific place or in care of a specific official. It is important that the Congress in addressing this problem not, in an effort to curb abusive practices by a small number of unscrupulous debtors, construct a system that would trap the larger number of honest taxpayers attempting to make proper notices in good faith.
Another objectionable feature of Section 503 of the Bill is that it would require that "if the debtor's liability to a governmental unit arises from a debt or obligation owed or incurred by another individual, entity, or organization, or under a different name, the debtor shall identify such individual, entity, organization or name." A similar proposal was rejected by the Advisory Committee. The impact of the proposal would be to require a debtor to specifically notify a governmental authority of the possibility of a trust fund penalty against such debtor or risk failure of discharge should a taxing authority assert such a claim years after the bankruptcy. The Advisory Committee had a simple solution for this problem. It would have required that such a debtor schedule any business entities in which he was an officer or in which he held an equity interest and such a requirement was contained within the Justice Department rules package that was approved by the Advisory Committee and the Commission. In this way, the government would be on notice that the debtor had an interest in such a business entity and would have some obligation to determine whether or not a possible trust fund penalty had arisen. The Justice Department rules package as so amended fairly allocated the burdens between the debtors and the governmental taxing agencies. The proposal in the Bill was not endorsed by any body addressing the Commission and there is no justification for it. It should be removed from the proposed statute.
Section 504 of the Bill would amend Section 505(b) of the Bankruptcy Code by requiring that any notice to a governmental unit of a request for determination of taxes under that section be made "in the manner designated by the governmental unit." The problem that this statute attempts to address is a real problem that the Advisory Committee and the Commission sought to resolve with the approval of governmental representatives; but once again, the proposal goes beyond and falls short of what is needed to address the problem. Today, Section 505(b) of the Bankruptcy Code contains no requirements whatever as to the form and content of notice addressed to a governmental unit for a determination of administrative period taxes. As a result, many debtors routinely, and properly under present law, simply file their Section 505(b) request as a rider to their filed tax returns during the course of administration of the estate. In most cases, this notice escapes the attention of the appropriate official at the taxing authority. All agree that governmental taxing authorities are entitled to more effective notice than that apparently permissible under present law. The Advisory Committee, as in the case of similar proposed requirements under Section 503 of the Bill discussed above, would have solved this problem by resort to a filing registry that taxing authorities could avail themselves of, and if they did, could obtain the notice sent to a designee of their own choosing. If such a registry were created by statute or rule, this problem could be solved. But Section 504 of the Bill as presently proposed does not contain such a requirement. As a result, a governmental taxing authority may publish a place for notice in a routine publication of that taxing authority, and a debtor residing in a different jurisdiction might not find such notice in the exercise of reasonable diligence. In an effort to prevent debtors from hiding the ball, Congress will have countenanced hiding the ball by governmental taxing authorities. Everyone would agree that the objective sought to be accomplished by Section 504 of the Bill is reasonable and proper. However, if it is done right, the filing requirement to be imposed on governmental taxing authorities must be made a part of the Bill.
Section 505 of the Bill would create a uniform interest rate for tax claims subject to payment deferral under the Bankruptcy Code. Enactment of this provision is in the interest of sound bankruptcy administration, because it would withdraw the possibility of litigation over an appropriate interest rate in the many cases where that now occurs.
Section 506 of the Bill would provide for tolling of the periods contained in Section 507(a)(8) of the Bankruptcy Code during the period in which a prior bankruptcy case was pending. If this is all that the proposal did, it would be unobjectionable. However, the proposal goes beyond the mere tolling in several important, and objectionable, respects. First, the provision would add six months to the three-year period contained in Section 507(a)(8)(A)(i). This six-month add-on goes beyond present law, and is unjustified. More significantly, the Bill would create a tolling period during the period of time when an installment payment agreement is in effect. This proposal was rejected by the Advisory Committee. It is objectionable on two grounds. First, it potentially stretches the non-dischargeable period for stale taxes to a very lengthy period of time, which is contrary to the purposes of the bankruptcy laws. Second, it punishes honest taxpayers who make a good faith attempt to settle their tax liabilities by entering installment payment agreements and gives a better bankruptcy result to taxpayers who spend the present three-year period successfully evading the government's tax collection efforts. This is unwise policy. Congress should clearly enact a simple tolling period for the time during which a prior bankruptcy case was pending, thus following the significant majority of courts who have reached this result under the present statute. The add-ons and the installment payment provisions should be rejected.
Section 507 of the Bill would remedy a defect in present law by creating a definition of the word "assessment" for Bankruptcy Code purposes. Many of the tax provisions of the Bankruptcy Code are geared to the date of assessment. Although this term has a well-defined and understood meaning under the Internal Revenue Code, it is not uniformly used under state and local tax regimes. Thus, the fixing of a date of assessment is not possible in such cases under present law. Section 507 would provide a useful definition.
Section 508 of the Bill would withdraw "superdischarge" protection from certain fraudulent and unfiled taxes in Chapter 13. Once again, such proposals failed to win a majority at either the Advisory Committee or the Commission. In the view of this writer, the government's attempts to close this supposed loophole in the statute are shortsighted. Today, government taxing authorities consign some taxpayers to life-long purgatory by alleging fraud that cannot be demonstrated under normal standards for defining that term. The superdischarge provisions of Chapter 13 allow some number of delinquent taxpayers to find their way back into the system as law-abiding citizens. This writer believes that governmental taxing authorities probably increase their tax collection as a result of the availability of the superdischarge, although I do not have empirical evidence to prove it.
Section 509 of the Bill deals with the possibility of discharging fraudulent taxes in the case of corporations. Arguably, the considerations are different for corporate debtors than they are for individuals. I have no strong views on this issue.
Section 510 of the Bill makes an exception to the automatic stay for appeal from lower court decisions in tax cases and should be enacted. For some inexplicable reason, the Bill fails to propose another recommendation of the Advisory Committee that would overrule a Tax Court case applying the automatic stay to proceedings in the Tax Court in respect of postpetition taxes. Both provisions should be enacted.
Section 511 of the Bill would amend Section 1129(a)(9) of the Bankruptcy Code to prevent taxpayers from backloading deferred tax payments that are permitted under that section of the Bankruptcy Code. The Bill seeks to accomplish an appropriate result, but it is not well drafted. Although Congress should express a principle that payments over the deferral period be reasonably level, the attempt of the Bill to fix minimum payments in each of the deferral periods by statute is problematic. The court should have the power to approve a payment plan that reasonably varies from level payments under appropriate circumstances, but the schedules set forth in the Bill seem inappropriate for a statute. The arithmetic in the Bill also seems faulty.
Insofar as Section 511 of the Bill would also apply the six-year payout period to secured as well as unsecured taxes, it should be enacted.
Section 512 of the Bill would prevent the trustee from avoiding tax liens based upon differences in statutory definitions of bona fide purchaser that now appear in Section 545(2) of the Bankruptcy Code and Section 6323 of the Internal Revenue Code. This writer supports the government's position, but notes for the Committee that the National Bankruptcy Conference opposes this provision of the Bill.
Section 513 of the Bill would amend various sections of the Bankruptcy Code and other federal statutes to make clear that postpetition taxes must be paid as a course of business expense and that no request by a governmental unit for payment of such tax as an administrative expense would be required. The Advisory Committee made such a recommendation and it is in general unobjectionable. My own experience is that, at least in large Chapter 11 cases, payment of such expenses in the ordinary course of business is the standard practice. I have a concern, however, that there may be cases that involve administratively insolvent estates. In such cases, the Bankruptcy Code does not generally give priority to one type of administrative expense over another, and if these proposals are adopted, there should be clarifying language to the effect that in the case of administratively insolvent estates, some or all of these taxes should be delayed so that there will be equitable distribution of estate assets among all administrative claimants.
Section 514 of the Bill would advance the last date on which a taxing authority could file a late claim and be entitled to distribution. Under present law, a late-filed claim is entitled to distribution in Chapter 7, provided it is filed before the trustee commences distribution. This has the potential for disruption of the distribution process, and the Advisory Committee recommended that the date be advanced to the date on which the court approves the final report and accounting of the trustee. Section 514 of the Bill adopts this recommendation of the Advisory Committee and it should be enacted.
Section 515 of the Bill would remedy a defect in present law by providing that the unfiled returns exception to discharge under Section 523(a)(1)(B) not apply in cases where a return is filed pursuant to Section 6020(a) of the Internal Revenue Code of 1986 or similar state or local law or a written stipulation to a judgment entered by a non-bankruptcy tribunal. This proposal also reflects a consensus of the Advisory Committee and it should be enacted. However, there is a confusing qualification in proposed Section 523(a)(1)(B)(iii)(II) of the Bankruptcy Code as it would read as a result of Section 515 of the Bill to provide that any such return "must have been filed in a manner permitted by applicable non-bankruptcy law." This qualification is ambiguous, and a number of commentators have noted that if read literally, it would swallow the amendment in the guise of a qualification. The basic proposal should be adopted, but the proviso should be deleted.
Section 516 of the Bill adopts a proposal recommended by the Advisory Committee and approved unanimously by the Commission. It would provide that the estate be added to "the debtor, a successor to the debtor and the trustee" as a party protected from a subsequently filed tax claim when a governmental taxing agency does not reply to a request for a determination of taxes under Section 505(b) of the Bankruptcy Code. Some cases have reached the anomalous result that once the short audit period provided by Section 505(b) of the Code has expired, taxing authorities cannot pursue a successor to the debtor or a trustee, but can still file a late claim against the estate to the detriment of creditors if the estate has not yet been closed. Such court decisions are a triumph of literalism over common sense and Section 516 of the Bill does away with these illogical results. The provision as proposed in the Bill should be enacted.
Section 517 of the Bill substantially adopts an important consensus compromise of the Advisory Committee. In brief, it requires a debtor to file at least the last six years of tax returns as a condition for obtaining Chapter 13 relief. Three minor clarifications to the proposed statute should be adopted. First, the Bill language suggests that the trustee "may continue" the first meeting of creditors to enable the debtor additional time to file delinquent returns. I believe that the intent of the Advisory Committee was to give the debtor a right to such continuances, and that should be made clear in the statute. Second, the Bill provides that further continuances may be granted by the court where the debtor demonstrates by clear and convincing evidence that the failure to file returns is because of circumstances beyond the control of the debtor. The "clear and convincing" standard was not part of the Advisory Committee's recommendation and does not otherwise appear as a burden of proof standard in the Bankruptcy Code. The integrity of the proposal would not be compromised by deleting the clear and convincing threshold. Finally, the proposal contains a definition of return that is identical to the definition in proposed Section 515 of the Bill. In my discussion of Section 515, I noted that Congress should delete the proviso requiring a return filed in accordance with applicable state law. For the same reasons that I objected to this proviso in my discussion of Section 515, I object to it here.
Section 518 of the Bill would set standards for tax discussions in disclosure statements under Section 1125(a) of the Bankruptcy Code. The proposal is generally a sound one, but a small amendment is required. As drafted, proposed Section 1125(a) would require a full discussion of the potential material federal and state tax consequences of the plan to the debtor, any successor to the debtor, and a hypothetical investor typical of holders of claims or interests in the case. Insofar as the proposal requires a discussion of the material federal income tax consequences to the debtor, it is unobjectionable. However, the Bankruptcy Code should not require a discussion of the state tax consequences to holders of claims and interests, as that could potentially require an analysis of the laws of fifty different states. If the federal income tax consequences are clearly set forth, any holder of a claim or interest should be required to consult with his own individual tax advisor to determine whether there are state tax consequences that are peculiar to him.
Section 519 of the Bill would give taxing authorities a right to set off prepetition income tax refunds against uncontested prepetition income tax liabilities. This follows a unanimous Commission recommendation. Under present law, the right of setoff is preserved, but in general, a creditor must petition the bankruptcy court to implement the right. Taxing authorities generally object to the necessity for such a petition because their computers are programmed to make such setoffs which would arguably violate the automatic stay. As a result, many existing local rules and standing orders presently contain automatic setoff rights for certain taxes. Unfortunately, these exceptions to the necessity of applying for relief from the automatic stay are not uniform. The Bill would recognize the legitimate needs of taxing authorities and therefore would extend limited setoff rights for taxing authorities in all jurisdictions, even where present standing orders and local rules do not grant an automatic exception. The provision should be enacted. However, once it is enacted, the necessity of standing orders and local rules that vary from district to district becomes questionable. The Bill should contain a sense of Congress that upon enactment of this provision, such local rules and standing orders should be withdrawn.
Summary and Conclusions
The Commission produced a massive work product in the area of tax issues in bankruptcy. It did so with the help of an Advisory Committee that represented governmental, private and academic interests. The consensus recommendations of the Advisory Committee and the Commission should be adopted in the form proposed, save for required technical clean up. Where the Advisory Committee and the Commission were divided on important issues, this Committee should set up a mechanism for considering the important issues presented and should include its considered resolution of such disputes in any bill that is sent to the floor of the House of Representatives.
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