Summer 2008 • Issue 29, page 15

Ignore at Your Peril: BAPCPA Tax Changes Affect all Bankruptcy Chapters

By Rosen, Charles*

The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) contained certain changes to the Bankruptcy Code that affect tax matters. I believe I must shoulder the blame — at least in part — for many of the changes. While I was still with the IRS in the mid-1990s the IRS national office made the mistake of asking me for suggestions for changes to the Bankruptcy Code.

I obliged them with a multi-page memo setting out changes that (a) codified existing majority position case law, (b) made hard and fast certain procedural positions that had been taken by the IRS, and, (c) generally simplified the life of those at the IRS Bankruptcy Units across the country which had to work with the law and the bankruptcy courts. Imagine my surprise when virtually all of my recommendations were contained in the IRS Chief Counsel’s letter of August 28, 1996 delivered to the National Bankruptcy Review Commission (attachment “A” to the Commission’s Tax Report). Now I don’t take all of the blame (I know many others in the IRS held similar views), but I do not know if any of the same suggestions were passed along by others to the IRS Chief Counsel. I presume they were passed along in some fashion, a presumption that allows me to sleep at night.

Chapters 7 and 13 Individual Debtor Cases
So what are the more significant changes that came from new BAPCPA traps for unwary debtors’ counsel? Three changes especially come to mind as they concern individuals in Chapters 7 and 13 cases.

First, Bankruptcy Code section 507(a)(8)(A)(ii)(I) was amended to clarify the 240-day-plus-30-day offer in compromise measuring period (measured from the date of assessment of a tax to the date of the petition filing) and to further include any offer that was more than pending (to include an offer that had been accepted but not fully performed by the debtor — i.e. where all offer payments were not yet paid or all required future years’ returns were not filed and paid timely).

Subsection 507(a)(8)(A)(ii)(II) was amended to further include a 240-day period, plus 90 days, as a measuring period for any time during a prior bankruptcy where the 240-day period had not fully run. But this subsection goes even further as it includes any tax collection action that was stayed in a prior bankruptcy case. Thus subsection (II) includes not only an offer in compromise in a prior bankruptcy but, among other scenarios, any time a Collection Due Process (CDP) hearing was requested during the period ended 240 days after the date of assessment. When applying these sections it must be kept in mind that there may have been several offers previously filed by the same taxpayer. Also remember that a taxpayer may have requested a CDP hearing for some tax periods but not others, so that the measuring period only applies to those tax periods for which a hearing was requested.

Remember that these are actual calendar day measuring periods, not monthly measuring periods. This is especially important if a measuring period includes February 29th of a Leap Year. Many bankruptcy attorneys have been burned by miscalculating the precise day (not monthly) time periods. The short-hand practice of estimating based on average 30-day months is a dangerous no-no. In my former life as an IRS Bankruptcy Advisor, I can’t remember how many times a lawyer would call and ask if I could help them out because of a malpractice claim caused by a few days’ miscalculation (sorry… the answer was that I had no authority to adjust the law).

Second, an unnumbered paragraph was added at the end of section 507(a)(8) — sometimes referred to as a hanging paragraph. The IRS has statutory appeal periods that prohibit the IRS from taking enforced collection action or filing Notices of a Federal Tax Lien if a taxpayer acts timely on a request for an administrative Collection Due Process hearing and, possibly, a judicial appeal of the results of the hearing (See 26 U.S.C. 6320 and 6330). The added hanging paragraph suspends the dischargeability measuring periods established by Section 507(a)(8) when the IRS (or a state taxing agency, for that matter) is prohibited from enforcing tax collection. There are also other periods when enforcement of tax obligations is prohibited, but these are often difficult to identify. They do not always appear in the literal (plain English) transcripts most attorneys request from the IRS and are often omitted in the more detailed internal computerese MCC transcripts that tax professionals prefer to use.

So why are these two Section 507(a)(8) changes important? The reason is straightforward. If you do not clear the hurdles posed by these changes, the debtor’s tax liabilities delineated in other portions of section 507(a)(8) remain priority taxes and are not dischargeable in bankruptcy (please see 11 U.S.C. 523(a)(1)(A) regarding exceptions to discharge).

The third significant change affecting individuals has to do with the death of the Chapter 13 super-discharge for all tax liabilities. Bankruptcy Code 1328(a)(2) was amended to make nondischargeable in a Chapter 13 case all those taxes that are non-dischargeable in a Chapter 7 case. This includes the priority taxes described in Section 507(a)(8), as well as taxes related to fraudulent returns, unfiled returns, unaudited deficiencies (and the like), and related to a debtor’s attempt to evade or defeat the tax. These are enumerated in Sections 523(a)(1)(B) and (C).

Thus it now appears that all taxes must be paid in full in a Chapter 13 case, with the possible exception of (a) general unsecured tax claims, (b) secured tax claims that are not fully secured and that absent the lien security would revert to general unsecured taxes, and (c) all unsecured penalties related to taxes for which the tax period ended more than three years before bankruptcy filing date (see 11 U.S.C. 523(a)(7).)

Under Section 1322 there is no requirement that general unsecured claims for taxes excepted from discharge under section 523(a)(1)(B) and (C) be paid in full. But if not fully paid under the plan, they will survive the new section 1328(a) discharge. This creates the issue of whether a Chapter 13 plan can have two general unsecured claim classes, one for tax claims and one for all other claims. If not, then a Chapter 13 plan will likely have to pay a 100% dividend on all general unsecured claims – seemingly defeating the purpose of the Chapter.

Chapter 11 Reorganization Cases
Section 1125(a) of the Bankruptcy Code was amended to make it clear that “adequate information” in the plan disclosure statement must include “A. . . a discussion of the potential material Federal tax consequences of the plan to the debtor . . .” Prior to this change drafters of Chapter 11 disclosure statements typically brushed off tax issues by cavalierly assuming that the requirement to discuss tax ramifications of a plan only meant the tax ramifications that might affect creditors, but not the debtor or successor to the debtor. Such disclosure statements merely tell readers/creditors that they should consult with their own tax professionals to determine how a confirmed plan might affect their own tax situation. This was never the intention of the drafters of the Bankruptcy Code.

Section 1129(a) also was amended to eliminate the disparate treatment that was often given to tax claims, especially those that were secured by liens on assets of the debtor. The changes bring tax claim treatment in Chapter 11 cases more in line with treatment of tax claims in other bankruptcies. For example, if what at first glance appears to be a wholly-secured tax claim but is really either unsecured or under-secured, the unsecured portion now must be treated as part of whatever category of claims it would have been found if not for the apparent perfected tax lien.

The section was also amended to require that unsecured priority claims must be paid within five years of the petition filing date rather than six years from the date of assessment. In the past debtors had some tax liabilities filed and assessed well after the petition was filed, through inadvertence, a lack of funds to have returns prepared, or because of strategic Chapter 11 planning. The amendment to the Bankruptcy Code now often greatly shortens the payout period. Finally, it is now codified that a taxing agency’s fluctuating rate of interest is the proper rate to be applied to payments, rather than some lesser discounted and/or fixed rate that is usually beneficial to the debtor. Remember that for about 9 months in 1982-83 the IRS’s rate of interest was at 16% - 20% because of substantially increased prime interest rates. At times since then the quarterly adjusted interest rate has been as high as 10%, compounded – not inexpensive interest.

Changes Affecting Chapter 11 DIPs / Trustees and Chapter 7 Trustees
Another significant change brought about by BAPCPA was to the Judicial Code at Section 960. Until BAPCPA became law, it was common for Chapter 11 debtors and Chapter 7 trustees to defer the filing of those tax returns that were required to be filed during the bankruptcy proceeding. Chapter 11 debtors are now required to file and pay all income tax returns and all payroll tax returns as they become due, rather than at the end of the case. Failure to do so in a Chapter 11 case can be a basis for conversion or dismissal of the case, pursuant to 11 U.S.C. 1112(b)(4)(I).

Chapter 7 trustees must file all returns on time and not at the end of the case. They may defer payment of the tax until final distribution only if A (1) the tax was not incurred by a trustee duly appointed or elected under Chapter 7 of title 11; or (2) [if] before the due date of the tax, an order of the court makes a finding of probable insufficiency of funds of the estate to pay in full the administrative expenses allowed under section 503(b) of title 11 . . . A (28 U.S.C. 960(C).)

Receivership Tax Obligations Contrasted With Bankruptcy Tax Obligations
How does all of the above fit into the ambit of a receivership? In a receivership most tax claims must be paid in full over time but there are no hard and fast rules of how or when they are to be paid. The exception to this is with respect to Federal taxes which, according to 31 U.S.C. 3713, must be paid after reasonable administrative and secured claims have been paid, but before all other creditors. There is no measurable timetable provided within which this is required to be done, except as might be mandated by the court.

There is a caveat to this. Where the majority of claims that are to be dealt with by the receivership entity are tax debts, and if the receivership entity and its creditors can agree that all other unsecured debts are not likely to be paid in any event, a receiver may discuss with interested parties whether filing a bankruptcy petition is in everyone’s best interests. It may be a quicker and cheaper alternative for all those involved.

*Charles F. Rosen is an attorney with the Law Offices of A, Lavar Taylor and is an expert on receivership and bankruptcy tax law. Mr. Rosen served as bankruptcy advisor for the Special Procedures Branch of the Internal Revenue Service for more than twenty years.