The 11th Circuit standard for determining the priority status of tax claims involving successive bankruptcy filings.

• Author: Jorgensen, Mike E.
• Position: Morgan v. United States

In the case of Morgan v. United States, 182 F.3d 775 (11th Cir. 1999), the 11th Circuit ruled that bankruptcy courts have the power under 11 U.S.C. [sections] 105(a)(1) to toll the three-year period of [sections] 507(a)(8)(A)(i),(2) which controls the priority status and dischargeability of certain tax claims. The issue of whether successive bankruptcy filings should or should not affect the dischargeability of tax claims has been litigated in bankruptcy courts, U.S. district courts, and the U.S. courts of appeals. These courts have used various interpretations of the relationship between the Internal Revenue Code(3) and the Bankruptcy Code,(4) and various interpretations of Congressional intent, and thus have produced inconsistent results for debtors and for the Internal Revenue Service.(5)

This article will discuss 1) the apparent standards set forth in Morgan for determining the dischargeability of tax claims in cases involving successive bankruptcy filings; 2) how lower courts in the 11th Circuit have interpreted those standards; and 3) how the criteria for applying equitable tolling could be structured to, in fact, be equitable to debtors, other creditors, and the IRS.(6)

General Principles

* The Dischargeability of Taxes

One of the primary purposes of bankruptcy is to give the "honest debtor" a fresh start under the discharge provisions of [sections] 727, 1141, 1228(a), 1228(b), or 1328(b). Except as provided in [sections] 523, a discharge under these sections relieves the debtor of all debts that arose before the date of the order for relief (i.e., usually the date the bankruptcy petition is filed).(7) Pursuant to the fresh start provisions, exceptions to the discharge are strictly construed in favor of the debtor.(8) In order to survive the Ch. 7 discharge, either the tax debt must be considered a "priority claim" rather than a "general unsecured claim," or a secured claim if a federal tax lien has been filed and the debtor owns pre-petition assets to which the tax lien attaches. Similarly, any priority or secured tax not fully paid within the context of a Ch. 13 may survive the bankruptcy discharge, or result in the dismissal of the Ch. 13 prior to discharge.

Section 523(a)(1) creates statutory exceptions to discharge.(9) Section 523(a)(1)(A) provides that taxes that fall within the purview of [sections] 507(a)(8) are not discharged by operation of the discharge provisions of the Bankruptcy Code, but survive the bankruptcy discharge as priority claims.(10) Section 523 provides a total of nine categories of claims(11) that are excepted from discharge, including income taxes for unfiled returns, for returns that were filed late and within two years of the bankruptcy petition, fraudulent returns, income taxes that have not been assessed for more than 240 days prior to the bankruptcy petition, and income taxes which are due less than three years prior to the bankruptcy petition.(12) The assessment date is important since the IRS cannot usually commence collecting the tax debts until after an assessment is made.(13) If the taxes have not been assessed for at least 240 days prior to the bankruptcy petition, they will not be discharged.(14) The statute specifically extends the limitations period, or the "240-day rule,"(15) by an additional 30 days in the case where the debtor has filed an offer in compromise with the IRS prior to the bankruptcy. Congress added the additional 30 days when offers in compromise are tendered to address a potential loophole in which taxpayers file offers in bad faith and then use the bankruptcy process to the prejudice of the IRS's collection efforts.(16) Other than the offer in compromise extension of the 240-day rule, the statute is silent with respect to any extension of any of the limitation periods for successive bankruptcy filings.

* Brief Overview of the Collection Process(17)

Before the IRS can commence collection, the tax must be assessed.(18) Once the IRS has assessed a tax, it can commence collection. A taxpayer may voluntarily pay the tax, but if the taxpayer fails to make full payment, the IRS can initiate "forced collection" practices. During the pendency of the bankruptcy (from the petition date until the discharge date), creditors, including the IRS, are precluded from taking any collection action absent authority from the bankruptcy court.(19)

Under the Bankruptcy Code, Congress requires that the IRS be given certain time periods to assess and collect taxes without threat of the taxes being discharged in bankruptcy. The IRS is concerned that when the debtor files bankruptcy, and the IRS is prevented from taking collection action due to the automatic stay provisions of [sections] 362, the IRS should be allowed additional time to continue its collection activities without threat of the dischargeability time periods expiring, should the debtor file a successive bankruptcy. If the debtor files a successive bankruptcy soon after the first bankruptcy, the IRS wants to have the debt considered "priority" rather than as a general unsecured claim. In order to accomplish the "tolling of the limitation period" under [sections] 507(a)(8)(A)(i) and (ii), the IRS suggests that the court read [sections] 108(c) and I.R.C. [sections] 6503(h) together to suspend the IRS dischargeability period for the additional time the debtor is in the prior bankruptcy plus six months, thus making the debt a priority claim. This allows the IRS to meet the statutory prerequisites of collection and would provide time to perfect its legal remedies and to secure its lien.(20)

Once the notice of federal tax lien is filed, the taxing authority is not prejudiced by successive bankruptcies, unless the debtors have assets available to the taxing authority, either acquired prior to or during the interim pendency of successive bankruptcies. The IRS's lien rights are preserved against the available assets despite the bankruptcy discharge.(21) For example, if the debtors possess property that could be attached by the taxing authority, the taxing authority has a perfected choate lien once the notice of federal tax lien is filed and recorded. The lien is not modified or stripped by the bankruptcy discharge in a Ch. 7.(22) The IRS may foreclose its lien on pre-petition property after obtaining relief from the stay, or after the Ch. 7 discharge. Similarly, a tax lien filed prior to a Ch. 13 bankruptcy provides the IRS claim with secured status to the extent of the pre-petition assets, whether the assets are exempt or nonexempt. Once the notice of federal tax lien is filed, the bankruptcy filing will not strip the IRS secured or priority position.

* The Consumer Bankruptcy Study

In Turner v. United States, 182 B.R. 317 (Bankr. N.D. Ala. 1995), and Gore v. United States, 182 B.R. 293 (Bankr. N.D. Ala. 1995), the bankruptcy court in the Northern District of Alabama found the "consumer bankruptcy study" significant in its analysis of balancing the equities of the debtor's fresh start and the IRS' collection process needs.(23) The study indicated that the majority of bankruptcy debtors have little assets for the IRS or other creditors to seize. The consumer bankruptcy study found:

that the median value of assets of, without deduction for liens and mortgages, for consumers in bankruptcy in 1991 was $16,765, while the median secured debt load of the same consumer bankrupts was $10,953. Id. at 128. The study also found that the median net worth of the same group of debtors was ($10,450). Id. at 135.

Regarding the latter figure, the study made the following observation:

It is, of course, unsurprising that the debtors net worth does not rival that of the average American. After all, bankrupt debtors have declared themselves financial failures. It may be more instructive to compare the poorest Americans from the general population with the debtors who have declared bankruptcy. Here the comparison is equally bleak.

If assets do not exist, and if a notice of federal tax lien is filed, then the debtor's fresh start is strongly balanced ahead of the IRS' argument that it needs additional time. In cases in which the debtors have no available assets to apply toward the tax debt, the IRS has not been prejudiced by having less time to attempt collection since its notice of federal tax lien protects whatever rights exist against pre-petition property.

The Morgan Decision

The Morgan case involved two successive Ch. 13 bankruptcy filings. The Morgans filed their first Ch. 13...