Discharging Income and Business-related Taxes in Bankruptcy
| Publication year | 1988 |
| Pages | 1755 |
1988, September, Pg. 1755. Discharging Income and Business-Related Taxes in Bankruptcy
A common debt of businesses or individuals experiencing financial difficulty is an obligation for federal, state or local taxes. Most practitioners believe that death and the payment of taxes are inevitable. While mortality is certain, a bankruptcy proceeding can eliminate taxes. This article discusses the kinds of taxes dischargeable in bankruptcy, the types of discharges available and the effect of tax liens. In addition, some planning techniques are suggested to maximize the bankruptcy discharge.
The key variable in determining the dischargeability of taxes in bankruptcy is whether the tax is a "priority" claim, which is not dischargeable, or an "unsecured" claim, which is.(fn1) All tax obligations which are classified as priority claims are nondischargeable.(fn2) Bankruptcy Code ("Code") § 507 prioritizes expenses of administration and claims of creditors, and provides a seventh priority to allowed unsecured claims of governmental units for various types of taxes ("priority taxes").(fn3)
Priority income taxes include taxes based on income or gross receipts (1) for a taxable year of the debtor whose tax return due date (including extensions) is more than three years prior to the bankruptcy petition filing date; (2) for taxes assessed within 240 days of the bankruptcy petition date; and (3) for taxes not yet assessed but assessable by law.(fn4) The 240-day assessment period is tolled for that time plus thirty days during which an offer in compromise with respect to such tax is pending with the Internal Revenue Service ("Service").
An example may be useful in applying the priority tax classification rules. Assume an individual's tax return for the tax year ending December 31, 1984, was timely filed, with no extensions, on the due date (April 15, 1985). The tax liability for the 1984 tax year was not paid with the tax return and remains unpaid as of April 1988. Assume also that the tax liability, including interest and penalties for that individual's 1984 return, was assessed by the Service more than 240 days prior to April 15, 1988.
The 1984 tax obligation, including penalties and interest, would be a nondischargeable priority tax if the bankruptcy petition was filed on or before April 15, 1988, and a dischargeable non-priority tax if filed after April 15, 1988. The effect of delaying the filing of the bankruptcy petition is dischargeability of the tax liability and treatment of the tax liability as a general unsecured claim.
In the above example, three crucial assumptions were made: (1) a timely filing of the 1984 tax return prior to the April 15, 1985, deadline; (2) no extensions of the April 15, 1985, deadline; and (3) an assessment by the Service earlier than 240 days prior to the bankruptcy petition. When planning for the three-year and 240-day rule of Code § 507(a)(7)(A), counsel must know the actual filing date of the tax return, the existence of any extensions of the filing due date and the date of assessment regarding the return. When properly applied, correct timing of the bankruptcy petition could result in tremendous savings to the client.
Code § 507(a)(7)(B)-(G) lists other priority taxes. These include taxes required to be collected or withheld and which the debtor is liable for in any capacity, such as employment taxes on priority wages, excise taxes, customs duties, and penalties relating to tax claims in compensation for actual pecuniary loss. The following discussion of other priority taxes centers around the more frequent delinquent taxes encountered by practitioners, such as
Payroll Taxes. Federal payroll taxes consist primarily of three components: employer FICA, employee FICA withheld and employee income tax withheld. The employee FICA and employee income tax withheld...
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