Lauren Schwartz, Time Is of the Essence: When Do Tax Claims ?become Payable? Under 11 U.s.c. § 1305(a)(1)?

• Publication year: 2011

TIME IS OF THE ESSENCE: WHEN DO TAX CLAIMS “BECOME PAYABLE” UNDER 11 U.S.C. § 1305(a)(1)?

INTRODUCTION

“A proof of claim may be filed by any entity that holds a claim against the debtor . . . for taxes that become payable to a governmental unit while the case is pending . . . .”1 This seemingly simple statement included in § 1305(a)(1) of the Bankruptcy Code has, until recently, enjoyed very little controversy surrounding its statutory interpretation. This lack of debate led to the belief that

this was a well-settled principle, and consequently, few scholars have considered other potential interpretations of § 1305(a)(1). Despite this, two understandings of this section have recently emerged, each creating extremely disparate outcomes for taxing authorities and for chapter 13 debtors. This question of statutory interpretation has created a split between the United

States Courts of Appeal for the Fifth and Ninth Circuits.2 The recent Ninth

Circuit decision in Joye v. Franchise Tax Board provides an ideal opportunity to assess the best possible reading of this section, taking into consideration all of the possible situations that implicate § 1305(a)(1).3

Section 1305(a)(1) allows postpetition tax claims to be filed against a chapter 13 debtor for taxes that “become payable” to a governmental unit while the bankruptcy case is pending.4 Currently, the Bankruptcy Code does not define “become payable,” so the meaning remains unclear. While courts have consistently agreed that the meaning of this term is ambiguous,5 they have not agreed upon a definition. Many courts have also concluded that the interpretation of this phrase is essential to determining whether certain tax

1 11 U.S.C. § 1305(a)(1) (2006).

1. No other circuits have addressed the issue yet; however, the Bankruptcy Appellate Panel for the Tenth Circuit concludes, as the Ninth Circuit does, that taxes “became payable” as soon as they are capable of being paid. Dixon v. IRS (In re Dixon), 218 B.R. 150 (B.A.P. 10th Cir. 1998) (internal quotation marks omitted).

2. See Joye v. Franchise Tax Bd. (In re Joye), 578 F.3d 1070, 1074 (9th Cir. 2009) (determining that for the purposes of § 1305, tax claims “became payable” at the end of the tax year as opposed to when the tax return is due) (internal quotation marks omitted).

4 11 U.S.C. § 1305(a)(1).

5 See, e.g., Savaria v. United States (In re Savaria), 317 B.R. 395, 401 (B.A.P. 9th Cir. 2004) (“There are two schools of thought about when taxes ‘become payable’ . . . .”).

claims are postpetition or prepetition claims.6 Section 1305 permits only certain postpetition claims to be filed. This means that if a tax claim is determined by the court to be a prepetition claim, then it will not be allowed under § 1305(a)(1) and may be discharged, depending on the facts of the case.

A hypothetical is instructive here. Consider a situation in which a debtor owes income taxes for the tax year ending on December 31, 2008. Additionally, imagine that the tax return for those taxes is due April 15, 2009, and that the debtor files for chapter 13 sometime between the end of the tax year and the due date of the taxes (for example, February 20, 2009). Should any claims for these taxes be disallowed because those taxes were for income earned during the year prior to when the debtor filed for chapter 13? Or should a claim for these taxes be allowed as a postpetition claim because the taxes do not become due until April 15, over a month after the debtor filed the chapter

13 petition (and consequently “while the case is pending”)? Determining whether claims for those taxes should be allowed becomes difficult without a clear definition of when such taxes become payable under § 1305(a)(1) or elsewhere in the Bankruptcy Code.

The Fifth and Ninth Circuits are divided as to whether § 1305(a)(1) allows tax claims like those in the hypothetical above.7 This division, however, does not solely result from each court’s differing interpretation of when taxes become payable. Rather, the courts incorrectly assume that whether the taxes give rise to a postpetition or prepetition claim depends on whether the taxes

become payable while the bankruptcy case is pending.

This Comment examines the current controversy over § 1305(a)(1). Part I explores the background of chapter 13 reorganizations and § 1305(a)(1), and it introduces the contrasting interpretations of the section’s statutory language. Part II then discusses the case law concerning this section of the Bankruptcy Code. Next, Part III sets out a framework for analyzing this conflict by stressing the importance of defining a claim as prepetition or postpetition before determining when it becomes payable. Part IV then explains the inherent policy considerations that must be taken into account when determining not only whether a tax claim is prepetition or postpetition, but also

1. See, e.g., In re Joye, 578 F.3d at 1074 (“[W]hether the Joyes’ outstanding taxes give rise to a post- petition claim pursuant to [§] 1305(a)(1) depends on when these taxes became ‘payable’ for the purpose of that section.”).

2. Compare United States v. Ripley (In re Ripley), 926 F.2d 440, 441 (5th Cir. 1991) (concluding that the

IRS’s claim became payable when the taxpayers had to file their tax returns), with In re Joye, 578 F.3d at 1077

1. (declining to follow the Fifth Circuit’s Ripley decision).

   whether a tax claim becomes payable during the pendency of the bankruptcy case. Finally, Part V argues that, properly interpreted, § 1305(a)(1) indicates that tax claims become payable on the tax return due date (including extensions), rather than the end of the taxable year. Additionally, Part V advocates for an amendment to the Bankruptcy Code providing a definition for “payable” in order to clarify legislative intent.

   
   

   1. BACKGROUND

      
      

      A. Chapter 13 Reorganization

      
      

      A chapter 13 reorganizations, also termed a “wage earner plan[],”8 is an option for a debtor who seeks to pay back his debts over time while retaining property.9 Congress began to allow this type of bankruptcy relief after recognizing the inadequacies of the former Bankruptcy Act in providing consumer debtors a fresh start.10 Now, nearly 1.5 million people file for consumer bankruptcy each year.11

      
      

      Eligibility to file for chapter 13 is determined by statutory guidelines limiting the amount of unsecured and secured debt a debtor can have, among other restrictions.12 Additionally, creditors cannot force a debtor into chapter 13, as it is purely voluntary on the part of the debtor.13 After the debtor files the petition, chapter 13 will generally require the debtor to make payments to creditors from future income, rather than a liquidation of current assets.14 The debtor will pay debts based on a court-approved plan,15 and at the completion of the plan, the debtor will receive a discharge.16

      
      

      Chapter 13 is advantageous, and many debtors choose it over chapter 7 liquidation because it “maximizes debtor relief by preserving to the debtor existing assets, as well as employment or going-concern value, pending completion of a repayment plan under the supervision of the chapter 13

      
      

      8 See H.R. REP. NO. 95-595, at 117 (1978), as reprinted in 1978 U.S.C.C.A.N. 5963, 6078.

      9 Chapter 13, Individual Debt Adjustment, U.S. COURTS, http://www.uscourts.gov/FederalCourts/ Bankruptcy/BankruptcyBasics/Chapter13.aspx (last visited Mar. 8, 2011).

      10 See H.R. REP. NO. 95-595, at 117.

      1. 1 HENRY J. SOMMER ET AL., CONSUMER BANKRUPTCY LAW AND PRACTICE 1 (9th ed. 2009).

      2. See 11 U.S.C. § 109(e) (2006) (outlining the precise statutory requirements).

      13 H.R. REP. NO. 95-595, at 120.

      1. SOMMER, supra note 11, at 49.

      2. See generally 11 U.S.C. §§ 1325, 1327 (detailing chapter 13 plan confirmation and the effects of confirmation).

      16 11 U.S.C. § 1328.

      trustee.”17 However, through the 2005 Amendments to the Bankruptcy Code, Congress chose to eliminate many of the previous advantages that debtors received in chapter 13.18 One particular aspect of this diminishment was the narrowing of the chapter 13 discharge.19 This Comment is written with an eye towards this trend of diminishing the previously broad discharge provisions of chapter 13 that debtors used to enjoy, and it notes that this may demonstrate increasing preferences that may conflict with a debtor’s fresh start.20

      
      

      B. 11 U.S.C. § 1305(a)(1)

      
      

      The result of the legislature’s inclusion of § 1305(a)(1) in the Bankruptcy Code is that governmental units are permitted the discretion to choose to collect taxes from chapter 13 debtors in the way that they see fit. Section 1305(a)(1) allows taxing authorities to file a proof of claim for those taxes that

      “become payable to a governmental unit while the case is pending.”21 By

      allowing, rather than requiring, this proof of claim, Congress encourages taxing authorities to select, at their option, the method that would be most effective for them to collect payment on tax claims.

      
      

      The ability to choose benefits taxing authorities by allowing them to select the method that results in greater tax collection and by providing them adequate time to assess and file claims, if they wish. The ability to make this choice, however, will depend on whether a tax claim is classified as a prepetition or a postpetition claim. Collection of a tax claim that is classified as a prepetition claim will be different than collection of a postpetition claim if the debtor taxpayer has filed for chapter 13 bankruptcy.

      
      

      1. Allowance of Postpetition Claims

         
         

         Chapter 13 is unlike chapters 7 and 11 in that it provides a mechanism that allows certain postpetition claimholders to file a proof of claim.22 In general,

         
         

         1. 8 COLLIER ON BANKRUPTCY ¶ 1300.02 (Lawrence P. King ed., 16th ed. 2010).

         2. Id.

         3. Id.

         4. This is particularly relevant for this Comment because in cases like Joye and Ripley, courts, in their interpretations of § 1305, must compare the advantages of upholding the discharge of a tax claim to provide the debtor more of a fresh start with refusing to discharge a tax claim, and allowing taxing authorities to collect. This trend...