Rulings that state taxes are nondischargeable in a bankruptcy proceeding have broad ramifications.

• Author: Ely, Mark H.

In a series of decisions beginning with Schlossberg v. Maryland, 119 F3d 1140 (4th Cir. 1997), and most recently Massachusetts u. Gosselin, DC Mass, 7/31/00, courts have concluded that state taxes are not dischargeable in a bankruptcy proceeding.

Each of these decisions is predicated on an interpretation of Seminole Tribe of Florida v. Florida, 517 US 44 (1996), in which the Supreme Court held that the Eleventh Amendment to the Constitution precluded states from being the subject of lawsuits in a Federal court, unless the state's laws waived immunity.

In Seminole Tribe, the Supreme Court established two requirements for a state to be subject to an adjudication in Federal court: "first, whether Congress has `unequivocally expressed' its intent to abrogate the immunity ... and second, whether Congress has acted pursuant to a valid exercise of power."

Statutory Tests for Dischargeability

The Bankruptcy Code provides that income taxes are dischargeable if three tests are met:

1. Under 11 USC Section 507 (a) (8) (A)(i), a return (whether or not filed) must have a filing date (including extensions) three years before the filing of a bankruptcy petition.

2. Under 11 USC Section 507 (a) (8) (A) (ii) , the tax to be discharged must not have been assessed within 240 days before the bankruptcy petition's filing date. Note: when an offer-in-compromise is made within the 240-day period, the statute tolls from the time the offer is pending, plus an additional 30 days.

3. Under 11 USC Section 523 (a)(1)(B) (in conjunction with 11 USC Section 523(a)(8)), the tax to be discharged must relate to a return filed after the date on which it was last due, under applicable law or under any extension, and two years before the date of the filing of the petition. Note: there is a growing body of law on nondischargeability of taxes for sequential nonfilers.

These provisions were intended to address both state and Federal tax delinquencies (the dischargeability of Federal taxes is unaffected by the courts' holdings).

Section 106 of the Bankruptcy Code is entitled "Waiver of Sovereign Immunity." However, while Congress intended Section 106 to provide for the discharge of state taxes, the courts have ruled (with one exception) that Congress did not have the authority to enact legislation that affected state taxes.

Ramifications

Historically, due to either local practice or the primacy of Federal law, the IRS has often been considered as a creditor of utmost importance...