Tax and pension claims in bankruptcy.

• Author: DeGeorgio, Thomas J.
• Position: Part 2

EXECUTIVE SUMMARY

* Individuals may elect to bifurcate Federal income tax liability for the filing tax year.

* Corporations and partnership cannot elect bifurcation; however, pre-and postpetition taxes are assigned significantly different priority status and treatment in bankruptcy proceedings.

* Payments not normally considered taxes may nonotheless be deemed taxes for bankruptcy purposes.

Planning in bankruptcy may produce valuable savings for vulnerable clients. Part II of this two-part article examines specific types of tax and pension claims, bifurcation of tax liability and other helpful bankruptcy planning considerations.

Nontax creditors and debtors in bankruptcy will generally seek the lowest priority for tax claims, while governmental tax claimants will claim the highest possible priority. The priority of tax claims and their characterization as tax claims in the first place can be significant factors in the outcome of a bankruptcy proceeding. In the August 2003 issue, Part I of this two-part article provided a general summary of bankruptcy law and claims rules and how they relate to tax. Part II, below, examines how (1) the priority of specific tax and pension claims is determined, (2) a debtor may influence a claim's priority by planning the bankruptcy petition and (3) priority, bifurcation and other considerations may affect liability and settlement.

Commingled Priorities

In the year of a bankruptcy filing, taxes on a single return might include a portion of a liability incurred after the taxpayer filed for bankruptcy (a first-priority administrative item) and a portion of a liability incurred before the filing (generally, an eighth-priority item). Exhibit 1 on p. 558 summarizes the priority treatment of specific types of taxes.

Exhibit 1: Summary of tax treatments in bankruptcy Type of tax Pre-/postpetition Priority/treatment Ad valorem taxes Prepetition if imposition 8th priority if date is prepetition, prepetition; regardless of assessment administrative if or payment date postpetition Property taxes Prepetition if imposition 8th priority if date is prepetition, prepetition; regardless of assessment administrative if or payment date; postpetition liability for leased property may be prorated if called for by contract (1) Excise taxes Prepetition if underlying 8th priority if transaction date is transaction is prepetition, regardless prepetition; of payment date administrative if postpetition Oil production Prepetition if production 8th priority if taxes is prepetition prepetition; administrative if postpetition Sales taxes Prepetition to the extent 8th priority if that underlying sales prepetition; are prepetition administrative if postpetition Employment taxes Prepetition if wage 8th priority if payment is made prepetition; prepetition administrative if postpetition Unemployment Taxes on prepetition if 8th priority if taxes work is performed prepetition; prepetition administrative if postpetition Pension Statutorily created 8th priority if contributions retirement plan premiums prepetition; are "taxes" administrative if postpetition Individual income Liability for years ended If bifurcated, 8th tax prepetition (including priority for "short" year if elected) prepetition portion is prepetition, and administrative regardless of whether for postpetition taxpayer filed return portion; if not bifurcated, all postpetition (responsibility of individual) Corporate income Liability attributable to Functionally tax prepetition portion of bifurcate income tax year based on interim liability for year closing of books is into pre- and prepetition postpetition portions; prepetition is 8th and postpetition is administrative Type of tax Example Ad valorem taxes Midland Central Appraisal District, 35 F3d 164 (5th Cir. 1994) Property taxes In re Columbia Gas System, Inc., 146 BR 114 (D DE 1992); see also In re Marion County Treasurer, 214 BR 188 (SD IN 1997) Excise taxes In re Melino Cigar & Candy Co., 22 BR 703 (1982) Oil production In re Brent Explorations, taxes Inc., 91 BR 104 (D CO 1988) Sales taxes Employment taxes In re Pacific-Atlantic Trading Co., 64 F3d 1292 (9th Cir. 1995); see also Aron Bellus, 125 F3d 821 (9th Cir. 1997) Unemployment In re Northeastern Ohio taxes Gen. Hosp. Ass'n, 126 BR 513 (ND OH 1991) Pension In re Sunnyside Coal Co., contributions 146 F3d 1273 (10th Cir. 1998) Individual income In re Marshall Dixon, tax Jr., 218 BR 150 (10th Cir. BAP 1998) Corporate income In re O.P.M. Leasing tax Services, Inc. 68 BR 979 (SD NY 1987); In re Prime Motor Inns, Inc., 144 BR 544 (SD FL 1992) (1) In re Montgomery Ward Holding Corp., 242 BR 142 (D DE 1999); see also In the Matter of Handy Andy Home Improvement Ctrs., Inc., 144 F3d 1125 (7th Cir. 1998). Individuals

Bifurcation is the process under Sec. 1398(d)(2)(A) of dividing the tax year including the bankruptcy filing date into two shorter tax years. In a Chapter 7 or 11 bankruptcy, individuals are required to bifucate state and local income taxes, (8) but have the option to bifurcate Federal income taxes. Bifurcation means that prepetition taxes for the short yea...