SCHEDULING THE TAX BASIS OF ASSETS

(COMMISSION TRACK NUMBERS 107 and 108)

Present Law

The Bankruptcy Code and the Internal Revenue Code contain no requirement for basis information to be provided when a debtor files a bankruptcy petition. See generally Bankruptcy Code Section 521(1), Rule 1007 F. R. Bankr. P., and Forms 6 and 7, Official and Procedural Bankruptcy Forms (as amended to November 1, 1995).

Proposals Before The Commission

Commission Track Numbers 107 and 108. Commissioner Shepard proposes that the bankruptcy forms be amended to require debtors to include information to determine tax consequences of liquidation with specific requirements that:

• basis information, original and adjustments, be provided for all of the debtor's assets;
• copies of tax returns, state and federal, are filed with the bankruptcy schedules; and
• a statement be made by the debtor that no returns are required for those time periods for which returns have not been filed.

See Santa Fe Discussion Issues, p. 26, Item IVE5; The Advisory Committee has recommended that these proposals be withdrawn as unimportant.

Task Force Position

The Task Force opposes any amendment creating requirements for (i) basis information to be furnished as part of either the debtor's schedules or statement of affairs and (ii) copies of returns to be attached to the schedules.

The Task Force recommends that Official Form 7 be amended to add a title "Tax Matters" including only (i) a statement that all tax returns (state and federal) for the three years prior to the filing of the bankruptcy petition have been filed and whether the debtor has copies; and (ii) if all such returns have not been filed, identify the returns not filed.

Reasons for Position

In addressing any question in a bankruptcy context, the process must balance the debtor's right to a fresh start and every creditor's concomitant right to obtain its fair share of the assets. Nowhere does that balance become more difficult to conceptualize, much less implement, than in addressing taxation in a bankruptcy context.

The suggestion which would require the "furnishing of information necessary to compute the tax consequences of a liquidation" in the schedules could easily crush the ability of most consumers to obtain the fresh start afforded by filing for Chapter 7 relief. Requiring any potential debtor to state that tax returns have been filed imposes no additional burdens. Such a disclosure affords ample opportunity for trustees and creditors to make further inquiry. More importantly, every debtor, and particularly all debtors' counsel, should consider which returns have been filed and which have not (fn. 26). A disclosure stating whether returns have been filed simply formalizes the due diligence that should occur without such a disclosure.

Currently, the schedules and statement of financial affairs required to be filed in a case under the Bankruptcy Code contain no "basis" data for the assets of the potential debtor (fn. 27). None of the specific questions in either set of documents contains any reference to the basis of any assets of the debtor. The Internal Revenue Code establishes only one clear and direct basis consequence for bankruptcy matters: Section108's adjustment to basis for debt discharged (fn. 28).

What reason supports any requirement that a debtor submit basis information as a part of the initial filing requirements? We can think of none. Filing a bankruptcy petition does not occur with a wealth of well organized tax information at the fingertips of the petitioner. The need for immediate and instant relief under Title 11 greatly outweighs any need for basis information. Simply stated, imposing a basis information requirement as a condition for filing a bankruptcy petition enables tax information rarely needed in the bankruptcy context to act as an impediment to the fundamental policy of bankruptcy: a fresh start! No balance exits. The information necessary to determine liquidation consequences can be obtained by anyone that wants it at any time (fn. 29).

In the overwhelming majority of consumer bankruptcy filings, the tax consequences of a liquidation of the debtor's assets does not and should not constitute even a minor "blip" on the radar screen of matters to consider before filing. Proceedings under Chapter 11, 12, or 13 simply do not present a basis problem; the debtor will continue to file returns and must report gain or loss in the ordinary course (fn. 30). Even in the rare case where liquidation consequences should be addressed, in either business or consumer cases, the debtor or debtor's counsel should, and in most cases will, address the tax issues. Where not addressed prior to filing, the trustee and the taxing authorities can examine the debtor and obtain the information needed (fn. 31).

Basis information must be obtained for one principal and not insignificant reason: a trustee's sale of assets (fn. 32). A bankruptcy trustee must file tax returns and report gain from the sale of assets. Before any potential sale, a trustee should, if not must, determine the actual cash benefit to the estate on an after tax basis. If the tax on the gain from the sale eliminates any cash flow to the bankruptcy estate, the trustee needs to consider abandoning the asset (fn. 33). That decision requires basis information. The trustee can determine if and when that information will be needed based on a review of the estate's assets after the petition has been filed. Again, in any significant bankruptcy estate, tax accountants and lawyers will certainly make the trustee aware of the need for basis information and will lead the search to obtain basis information.

Basis information must be made available to a trustee, when and as needed, not when the petition is filed. In most cases, the debtor will find the basis information, if available. If not available, should a debtor be precluded from bankruptcy relief? Only if fraud or destruction of information can be affirmatively established. Otherwise a motion to compel can address the failure of a debtor to supply basis information when requested.

Filing a bankruptcy necessarily mandates gathering and classifying significant amounts of information to identify creditors and transactions. The information currently required generally establishes the persons to whom notice must be given, the amounts of claims, the value of assets and the transactions that should be examined. Identifying tax returns filed and not filed imposes virtually no additional burden. Imposing an additional filing requirement for basis information on each and every debtor will create problems for all debtors without solving any. Whenever any party in interest needs information to determine the tax consequences of a liquidation, or basis information, the tools exist to obtain it. The Trustee has the only real need for that data and all trustees know (1) when they need that information and (2) how to obtain it.

Other Institutional Positions

The Association of the Bar of the City of New York opposes any requirement to schedule the tax basis of assets.

**************************FOOTNOTES*********************************

fn. 27: See Official and Procedural Bankruptcy Forms (As Amended to November 1, 1995) generally and Forms 6 and 7 specifically. A spearate shcedule does exist for unsecured priority claims, which can cover some unpaid tax claims. See Official Form Schedule E - CREDITORS HOLDING UNSECURED PRIORITY CLAIMS. See also Rule 1007, F.R. Bankr.P.

fn. 28: I.R.C. Seciton 108(b)(2)(E) requires the basis adjustment; Section 1017 defines the manner in which the adjustment should be made.

fn. 29: See Fed. R. Bank. P. Section 2004.

fn. 30: Indeed the Chapter 11 debtor must repor the COD income and make the adjustments required by Section 108.

fn. 31: At any time a creditor or trustee desires, the debtor can be required to appear and produce all tax returns and other financial data necessary to determine the tax consequences of liquidating the debtor's assets in a Rule 2004 examination. No litigation needs to be initiated.

fn. 32: I.R.C. Section 6012(a)(9) for individual estates in chapter 7 or 11; and (b)(3) for trustess for corporations under Title 11, whether in Chapter 7 (liquidation) or Chapter 11 (Reorganization).

fn. 33: In an abandonment, the trustee actually determines only if the asset has little value to the estate and is burdensome to the estate. The Trustee does not have to consider any adverse tax consequences to the debtors (if the property is abandoned. Johnston v. Webster, 49 F.3d 528 (8th Cir. 1995).

Questions, comments or suggestions? kbercik@taxcounsellor.com

Last updated June 1, 1997