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The Internal Revenue Code generally requires any person liable for any tax imposed by Title 26 of the United States Code to file a tax return (fn. 42). A willful failure to file a federal tax return constitutes a misdemeanor and is punishable by imprisonment for a term not exceeding one year, a fine not exceeding $25,000, or both (fn. 43).
If a taxpayer fails to file a tax return required to be filed under federal or state law, the taxes with respect to such return are not dischargeable in bankruptcy (fn. 44).
If an individual files a chapter 7 or chapter 11 petition, a bankruptcy estate is created and is treated as a separate taxpayer (fn. 45). In a chapter 7 case involving an individual, the bankruptcy trustee is responsible for filing the estate's federal income tax return (fn. 46). If a trustee is appointed in an individual's chapter 11 case, such trustee is responsible for filing the estate's federal income tax return (fn. 47). If the individual debtor is a debtor in possession, the individual debtor is responsible for filing the estate's federal income tax return (fn. 48).
An individual debtor in a chapter 7 or chapter 11 case is responsible for filing a federal income tax return with respect to the debtor's (as distinguished from the estate's) postpetition income (fn. 49).
No separate taxable entity is created for federal income tax purposes when an individual files a petition under chapter 12 or chapter 13. In such cases, the debtor and the estate are one and the same, and the debtor is responsible for filing a federal income tax return (fn. 51).
With respect to corporations, no separate taxable entity is created when a chapter 7 or chapter 11 petition is filed (fn. 52). The bankruptcy trustee is responsible for filing the corporation's federal income tax return in a chapter 7 case and a chapter 11 case (assuming a trustee is appointed) (fn. 53). A debtor in possession in a corporate chapter 11 case is responsible for filing the corporation's federal income tax return (fn. 54).
A willful failure to pay federal taxes is a misdemeanor, punishable by imprisonment for a term not exceeding one year, a fine not exceeding $25,000 or both (fn. 55).
A chapter 11 plan cannot be confirmed unless it provides for the payment of allowed administrative tax claims (i.e., postpetition taxes) in cash in full on the effective date of the reorganization (unless the claim holder agrees to different treatment of such claim) (fn. 56). Neither a chapter 12 nor a chapter 13 plan can be confirmed unless it provides for the full payment, in deferred cash payments, of all allowed tax claims entitled to priority under Bankruptcy Code Section 507 (including, but not limited to, administrative tax claims), unless the claim holder agrees to different treatment (fn. 57).
An individual debtor in a chapter 7 case is not barred from receiving a discharge merely because the bankruptcy estate is administratively insolvent and cannot pay all administrative tax claims.
Commission Track Number 212. The Government Working Group proposes the following:
1. Bankruptcy Code Sections 707(a), 727(a), 1121(b), 1121(c), 1222(a) and 1322(a) should be amended to require a debtor, as a precondition to plan confirmation, discharge or an order extending exclusivity, to file verified proof that the debtor has (i) timely paid all postpetition taxes then due, (ii) timely filed all postpetition tax returns then due, and (iii) filed all theretofore unfiled prepetition tax returns by the conclusion of the section 341 first meeting of creditors for the last six taxable years preceding the commencement of a bankruptcy case.
2. Bankruptcy Code Sections 1112(b), 1208(c) and 1307(c) should be amended to provide that failure to file tax returns or timely pay postpetition taxes shall be grounds for dismissal or conversion upon motion by the United States Trustee or any aggrieved governmental unit or, possibly, other parties in interest. Government Working Group Proposal No. 10. See also Santa Fe Discussion Issues, p. 15, Item II D7; Justice Proposal, p. 83; IRS Proposal, p.2.
It should be noted that under this proposal a late filing of a tax return for a postpetition taxable period will preclude a discharge or confirmation of a plan of reorganization. If a tax return is filed late, it will be impossible to provide verified proof of timely filing, thereby making it impossible to satisfy a condition precedent for discharge or plan confirmation.
The Task Force generally opposes the proposal, particularly as it relates to individual debtors (as distinguished from corporations or partnerships), chapter 7 cases and the payment of taxes (as distinguished from the filing of tax returns). However, the Task Force agrees with the following aspects of the proposal:
1. Bankruptcy Code Sections 1121(b) and 1129(a) should be amended to provide that in a case where the debtor is a corporation or partnership, a debtor in possession or a chapter 11 trustee is required, as a condition to plan confirmation, discharge and an order extending exclusivity, to file verified proof that the debtor has filed (but not necessarily timely filed) (a) all postpetition returns then due and (b) all theretofore unfiled prepetition tax returns for the last three taxable years preceding the commencement of a bankruptcy case. The same rule should apply to an individual debtor who is a debtor in possession.
2. Bankruptcy Code Section 1112(b) should be amended to provide that in a case in which the debtor is a corporation or partnership, a failure to file postpetition tax returns shall be grounds for dismissal or conversion upon motion by the United States Trustee or an aggrieved governmental unit. The same rule should apply to an individual debtor who is a debtor in possession, but the rule should be limited to tax returns of the estate and should not extend to tax returns of the debtor.
3. Bankruptcy Code Sections1222(a) and 1322(a) should be amended to provide that an individual debtor is required, as a condition to plan confirmation and discharge, to file verified proof that the debtor has filed (but not necessarily timely filed) (a) all postpetition tax returns then due, and (b) all theretofore unfiled prepetition tax returns for the last three taxable years preceding the commencement of a bankruptcy case.
4. Bankruptcy Code Sections1208(c) and 1307(c) should be amended to provide that a failure to file postpetition tax returns shall be grounds for conversion or dismissal on motion by the United States Trustee or an aggrieved governmental unit.
The proposal before the Commission is complex and multifaceted, involving chapters 7, 11, 12 and 13 and applying to individual debtors as well as corporation and partnership debtors. This broad-based approach is unwarranted and inappropriate in view of substantive tax rules (namely, Internal Revenue Code sections 1398 and 1399) that create important distinctions between chapter 7 and chapter 11 cases involving individual debtors and other kinds of chapter proceedings and debtors. In addition, "timely payment" requirements embedded in the Commission's proposal run counter to existing provisions of the Bankruptcy Code regarding the payment of administrative and prepetition tax claims in chapters 11, 12 and 13. Finally, the proposed requirement that tax returns be "timely" filed and taxes be "timely" paid creates the potential for imposing drastic penalties for minor footfaults.
As discussed above (fn. 58), the federal income tax return for the bankruptcy estate is prepared by the bankruptcy trustee, not the debtor. The debtor and the estate are separate taxpayers. To deny the debtor a discharge because his or her bankruptcy trustee fails to file a tax return with respect to a postpetition tax period of the estate (or files such return late) is manifestly inappropriate and wrong. It amounts to severely penalizing the debtor for a matter over which he or she has no control.
The Commission's proposal is also flawed to the extent it envisions denying the debtor a discharge in the event the debtor fails to file a tax return with respect to a debtor's postpetition tax period. A debtor's tax liability for a postpetition tax period is not a claim against the estate nor in any way involved in the debtor's chapter 7 case. The liability remains outstanding notwithstanding the discharge the debtor may receive in the chapter 7 case.
Under these circumstances, denying a discharge because a debtor fails to file a return for a postpetition period would be a purely punitive measure. The Task Force believes sufficient penalties already exist to punish a willful failure to file a tax return, namely, potential imprisonment, fines and civil penalties. There is no need to add the denial of a discharge in bankruptcy to this already formidable array of penalties.
Finally, many chapter 7 cases involving individual debtors are "no asset" cases in which the estate's resources are insufficient to pay for the preparation of postpetition tax returns. Although a bankruptcy trustee conceivably could be required to pay for return preparation, this would increase the cost of administering such cases and ultimately require the government to pay additional compensation to trustees, possibly resulting in no net increase (or perhaps even a net decrease) in government revenues.
A corporate or partnership debtor in a chapter 7 case does not receive a discharge (fn. 59). Consequently, the Commission's Proposal is superfluous to the extent it provides for denying a discharge to a corporate or partnership debtor in a chapter 7 case.
If a trustee is appointed in an individual debtor's chapter 11 case, the trustee is responsible for filing the estate's federal income tax return (fn. 60). Denying a discharge to a debtor because his or her trustee fails to file a postpetition tax return for the estate is unwarranted and inappropriate. If, notwithstanding this consideration, the Commission believes a debtor should be denied a discharge under these circumstances, the debtor should have a private right of action against the trustee for monetary damages for the trustee's failure to file an estate tax return.
If an individual debtor is a debtor in possession, it is reasonable to require that prepetition tax returns for the preceding three years as well as all postpetition returns be filed as a condition to the entry of an order extending exclusivity, confirming a plan of reorganization or granting a discharge. If an individual debtor's chapter 11 estate possesses adequate resources to confirm a chapter 11 plan, it is likely to possess sufficient resources to pay for the preparation of prepetition and postpetition tax returns.
Similarly, the Task Force believes Bankruptcy Code Section 1112(b) should be amended to provide that an individual debtor in possession's failure to file postpetition tax returns for the estate (but not the debtor) shall be grounds for dismissal or conversion upon motion of the United States Trustee or an aggrieved governmental unit.
The Task Force believes it is reasonable to require a corporate or partnership debtor in a chapter 11 case to file all postpetition tax returns and prepetition tax returns for the three years preceding the filing of the petition as a condition to the entry of an order extending exclusivity, confirming a plan of reorganization or granting a discharge. The confirmation of a chapter 11 reorganization plan presupposes that the debtor possesses sufficient resources to render the plan "feasible" (fn. 61). Thus, a chapter 11 debtor who can confirm a plan is likely to possess sufficient resources to pay for the preparation of prepetition and postpetition tax returns.
Requiring that prepetition returns be filed for the preceding six years seems excessive. A three year filing requirement would be in harmony with the three year period generally applicable with respect to eighth priority taxes (fn. 62) and seems more reasonable than a six year requirement.
For similar reasons, the Task Force believes that Bankruptcy Code section 1112(b) should be amended to provide that a failure to file postpetition tax returns shall be grounds for dismissal or conversion upon motion by the United States Trustee or an aggrieved governmental unit.
If adequate resources exist to permit confirmation of a chapter 12 or 13 plan, it is likely that adequate resources exist to pay for the preparation of prepetition and postpetition tax returns. The Task Force supports the Government Working Group's proposal insofar as it requires the filing of all postpetition tax returns and prepetition tax returns for the three years preceding the filing of the petition as a condition to plan confirmation and, upon successful completion of the plan, the granting of a discharge to the debtor.
The Task Force also supports the Government Working Group's proposal that Bankruptcy Code sections 1208(c) and 1307(c) be amended to provide that failure to timely file postpetition tax returns shall be grounds for dismissal or conversion upon motion by the United States Trustee or an aggrieved governmental unit.
A bankruptcy trustee's failure or inability to pay the estate's postpetition taxes should have no effect on the debtor's entitlement to a discharge. This is a matter over which the debtor has no control, and it would be patently unfair to severely penalize the debtor for a trustee's omissions or mistakes or the estate's administrative insolvency.
As discussed above (fn. 63), no discharge is available in a chapter 7 case involving a corporate or partnership debtor, so the entire issue is moot.
Chapter 11 already provides for the payment of postpetition taxes under a confirmed plan of reorganization. Such taxes must be paid in cash in full on the plan's effective date unless the taxing authority holding the claim agrees to different treatment (fn. 64).
This provision is in the nature of a fail-safe mechanism designed to backstop any administrative claims not paid in the ordinary course of business. A creditor (including a taxing authority) holding an administrative claim generally is assured that its claim, if not earlier paid, will be paid when a plan of reorganization becomes effective.
See our response to Commission Track Numbers 421-4, infra.
Chapters 12 and 13 each provides for the payment of postpetition taxes pursuant to a confirmed plan: there must be full payment, in deferred cash payments, of all administrative tax claims unless the claim holder agrees to different treatment (fn. 65). Moreover, Bankruptcy Code sections 1226(b)(1) and 1326(b)(1) provide that administrative tax claims must be paid before or at the time of payments under the plan to other creditors (fn. 66). This gives administrative tax claims a priority over (or, at the very least, makes them pari passu with)all claims other than other administrative claims.
There is no valid reason why the payment of administrative tax claims should be accelerated any more than they already are under Bankruptcy Code sections 1226(b)(1) and 1326(b)(1). A taxing authority holding a postpetition tax claim should be subject to the same rules regarding payment as other administrative claim holders; no special exception should be made. But see our response to Commission Track Numbers 421-4, infra.
Under the Commission's proposal, a debtor could be denied a discharge if he or she was even one day late in filing a tax return or paying taxes. A chapter 11, 12 or 13 plan could not be confirmed if a debtor was even one day late in filing a tax return or paying taxes.
These are truly draconian penalties for minor (and probably harmless) mistakes.
Unfortunately, this is not the type of problem that can be solved by giving a debtor an additional period of time in which to file a postpetition tax return. If a debtor is given an additional period of time (say, 90 days) in which to file a return, there will be some debtors who will file on the 91st or 92nd day, creating the same problem of a disproportionate penalty for a minor footfault (filing one or two days beyond the deadline).
A better approach is to require that all postpetition tax returns be filed before a plan can be confirmed, but not to require that such returns be filed on time. A corollary rule would give a taxing authority an additional period of time in which to file a claim in the event that a tax return for a postpetition period is tardily filed.
The Association of the Bar of the City of New York generally opposes requirements to bring filings current as a condition for obtaining bankruptcy relief. A focus group of the American College of Bankruptcy believes that the bankruptcy process should not be used to obtain compliance with tax reporting requirements.
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fn. 42: I.R.C. Section 6001.
fn. 43: I.R.C. Section 7302.
fn. 44: Bankruptcy Code Section 523(a)(1)(B)(i)..
fn. 45: I.R.C. Section 1398.
fn. 46: I.R.C. Section 6012(b)(4).
fn. 47: Id.
fn. 48: Id.; Bankruptcy Code Section1107(a).
fn. 49: I.R.C. Sections 1398, 6012(a)(1).
fn. 50: I.R.C. Section 1398(a).
fn. 51: Elkins v. Commissioner, 88-1 U.S.T.C. Para. 9338 (Bankr. D.C. 1988) (chapter 13 case).
fn. 52: I.R.C. Section 1399.
fn. 53: I.R.C. Section 6012(b)(3), Bankruptcy Code Section 1106(a)(6).
fn. 54: I.R.C. Section 6012(a)(2), Bankruptcy Code Sections 1106, 1107(a).
fn. 55: I.R.C. Section 7203.
fn. 56: Bankruptcy Code Section 1129(a)(9)(A).
fn. 57: Bankruptcy Code Sections 1222(a)(2) (chapter 12), 1322(a)(2) (chapter 13).
fn. 58: See text accompanying footnote 5, supra.
fn. 59: Bankruptcy Code Section 727(a)(1).
fn. 60: See text accompanying footnote 6, supra.
fn. 61: Cf. Bankruptcy Code Section 1129(a)(11)(feasibility requirement).
fn. 62: Bankruptcy Code Section 507(a)(8)(A), (D), (E).
fn. 63: See text accompanying footnote 18 supra.
fn. 64: Bankruptcy Code Section 1129(a)(9)(A).
fn. 65: Bankruptcy Code Sections 1222(a)(2), 1322(a)(2).
fn. 66: Bankruptcy Code Sections 1226(b)(1), 1326(b)(1).
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Last updated June 1, 1997