THE CHAPTER 13 "SUPERDISCHARGE"

(COMMISSION TRACK NUMBER 213)

Present Law

In order for income taxes to be dischargeable in a Chapter 7 case a debtor must have filed her tax returns for the years in question at least more than two years prior to filing the bankruptcy petition (fn. 67). In a Chapter 7 case a debtor who has not filed his returns at all, or has filed them within two years prior to the bankruptcy, cannot discharge those taxes even though the tax has been assessed more than 240 days. In a Chapter 13, however, if a tax meets all the other criteria for dischargeability, it may be wiped out or reduced in a Chapter 13 plan (fn. 68). That a return need not be filed in order to make a tax dischargeable under Chapter 13 is apparent from a careful reading of the priority language of the Bankruptcy Code. A taxpayer's failure to file a return, or if she filed it less than two years prior to the bankruptcy, renders the tax nondischargeable under Chapter 7 pursuant to section 523(a)(1), but this code section does not apply in Chapter 13 (fn. 69). Bankruptcy Code Section 1322(a)(2) requires only that the Chapter 13 plan provide for full payment of priority taxes under section 507(a)(8). Referring to section 507(a)(8), nowhere does the language include within the category of priority tax one for which a tax return was filed late or not filed. Hence, the failure to file a return does not render that tax a priority tax. Compare section 1322 with section 523 (exceptions to discharge) which renders tax for which no return was filed or which was filed less than two years prior, nondischargeable under Chapter 7 (section 727) (fn. 70).

Where the taxpayer filed a fraudulent return and engaged in activity which is deemed to be willful evasion of a tax obligation, any tax arising in connection with such return or evasion is ordinarily not dischargeable in Chapter 7 (fn. 71). The discharge available in Chapter 13 does not exclude the claims in this category (fraud or evasion), and therefore they are dischargeable to the extent any other secured or unsecured claim may be discharged, depending on the particular plan. As long as the Chapter 13 plan provides for full payment of priority claims provided by section 507, the discharge is allowable as to tax claims (fn. 72). Section 507 does not include tax claims based on fraud or evasion; therefore, the plan need not provide for full payment of them, unless the tax claims fall within some other category provided in section 507 (fn. 73).

Regardless of whether a tax obligation is found to be based on fraudulent returns, the debtor's dishonest prepetition conduct in regard to his tax obligations may be taken into consideration on the issue of bad faith (fn. 74).

Proposals Before the Commission

Commission Track Number 213. Commissioner Shepard proposes to close the perceived loophole which allows for a discharge of fraudulent and/or unfiled or late returns in Chapter 13. He believes that taxes which are otherwise entitled to priority should not be denied priority status simply because the taxpayer filed under Chapter 13, not Chapter 11 or 7. The taxes resulting from debtor's misconduct because of fraud, failure to file or late filing should not be dischargeable in Chapter 13. See Santa Fe Discussion Issues p. 12, Item IIC1; See also Justice Proposal, p. 91; IRS Proposal, p.8 (each proposing repeal of the Chapter 13 superdischarge altogether.)

Task Force Position

The Task Force does not support these proposals, but instead supports maintenance of the status quo.

Reasons for Position

Present law allows taxpayers who may have engaged in prior tax misconduct by not filing a return or by having filed a fraudulent return to gain a fresh start. Courts are currently authorized to review each plan based upon a bad faith standard. The bad faith standard can be determined by the bankruptcy bench. There are valid reasons why a taxpayer should be allowed rehabilitation under a Chapter 13 plan. A taxpayer faced with an overwhelming tax debt as a result of prior tax misconduct would have greater incentive to be productive if she could satisfy her tax obligation by paying a portion over a period of years. The IRS Collection Division is inflexible and imposes draconian allowable expense standards. The current law allows a bankruptcy judge to protect a Chapter 13 debtor from the harsh collection approach of the IRS.

The Task Force would agree that in no event should someone who has failed to file a return, or who has filed a fraudulent return, be allowed a zero percent plan. A better solution to the problem would be to require a minimum percentage payment. It should also be noted that by law Chapter 13 only is available to someone with unsecured debts less than $250,000, thereby preventing its use by the most unworthy taxpayers.

Other Institutional Positions

A focus group of the American College of Bankruptcy believes that the chapter 13 discharge should be conformed to the discharge in chapters 7 and 11.

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

fn. 67: Bankruptcy Code Section 523(a)(1)(B)(ii).

fn. 68: Bankruptcy Code Section 1322(a)(2) and 11 U.S.C. Section 1328(a).

fn. 69: In re Daniel, 170 B.R. 466 (Bankr. S.D. Ga. 1994) at page 468 (exceptions to discharge do not apply to a Section 1328(a) discharge.").

fn. 70: In re Bailey Bradley, 36 B.R. 655 (Maryland 1984).

fn. 71: Bankruptcy Code Section 523(a)(1)(C).

fn. 72: Bankruptcy Code Seciton 1322(a)(2).

fn. 73: In re Muina, 75. B.R. 192 (S.D. Florida 1987).

fn. 74: A discussion of factors to be considered in determining the good an dbad faith of the plan may be seen in In re Coburn, 1994 B.R. LEXIS 1875 (B.R.D. Oregon 1994).

Questions, comments or suggestions? kbercik@taxcounsellor.com

Last updated June 1, 1997