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Section 505 of the Bankruptcy Code provides, subject to enumerated exceptions, that the Bankruptcy Court may determine the "amount or legality of any tax . . . whether or not previously assessed, whether or not paid. . . ." In appropriate and rare cases, the Bankruptcy Courts have exercised their jurisdiction to grant declaratory judgments on tax matters, particularly where the success of the plan of reorganization depends upon the outcome of that tax dispute.
Commission Track Number 329; Commission Track Number 433. Commissioner Shepard would amend Bankruptcy Code Section 505 to significantly limit its scope by (i) requiring all administrative remedies be fully exhausted and "normal" channels of judicial review fully exploited before the Bankruptcy Court could entertain a request for a tax determination or other appropriate relief; (ii) deny adjudication of a tax dispute unless the debtor, and not a creditor other than the taxing authority, is the true party in interest in the outcome of the dispute and (iii) deny a debtor taxpayer or trustee who has not paid her tax the right to contest the tax where the time to file a Tax Court petition has lapsed prior to the commencement of the bankruptcy case. See Santa Fe Discussion Issues, p. 23, Item IVC1; Id., Item IIC2; See also Unnumbered Government Working Group Proposal.
Bankruptcy Code Section 505 jurisdiction should be expanded, not limited. We join the National Bankruptcy Conference in urging Bankruptcy Code Section 1146(d) be modified to clarify that the Bankruptcy Court is authorized to declare the federal tax effects of a plan of reorganization (fn. 122).
These innocuously worded proposals fail to take into account significant real world concerns of debtor taxpayers and their creditors. Frequently, the efficacy of a Plan of Reorganization depends upon its tax consequences; a debtor's successful rehabilitation turns on her ability to determine and satisfy her tax obligations; and a creditor's vote to confirm a plan depends upon how a tax issue will be resolved. To require the bankruptcy judge to stay all proceedings until all tax bureaucracies have determined their view of the debtor's tax status, using their rules and procedures in making those determinations, and then further delaying the bankruptcy case proceedings until the appropriate State or Federal courts have confirmed or rejected the administrative determinations would unnecessarily delay and defuse the rehabilitation process (fn. 123).
Congress refined the statute for the express purpose of providing a forum for the rapid determination of claims so that disputed tax claims would not delay the conclusion of the administration of a bankruptcy estate.
In re Millsaps, 133 B.R. 547, 554 (Bkrptcy. M.D. Fla. 1991) citing 124 Cong. Rec. H 11095 (1978).
Frequently, the United States Justice Department, representing the Internal Revenue Service in Bankruptcy Court proceedings, will resist a debtor's motion to fix a tax liability under Bankruptcy Code Section 505, arguing the "absence of a case or controversy." The Department of Justice attorneys have been heard to argue that "the IRS may never raise the issue presented by the debtor and thus any determination at this time is conjectural and unnecessary." That assertion may well be true, but if the success of the plan depends upon a favorable resolution of the tax issue, the uncertainty cannot be removed by the chance no one will question the result or if it is questioned, a taxpayer favorable result will be achieved.
In other cases, the Justice Department has been heard to argue the debtor has not sought the determination of the IRS. Leaving aside the extended delays taxpayers routinely encounter in the IRS ruling process, the IRS frequently declines to provide definitive advice because of a "no ruling policy" or other administrative reason (fn. 124). These are not theoretical concerns. In one case, the Plan of Reorganization called for a distribution of the debtor's subsidiary to the debtor's stockholders. If that distribution failed to qualify as a tax-free spin-off, the distribution would have triggered a $100 million taxable gain to the debtor. The success or failure of the Plan of Reorganization turned on the taxability of that distribution. What if the IRS refused to rule? Under the proposal to amend Bankruptcy Code Section 505, no court would have jurisdiction to determine the efficacy of the plan of reorganization, and without assurance of the tax ramifications of the plan, the plan could not proceed. Absent a ruling from the IRS, all too frequently the tax consequences of a transaction cannot be determined with acceptable certainty. Until a tax return is prepared and filed, the IRS will make no claim to tax. Until the IRS issues a Notice of Deficiency, no court has jurisdiction to adjudicate an IRS tax assertion and unless the tax is fully paid, no refund suit will lie in the U.S. Claims Court or U.S. District Court (fn. 125).
Where participants in the Bankruptcy Court proceedings are concerned with issues such as personal liability as a responsible officer under Internal Revenue Code Section 6672 or have a need to know whether the debtor's NOLs survive the Chapter 11 confirmation or have a need to know the tax bases of the debtor's properties, even though the administrative remedies afforded nonbankrupt taxpayers have not been exhausted and even though jurisdiction would not lie in other courts, the Bankruptcy Court properly invokes its jurisdiction under Bankruptcy Code Section 505 to make these necessary determinations (fn. 126). In Holywell Corp. v. Smith (fn. 127), the Supreme Court, in reversing the decision of the Bankruptcy Court, took no exception to the Bankruptcy Court's rendering a declaratory judgment that the liquidating trustee, appointed pursuant to a plan of reorganization, had no duty to file an income tax return or pay income tax under the federal income tax laws.
To date, Bankruptcy Code Section 505 determinations have not overwhelmed the resources of the Bankruptcy Courts. The judges have selected the issues that had to be decided. See, e.g., In re Mahoney, 80 B.R. 197 (Bankr. S.D. Cal. 1987) and In re Mannier Bros., 755 F.2d 1336, 1341 (8th Cir. 1985). Because of the 1978 amendment to the Declaratory Judgment Act, Bankruptcy Code Section 505(a)(1) permits the determination of any tax. Compare In re Statmaster Corp., 332 F.Supp. 1248 (S.D.Fla. 1971), aff'd, 469 F.2d 978 (8th Cir. 1972) with In re Goldblatt Bros., Inc., 106 B.R. 522 (N.D.Ill. 1989). The Supreme Court's decision in United States v. Energy Resources, 495 U.S. 545 (1990), reveals a judicial belief the Bankruptcy Courts have (and require) jurisdiction to determine tax issues that must be decided to assure the success of a bankruptcy reorganization, even where those same issues would not be considered "ripe" for resolution outside bankruptcy.
The proposal seeks to overrule In re Piper Aircraft Corp., 171 B.R. 415 (Bankr. S.D. Fla. 1994) (fn. 128) holding a bankruptcy court has authority to determine the amount of a debtor's tax, notwithstanding the debtor's failure to comply with state law administrative procedures. We believe the need to reach closure on all open tax issues in one forum overrides the claims and legitimate concerns of the various taxing jurisdictions that their administrative procedures must govern all claims and proceedings. As noted by Chief Judge Queenan in Ledgemere.
Section 505, however, bars the court only from resolving tax issues "contested before and adjudicated by a judicial or administrative tribunal of competent jurisdiction." These taxes were never "contested" . . . [or] "adjudicated" through the act of assessment. 135 B.R. at 195. (fn. 129).
While we recognize some local taxing authorities may be inconvenienced by the operation of Bankruptcy Code Section 505, we fail to see a compelling need to narrow its scope. The Bankruptcy Courts have in the past -- and can be expected in the future -- exercised appropriate discretion in determining which tax issues need be resolved to provide an orderly completion of the pending case.
The Association of the Bar of the City of New York opposes narrowing the bankruptcy court's tax jurisdiction. They and the National Bankruptcy Conference would give the bankruptcy court declaratory judgment jurisdiction.
*************************FOOTNOTES**********************************
fn. 122: "The fairness and feasibility of a plan of reorganization often turn upon the future tax effects (federal, state and local) of the plan. Essential to the court's ability to approve or disapprove the plan, therefore is the ability of the plan proponent to obtaina prospective determination of the tax effects of the plan." The National Bankruptcy Conference's Code Review Project, "Reforming the Bankruptcy Code," 68-71 (1994).
fn. 123: See Plumb, The Tax Recommendations of the Commission on the Bankruptcy Laws--Tax Procedures, 88 Harv. L. Rev. 1360, 1476 (1975) where he describes the need for limited declaratory judgment jurisdiction in the Bankruptcy Court in matters involving unresolved tax issues.
fn. 124: See NYSBA, REPORT ON SUGGESTED BANKRUPTCY TAX REVENUE RULINGS, 50 Tax Notes 631 (Feb. 11, 1991) suggesting 29 proposed revenue rulings to resolve tax uncertainties that arise in bankruptcy reorganizations. To date, few have been addressed or resolved.
fn. 125: In re Shapiro, 188 B.R. 140, 142 (Bkrtcy. E.D. Pa. 1995) notes the problem faced by debtors seeking a determination of their nondischargeable tax obligations:
"While a partial payment may suffice with respect to the debtors' tax obligation under 26 U.S.C. Section 6672, the debtors otherwise are now limited to paying in full the taxes assessed and seeking a refund in the appropriate United States District Court, 26 U.S.C. Section 7422, or possibly in the United States Court of Federal Claims. See Bob Jones University v. Simon, 416 U.S. 725 . . . (1974) (if taxpayer fails to timley file a Tax Court peition, 26 U.S.C. Section 7421(a) enjoins taxpayer from impending tax collection efforst; sole recourse is to pay tax in full and then contest the merits in a refund action)..."
fn. 126: Congress anticipated the Bankruptcy Court would decide all matters affecting a debtor, including matters that orinarily would be heard in another court -- at another time. An objective of the Bankruptcy Court is to get all claims against a debtor into one forum. See H.R. Rep. No. 595, 95th Cong., 1st Session 46 (1977). Prior to the 1978 amendment, the Declaratory Judgmen tAct, 28 U.S.C. Section 2201, could be invoked by the Justice Department to block a reorganization plan where possible tax liabilities could render the plan as not equitable and feasible. See, In re Inland Gas Corp., 241 F.2d 374, 379 (6th Cir.), cert. denied, 355 U.S. 838 (1957). Under present law, the Bankruptcy Court's jurisdiction to determine the tax consequences of a plan or reorganization, "corresponds with general principles governing a Bankruptcy Court's power to adjudicate at least core matters under 28 U.S.C. Section 157." In re Goldblatt Bros., Inc., 106 B.R. 522, 529 (N.D. Ill. 1989).
fn. 127: 911 F.2d 1539 (11th Cir. 1990), aff'g 85 B.R. 898 (Bankr. S.D. Fla 1988), rev'd. 112 S.Ct. 1021 (1992).
fn. 128: Piper followed In re AWB Associates, 144 B.R. 270 (Bankr. E.D. Pa 1992), In re Ledgemere Land Corp., 135 B.R. 193 (Bankr. D. Mass 1991) and In re W. Warren Street Associates, 143 B.R. 326 (Bankr. N.D.N.Y. 1992).
fn. 129: In re Cumberland Farms, Inc., 175 B.R. 138 (Bankr. D. Mass 1994), Chief Judge Queenan limited his Ledgemere decision to unpaid taxes owed by the debtor, thus, denying jurisdiction over refund claims that had not been adjudicated previously. As to unpaid tax claim, Judge Queenan apparently believes the court should exercise discretion in deciding whether to detemine liability for unpaid taxes. 175 B.R. at 143.
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Last updated June 1, 1997