Report of the American Bar Association Tax Section Task Force on the Tax Recommendations of the National Bankruptcy Review Commission

PRIORITY FOR EXCISE AND EMPLOYMENT TAXES

(COMMISSION TRACK NUMBER 335)

Present Law

The priority provisions found in section 507(a)(8)(A)(i) (for income and gross receipts taxes), section 507(a)(8)(D) (for certain employment taxes), and section 507(a)(8)(E) (for certain excise taxes) all allow a federal, state or local governmental unit's tax claim a priority so long as the tax return with respect to those taxes was due no more than three years before the date of the filing of the bankruptcy petition (the "3-Year Rule"). With respect to income or gross receipts taxes, section 507(a)(8)(A)(ii) and (iii) can give priority to some governmental income and gross receipts tax claims that fail the 3-Year Rule.

Section 507(a)(8)(A) (Certain Income and Gross Receipts Taxes). Section 507(a)(8)(A)(ii), for example, only requires that the income or gross receipts tax be validly assessed within 240 days of the filing of the bankruptcy petition ("240-Day Rule"). Since the statute of limitations on assessing these taxes is often tolled or suspended, many valid assessments are made with respect to tax years that are 4, 5, 6 or even more years in the past. Similarly, under section 507(a)(8)(A)(iii), any income or gross receipts tax that remains assessable as of the bankruptcy filing date can get a priority, again irrespective of the tax year to which the assessment relates (the "Still Assessable Rule"). According to the Senate Report to the 1978 Bankruptcy Code, both the 240-Day Rule and the Still Assessable Rule were designed to plug "loopholes" (fn. 136). For example, a taxpayer might delay an assessment until the 3-Year Rule was exhausted by negotiating with the IRS concerning a tax audit or by commencing litigation in Tax Court.

Section 507(a)(8)(D) (Certain Employment Taxes). The Employment Taxes that are subject to section 507(a)(8)(D) include (but are not limited to) the employer's share of FICA (fn. 137), FUTA and Railroad Retirement Act taxes which -

(1) are "of a kind specified in" section 507(a)(3);

(2) are earned from the debtor before the date of the filing of the petition;

(3) which may or may not have actually been paid by the date of filing the bankruptcy petition; and

(4) satisfy the 3-Year Rule.

The reference in section 507(a)(8)(D) to section 507(a)(3) deals with unpaid wages of less than $4,000 that were earned within the 90-day period prior to the filing of a bankruptcy. Apparently, however, section 507(a)(8)(D) is not so limited. First, the 3-Year Rule obviously reaches back longer than 90 days from the date of filing. Second, section 507(a)(8)(D) appears only to apply to employment taxes with respect to wages which were paid before the filing of the bankruptcy petition (fn. 138). This is so because most, if not all, federal and state employment taxes only arise when wages are "paid" (fn. 139). (The reference to "whether or not actually paid before such date" found in section 507(a)(8)(D) obviously causes some confusion on these two points. See recommendation below.)

Section 507(a)(8)(E) (Certain Excise Taxes). The exact scope of subparagraph (E) is far from certain because the Bankruptcy Code has no definition of "excise tax." This definitional deficiency has led to numerous cases, including one last year before the United States Supreme Court (fn. 140). It is hard, therefore, to be sure as to exactly what types of governmental claims are covered by this provision (fn. 141).

Subparagraph (E) contains the 3-Year Rule and also has a separate limitation with respect to excise taxes for which no tax return is required. In this latter case, the limitation is three years from the date of the transaction which gave rise to the excise tax (the "Special Excise Tax Rule").

Section 523(a)(1)(A) (Nondischargeability). For an individual bankrupt, a consequence of having an employment or excise tax receive a priority under section 507(a)(8) is that the individual is not discharged from these tax claims because of section 523(a)(1)(A). Therefore, any expansion of the governmental claims that get priority under section 507(a)(8) increases the chances that an individual Chapter 7 debtor will not emerge from his or her bankruptcy "clean" (fn. 142).

Proposals Before the Commission

Commission Track Number 335. Commissioner Shepard proposes that the priority treatment for excise and employment taxes be the same as the treatment of income taxes found in section 507(a)(8)(A)(i)-(iii). Santa Fe Discussion Issues, p. 11, II.B.7. These changes presumably include the proposals of Commissioner Shepard found in Tracks' 313 and 314 (fn. 143). Commissioner Shepard's rationale is to simply point out the difference in priority treatment for income, employment and excise taxes and to suggest that "logic would indicate that the priority treatment should be the same for all three taxes."

Internal Revenue Service. The IRS also recommends adding the 240-Day Rule and Still Assessable Rule to the employment tax and excise tax provisions of section 507(a)(8)(D) and (E). IRS Proposal, p. 55. Again, presumably the IRS proposal includes its suggested changes to section 507(a)(8)(A)(ii) and (iii) as well as to section 523. The rationale given by the IRS is that the purpose of the rules found in section 507(a)(8)(A)(ii) and (iii) is, essentially, to give the IRS more than three years from the due date for filing income tax returns in order to give the IRS time to solicit delinquent returns, complete audits of those returns, afford taxpayers administrative appeal rights and to give due consideration to offers and compromise. The IRS suggests that the same need for extra time exists with respect to employment and excise tax returns. See also Unnumbered Government Working Group Proposal.

Task Force Position

The Task Force opposes Commissioner Shepard's and the Internal Revenue Service's proposals to extend the 240-Day Rule and Still Assessable Rule to employment and excise taxes.

The Task Force suggests that section 507(a)(8)(D) be amended to delete the phrase "whether or not actually paid before such date" to avoid any confusion as to the applicability of that subparagraph.

Reasons for Position

None of the "loophole" problems (identified in the Bankruptcy Code's legislative history) that prompted adoption of the 240-Day Rule and the Still Assessable Rule apply to employment taxes or excise taxes. The IRS even notes in its letter that:

"The Internal Revenue Code's deficiency procedures, allowing the taxpayer an opportunity to contest the Service's tax audit determinations for income taxes in the U.S. Tax Court, do not literally apply to employment taxes or to excise taxes."

Absent such a showing, there is not sufficient justification to expand the claims of governmental units at the possible expense of general unsecured creditors and individual bankrupts.

Further, at least in the employment tax arena, it seems that the IRS has ample tools to easily identify unpaid employment taxes during the three-year period prior to any bankruptcy filing. Since section 507(a)(8)(D) apparently only applies if the wages giving rise to the employment tax have been paid, the employers' W-2's and employees' Form 1040's offer ample audit opportunities. To the extent that "unemployment taxes" include state and local taxes, the rationale supporting this proposal appears to be irrelevant.

Further, it is not clear how the addition of the 240-Day Rule and the Still Assessable Rule would work with the Special Excise Tax Rule of section 507(a)(8)(E)(ii) which applies to excise taxes with respect to which no return is required to be filed. Finally, there is uncertainty as to the scope of the meaning of the term "excise tax" both at the federal and state and local levels. (In some instances, excise taxes can be assessed where the governmental unit has suffered no pecuniary loss (fn. 144). The statutory policy against granting a priority for such non-pecuniary losses is shown in section 507(a)(8)(G).) With such uncertainty, it seems unwise to extend the reach of section 507(a)(8)(E).

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

fn. 136: Senate Report No. 95-989, 95th Congress, 2nd Session, 68-73 (1978).

fn. 137: Interestingly, I.R.C. Section 3111(a) and (b) describe this tax on an employer as "an excise tax." Thus, arguably, these taxes fall under Section 507(a)(8)(E). Nontheless, all the commentators and cases seem to agree that section 507(a)(8)(D) is the proper provision to apply.

fn. 139: See e.g., I.R.C. Section 311(a).

fn. 140: U.S. v. Reorganized CF&I Fabricators of Utah, Inc., 116 S. Ct. 2106 (1996).

fn. 141: See, e.g., footnote 137 above.

fn. 142: The consequences to Chapter 13 bankrupts is similar. See our response to Commission track numbers 313 and 314.

fn. 143: Shepard p. 10, II.B.3 and p. 12, II.C respectively. For a discussion of these proposals, see our response to Commission track numbers 313 and 314.

fn. 144: See e.g., I.R.C. Section 4971 which was the "excise tax" involved in the 1996 Supreme Court case cited in footnoe 140 above.

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