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

FILING PARTNERSHIP TAX RETURNS

(COMMISSION TRACK NUMBER 414)

Present Law

1. Duty to file partnership tax returns

There is a surprising amount of confusion concerning the obligation of a trustee to file a federal income tax return (on form 1065) for a debtor partnership in a chapter 7 or chapter 11 proceeding.

Internal Revenue Code Section 6012(b)(3) requires a title 11 trustee to file tax returns for the bankruptcy estates of corporate debtors, and section 6012(b)(4) contains a similar requirement for bankruptcy estates of individual debtors (fn. 150). But nowhere in the either the Internal Revenue Code or the Treasury Regulations is there a clear requirement that a trustee for a partnership debtor must file a federal income tax return on behalf of the bankruptcy estate.

Several courts have held that a chapter 7 trustee must file a partnership return, but the authorities cited for that proposition do not support it (fn. 151).

Several private letter rulings appear to assume that such an obligation exists (fn. 152).

Section 1106(a)(6) of the Bankruptcy Code provides that, if the debtor has not filed a tax return required by law for any year, the trustee shall "furnish, without personal liability, such information as may be required by the governmental unit with which such tax return was to be filed, in light of the condition of the debtor's books and records and the availability of such information . . ." But this section, which applies to all debtors and not merely partnerships, seems to be addressed at prepetition years, rather than any returns required on behalf of the estate for periods after the petition is filed. Nor does it apply in Chapter 7 proceedings. And it may not apply to federal taxes.

One bankruptcy court held that a trustee of an estate had to file a return, even in the absence of sufficient estate income to require one, because of the need to determine the tax attributes and deductions under Internal Revenue Code Section 1398(g) and (h) (fn. 153). Extension of this principle would require the trustee of a partnership debtor to file returns so that the individual partners could determine their respective tax attributes and other consequences.

However, in the absence of a clear requirement to file a return, a trustee who attempts to do so may be denied compensation for his time or recovery of his costs (fn. 154).

Of course, there is no question but that a trustee must file withholding and similar payroll tax returns and pay the taxes (fn. 155).

In Holywell Corp. v. Smith, 112 S. Ct. 1021 (1992), the Supreme Court held that a liquidation trustee in a chapter 11 case involving individuals and corporations had to file returns, but the reasoning was unclear, and there is no guidance in the opinion as to what happens if there are two or more liquidating trusts (as sometimes occurs where there are both recourse and nonrecourse liabilities to be administered) or a partnership is involved. In any event, this decision only applies to liquidating trusts, and not to the estates of partnership debtors.

The closest there is to any authority for a federal requirement to file a partnership tax return is the following language in the Senate Finance Committee Report on the Bankruptcy Tax Act of 1980 (fn. 156):

"Accordingly, the bankruptcy trustee of a bankruptcy case is required to file annual information returns (under section 6031 of the Code) for the partnership."

Unfortunately, this reading of section 6031 is difficult to understand, since section 6031 talks about the partnership filing returns, not the trustee. Possibly, the Senate Finance Committee thought that section 1399 of the Internal Revenue Code, which provides that there is no separate taxpayer in the case of a partnership debtor under title 11, makes the trustee the alter ego of the partnership and thereby subjects the trustee to the obligations imposed by section 6031, but it is hard to sustain that interpretation, since the Bankruptcy Code does treat the debtor and the bankruptcy estate of a partnership as separate persons. See Bankruptcy Code Section 541(a).

Adding to the confusion about the lack of a specific direction to file federal tax returns is the clear requirement in Sections 346(c)(2), 728(b) and 1146(b) that trustees file all state income tax returns, including partnership information returns. Given the fact that most states use the federal income tax return as the starting point for calculating the state tax return and, in most cases, require that a copy of the federal return be attached to the state tax return when it is filed, there is usually no practical way that a trustee can satisfy his obligation under the Bankruptcy Code without also preparing a federal tax return on form 1065.

2. Ability to file amended returns

Under Internal Revenue Code Section 6227, only a Tax Matters Partner (or another general partner) may file a request for an "administrative adjustment", which is the procedure for amending a partnership tax return. There is no authority anywhere in the statutes (other than possibly section 323 of the Bankruptcy Code) authorizing a trustee to file an amended partnership return.

Proposals Before the Commission

Commission Track Number 414. This proposal. Commissioner Shepard suggests that the trustee does not have this duty under present law. See Santa Fe Discussion Issues, p. 25, Item IVE.

Task Force Position

The Task Force recommends that either the Internal Revenue Code or the Bankruptcy Code be amended to make it clear that a trustee in either a chapter 7 or a chapter 11 case in which the debtor is treated as a partnership for federal income tax purposes is required to file all federal income tax returns for all taxable periods of the partnership ending on or after the commencement of the case. To the best of his ability, the trustee should also be required to file any federal income tax return for any taxable period of the partnership that ended prior to the commencement of the case but which was not filed prior thereto (fn. 157).

In addition, the statute should authorize the trustee to file on behalf of the partnership estate an amendment to any tax return previously filed by the trustee on behalf of the partnership estate.

Reasons for Position

Generally, the tax liability for the income of the estate during the pendency of a Chapter 7 case falls on the estate or on an entity that will not, as a practical matter, survive as a continuing person. After the case is closed, there are few, if any, continuing tax consequences.

The estate of a partnership differs in that the obligations to pay taxes on its income falls on the partners themselves. To them, the tax consequences are extremely important and do not go away upon the closing of the bankruptcy case. In order to determine those consequences, either they must each get a properly prepared schedule K-1 from the trustee, or they must be given access to the estate's books and records to determine those consequences themselves--a clearly impractical situation, especially where there is more than a small number of partners. The bottom line is that if the trustee does not prepare the tax return, no one can do it, and no one will do it.

Since the Bankruptcy Code already requires the trustee to prepare the state partnership tax return, which cannot usually be prepared without first preparing a federal tax return, the proposed change will not increase administrative costs to the estate to any measurable extent.

In view of the fact that the IRS believes that the trustee is obligated to file a partnership return, and this Task Force is recommending that the law be clarified to confirm the IRS position on that point, it would be anomalous if the trustee, after filing a return and subsequently discovering that the return was erroneous (e.g., as a result of the discovery of additional records), was unable to correct the return by filing an amendment. This proposal would avoid that anomaly.

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

fn. 150: See In re Hudson Oil Co., 91 B.R. 932 (Bankr. D. Kans. 1988) (88-2 USTC Paragraph 8554).

fn. 151: E.g., In re Riversiden-Linden Investment Co., 85 B.R. 107 (S.D. Calif. 1988) (citing IRC Sections 6012(b) and 6031).

fn. 152: PLR 8509038 (11/3/84) and PLR 8535015 (5/31/85).

fn. 153: In re Willis, 46 B.R. 333 (Bankr. D. Md. 1985).

fn. 154: See, e.g., In re Riverside-Linden Investment Co., 85 B.R. 107 (S.D. CA 1988).

fn. 155: Otte v. U.S., 419 U.S. 43 (1974); Bankruptcy Code Section 346(f) (relating to state taxes).

fn. 156: S. Rep. 96-1035, 96th Cong. 2d Sess.

fn. 157: The trustee should have the same obligation to amend prior returns because of information acquired during the administration of the estate as the partnership would have had had it not become a debtor in a Title 11 case. Assuming that the partnership was reasonable in relying on the information that it had at the time it filed the return and that it otherwise was acting in good faith, there may not be any obligation to amend that return merely because of a subsequent discovery of additional information. However, if the trustee discovers that the earlier return was filed other than in good faith or that the partnerhsip did not act reasonably in relying on the information it had at the time, the trustee should file a corrective return.

Of course, if the additional information results in a reduction of taxable income for the partners, amending the prior return may enhance the ability of the partners to make the contributions to the partnership necessary to satisfy the partnership's obligations to creditors. In that case, the trustee might well elect to amend the prior return even though not required to do so.

Questions, comments or suggestions? kbercik@taxcounsellor.com

Last updated July 6, 1997