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

THE ESTATE AS SUCCESSOR UNDER SECTION 505(b) OF THE BANKRUPTCY CODE

(COMMISSION TRACK NUMBER 438A)

Present Law

Bankruptcy Code Section 505(b)(1) provides:

(b) A trustee may request a determination of any unpaid liability of the estate for any tax incurred during the administration of the case by submitting a tax return for such tax and a request for such determination to the governmental unit charged with responsibility for collection or determination of such tax. Unless such return is fraudulent, or contains a material misrepresentation, the trustee, the debtor, and any successor to the debtor are discharged from any liability for such tax --

(1) upon payment of the tax shown on such return, if--

(A) such governmental unit does not notify the trustee, within 60 days after such request, that such return has been selected for examination; or

(B) such governmental unit does not complete such a examination and notify the trustee of any tax due, within 180 days after such request or within such additional time as the court, for cause, permits.

(Emphasis supplied.) Although the law is well-settled with regard to the dischargeability of the trustee, the debtor, and the successor to the debtor from further tax liability, the code is silent with regard to the dischargeability of the "estate" from such debts. Several courts have, however, addressed the issue of estate's tax liability in such matters. Matter of Fondiller, 125 B.R. 805 (N.D Cal 1991); In re Rode, 119 B.R. 697 (Bankr. E.D. Mo. 1990); and Matter of West Texas Marketing Corp, 54 F.3d 1194 (5th Cir. 1995) all held that the estate is not entitled to a discharge because the "estate" is not specifically referenced in the emphasized language above.

Proposals Before the Commission

Commission Track Number 438A. Commissioner Shepard proposes that the Bankruptcy Code Section 505(b) be amended to provide that the estate be discharged from additional tax obligation in the same manner as the trustee, the debtor, and the successor to the debtor are discharged, thus overruling Matter of Fondiller, 125 B.R. 805 (N.D Cal 1991); In re Rode, 119 B.R. 697 (Bankr. E.D. Mo. 1990); and Matter of West Texas Marketing Corp, 54 F.3d 1194 (5th Cir. 1995). See Santa Fe Discussion Issues, p. 24, Item IVC6.

Task Force Position

The Task Force supports the proposal to amend Section 505(b) to include the "estate" in the list of dischargeable entities.

Reasons for Position

The Task Force believes that this amendment would be consistent with Congressional intent of providing for expedited audits and speedy, final determination of tax liabilities in bankruptcy (fn. 191). Currently, even if all procedures are followed under Section 505(b), the trustee who is working diligently to settle the estate and make a final distribution to creditors still can have the government assert an unexpected deficiency against the estate long after the time period under Section 505(b) has passed. There are at least two negative practical results from a trustee's perspective, as follows.

First, the trustee is prevented from finalizing the estate in an efficient, accurate and timely manner. If Section 505(b) does not protect the estate, then the estate is effectively subject to the normal statutes of limitations, e.g. three years for federal income tax audit and additional assessment purposes (fn. 192). Therefore, only tax years which are past the statute can be deemed final. Taken to the absurd, this means that until the day the trustee makes a final distribution, there is no assurance that an unexpected deficiency will not be asserted by a taxing authority to the detriment of the other creditors. If the income tax returns for any of the "open" years contain any complex issues (e.g. sales of assets, etc.), Section 505(b) filing would not offer much reassurance to the trustee or the creditors until the final distribution was made (fn. 193). This effect has sometimes stymied the willingness of trustees to make partial distributions during the pendency of the case. In addition, even if the trustee were to prevail in defeating a late-asserted claim, the delay and cost of defending the claim would cause a significant detriment, and would probably further diminish the assets of the estate.

Second, a serious problem stemming from this open-ended estate exposure is the potential for suits (fn. 194) against the trustee's bond by creditors. Disgruntled by the last-minute assertion of a priority governmental claim other creditors may attack the trustee in a tort claim in order to recoup some of their losses. The creditors may claim that the delayed additional assessment against the estate arose because the trustee was negligent in the preparation and analysis of the tax return. This result is inconsistent with the purpose of Section 505(b) to absolve the trustee from liability related to additional assessments. In essence, the government has developed a mechanism of indirectly extracting the payment of additional taxes from the trustee's bond. In addition, exposure to such liability is a disincentive to serving as trustee .

The Task Force recommends that the amendment be accomplished by adding the word "estate" to the enumerated list of parties discharged under Section 505(b), as opposed to a mere interpretation that the estate should be deemed a "successor to the debtor" (fn. 195).

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

fn. 191: Procedures for making Section 505(b) filings are clear at the federal level, but of questionable effectiveness when dealing with multiple states and localities. Local governments have complained that they do not receive adequate notice because of improper or ambiguous filings which are later asserted by trustees to be valid 505(b) filings and that, therefore, the estate should remain liable regardless of valid 505(b) filings. While acknowledging this difficulty, the Task Force is of the view that the solution is not to retain estate liability, but to permit state and local agencies to publish procedures and addresses to which such filings shall be made in the same way that the IRS has publishied Rev. Proc. 81-17 and to which trustees shall be bound. See Commission Track Number 216.

fn. 192: Under Internal Revenue Code Section 6501(a), the government generally has 3 years from the date of filing to assess additional tax.

fn. 193: Critics have complained that this shortcoming of Section 505(b) has permitted governmental agencies the luxury of sitting on their rights without losing any substantive right to recovery except for a right of action against the trustee and debtor. Such result clearly prejudices other creditors in the case.

fn. 194: This issue also raises the question of trustee's negligence and the standard of care which should be applicable and is beyond the scope of this tracking item.

fn. 195: The latter is problematic because of the langauge in Section 505(c) which separately lists the estate in addition to successor to the debtor and may, therefore, present interpretational problems. Case law under Section 544 addresses the issue, concluding that "successor to the debtor" includes the estate; such reasoning was not convincing to the courts in cases cited above as Section 544 context was viewed as non-transferable to Section 505(b).

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Last updated June 1, 1997