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

FAILURE OF TAX AUTHORITY TO FILE CHAPTER 13 PROOF OF CLAIM

(COMMISSION TRACK NUMBER 441A)

Present Law

Bankruptcy Code Section 502(b)(9) provides that a claim shall be allowed except to the extent that ". . . proof of such claim is not timely filed. . ." This section further provides that a proof of claim of a governmental unit (e.g., tax claim) ". . . shall be timely filed if it is filed before 180 days after the date of the order for relief. . ."

Thus, failure to file a proof of tax claim within 180 days of filing the chapter 13 case, or later pursuant to an order extending the deadline, will result in the claim being extinguished.

Proposals Before the Commission

Commission Track Number 441A. The IRS proposes that Bankruptcy Code Section 1322(a) be amended to provide that priority taxes must be paid in chapter 13 even if no proof of claim is filed. IRS Proposal, p. 62; see also Santa Fe Discussion Issues, p. 13, Item IIC4.

Task Force Position

The Task Force opposes this proposal. The law with respect to the requirement for filing timely proofs of claim should remain unchanged.

Reasons For Position

The proposal to allow payment of priority taxes notwithstanding failure to file a timely proof of claim is asserted, presumably, to provide relief to the government for the occasional failure of the I.R.S. to file a proof of claim on time for priority taxes in chapter 13 cases.

Adoption of such a rule would result in:

1) substantial impairment of the administration of chapter 13 cases;

2) reward a governmental agency for inefficiency;

3) discriminate against private entities, such as general unsecured creditors, whose claims would still be extinguished in the event of tardy filing of claims; and

4) an undesirable situation in which the debtor is expected to pay claims the amount, extent and validity of which are unknown for years during which he is expected to perform under the plan.

Prior to the adoption of the Bankruptcy Reform Act of 1994, the law governing chapter 13 proceedings provided a creditor, including a governmental agency, 90 days from the date first set for the meeting of creditors in which to file a proof of claim. In the case of unsecured claims, failure to file a timely claim generally resulted in extinction of the claim. However, the courts were split on this issue.

In those jurisdictions following the rule in Tomlan, the IRS and other governmental taxing entities occasionally missed the 90-day deadline, resulting in some cases in discharge of priority taxes, including trust fund taxes and excise taxes.

In order to settle the split in authority on this issue, and, as well, in order to accommodate the need of the IRS for more time to react to chapter 13 filings and problems of identifying taxpayer's claims in time to meet the deadline, Congress increased the amount of time given governmental entities to 180 days following the filing of the case (or, in essence, about 150 days following the first meeting of creditors).

It should be noted that this extra time already grants governmental entities a privilege not extended to the holders of other unsecured or priority claims, who are still required to file within 90 days, or risk extinguishment of their claims.

>From a practical point of view, allowing priority or any other kind of claim to survive past a reasonable deadline for filing of the claim will result in chaos in the administration of cases in which the debtor owes one or more tax claims.

Chapter 13 is established to be a fast, efficient remedy which avoids the costly and protracted proceedings found in chapter 11 cases. The prompt identification of claims, in particular tax clams, is essential to allow the debto r, the trustee and the court to evaluate a proposed chapter 13 plan and fix the proper manner in which various claims should be handled in the plan. This point is made perfectly clear by the requirement that a plan be filed immediately, and that payments under the plan commence within 30 days of filing the plan.

The debtor and the trustee need reasonably prompt notice of claims, including tax claims, and the nature of such claims, in order to have time to sort out the extent, amount, and validity of such claims.

For example, the government frequently files proofs of claim that are incorrect. The IRS routinely files claims as completely "secured" because liens have been recorded for them. However, in a great many such cases the property securing such claims is less than the face value of the liens. Thus, these are undersecured claims which should be bifurcated into their respective secured and unsecured portions, because these categories of claims are treated differently in the plan in terms of whether interest may accrue, whether they must be paid in full, the priority of payment, and the like. The debtor must have an opportunity to object to such claims which are asserted to be fully secured when in fact they are not.

Similarly, many personal income tax claims are asserted by the government to be priority taxes when in fact they are merely general unsecured claims. Tax claims are incorrectly deemed priority for a variety of reasons, all of which require early notice in order to provide the debtor fair opportunity to identify and correct the errors by communication with the taxing entity, or objection to claim.

If the government requires more time in which to study and properly characterize its tax claims, existing law permits it to move for an order extending the deadline pursuant to Bankruptcy Rule 3002(c)(1).

Were the government allowed to slide by the deadlines with no repercussions, the result would be further relaxation by government employees and deterioration of vigilance and the standard of care in promptly identifying and filing claims. Claims would be filed late, perhaps years late, and claims would be filed with even more errors than already occur in tax claims.

As Robin Phelan, former president of the American Bankruptcy Institute, observed:

There seems to be more concern about the ineptitude of the taxing authorities' computers than there is about the taxpayer and the crushing tax debt that sometimes occurs that people just can't get out from under . . .

The result would be that the debtor, the trustee and the court would be required to draft and approve plans based on only the vaguest notions regarding the amount or correct treatment of the tax claims. In some cases the plans would not properly characterize some claims as priority or secured, with the result that at the end of the plan the debtor, instead of receiving a fresh start, would be presented with a surprise from the government . . . a substantial unpaid balance of taxes. This can only hurt the government as well as the debtor. In other cases the government would be paid an undeserved windfall, at the expense of general unsecured creditors, by debtors who pay tax claims unaware that they are being treated as priority or secured when in fact they are neither.

Because Chapter 13 serves as a flexible vehicle for the repayment of allowed claims, all unsecured creditors seeking payment under a Chapter 13 plan must file their claims on a timely basis so that the efficacy of the plan can be determined in light of the debtor's assets, debts and foreseeable earnings.

Questions, comments or suggestions? kbercik@taxcounsellor.com