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

INTEREST ON DEFERRED CHAPTER 13 TAX PAYMENTS

(COMMISSION TRACK NUMBER 503A)

Present Law

Bankruptcy Code Section 322(a)(2) provides, in essence, that priority taxes shall be paid in full in a chapter 13 plan, together with such prepetition interest as has accrued to date of filing, but without postpetition interest (fn. 207).

[I]t is also important to note that while section 1322(a)(2) requires payment in full of priority claims, it does not provide for payment of their present value as of the effective date of the plan. Therefore, the payment of interest on priority claims is not required unless the court finds it necessary to satisfy the best interest of the creditors test (fn. 208).

This is the majority rule in the published opinions (fn. 209).

Proposal Before the Commission

Commission Track Number 503A. Commissioner Shepard and the IRS recommend that the law be amended to provide that priority taxes paid through a chapter 13 plan include interest on deferred payments in a manner similar to chapter 11 deferred payments. Santa Fe Discussion Issues, p. 13, Item IIC7. IRS Proposal, p 62.

Task Force Position

The task force opposes amending the Bankruptcy Code to provide for the interest on deferred payment of prepetition priority tax claims (fn. 210) in chapter 13. In addition, Congress should consider amending the Code to provide that the prepetition interest that has accrued on prepetition priority tax claims up to date of filing the chapter 13 be deemed non-priority for purposes of chapter 13.

Reasons For Position

Increasing the burden of tax payments in chapter 13 by adding interest on priority taxes will:

1) By costing more, erode incentives to choose chapter 13 over straight liquidation and increase incentives to simply remain "underground" and 'on the run" from the tax collector. Thus, such a policy will deter tax burdened individuals from attempting to reenter the system and come into compliance with the tax laws. "Chapter 13 succeeds if incentives to the debtor are adequate and demand for payments is not excessive . . ." (fn. 211);

2) By costing more, reduce the already inadequate level of successful adjustments of debt under chapter 13 (fn. 212);

3) By reducing the chapter 13 incentives and increasing the failure rate of chapter 13 plans, ultimately reduce the total amount of recovery of tax revenue currently enjoyed by the Government at relatively little cost or effort;

4) By shifting more money away from general creditors to the government, further erode the credit industry's confidence in the fairness of the bankruptcy system and ignite new legislative warfare in a struggle for preferential treatment (fn. 213).

Consistent with the notion of a fair and equitable balance of competing interests in bankruptcy is the rule that priority claims (including priority tax claims) paid through a chapter 13 plan should not be entitled to interest.

The basic reasons for the rule denying post-petition interest as a claim against the bankruptcy estate are the avoidance of unfairness as between competing creditors and the avoidance of administrative inconvenience (fn. 214).

As Prof. Jack F. Williams points out in his extensive exploration of tax policy in bankruptcy cases ". . . general unsecured creditors partially subsidize the payment of a debtor's taxes, even those that result from debtor misconduct. It is questionable whether this is an appropriate cost for the general creditors to bear" (fn. 215) He further observes:

Priority treatment accorded most current taxes increase the number of no-asset cases filed in bankruptcy. It also increases general creditor disenchantment with the entire process (fn. 216).

Unsecured creditors essentially pay priority claims and no matter how extensive, there is always one deserving creditor who is excluded (fn. 217).

It may reasonably be presumed that each additional dollar that a debtor must pay to the government decreases the amount of recovery that may be enjoyed by the already underprivileged general unsecured creditors, and increases the difficulty of completing a successful adjustment of debt by the taxpayer in chapter 13.

The notion of increasing the debtor's debt service burden by adding interest to priority tax claims will almost certainly elicit a clamor in the legislature to provide the same privilege to other priority claims in bankruptcy, and possibly to other unsecured claimants as well (fn. 218). Observed Prof. Williams:

Priority claims are the antithesis to the bankruptcy principle that similar creditors be treated similarly. . . . Priority claims reduce the distribution to general unsecured creditors and make it more difficult to reorganize. Furthermore, to the extent the government insulates itself from the impact of bankruptcy through the use of priority and nondischargeability treatment for governmental claims, a bankruptcy system may be viewed as hypocritical if not contemptuous (fn. 219).

The notion of adding interest on priority claims is made without due appreciation for the problems, needs and motivations of individuals experiencing tax problems. In the typical debtor's attorney's office, the privilege of paying off nondischargeable taxes through chapter 13 without additional interest and penalties is one of the chief selling points to get a distressed taxpayer to take the plunge into chapter 13 (fn. 220). The no-interest feature of repayment in chapter 13 is clearly perceived by the average potential debtor as a major advantage to trying to cope with the problem outside of bankruptcy, because even an unsophisticated potential debtor senses how a small or manageable tax claim may skyrocket in a few years on account of interest and penalties.

Many taxpayers come into the law office only after years of trying to pay off an old tax claim through a voluntary payment plan, and having come to the depressing realization that the balance owed on the original tax claim has not only not shrunk, but in many cases is increasing due to runaway interest and penalties.

Finally, any further tilting of the balance of treatment as between the government and other priority or general unsecured creditors may embroil the courts in a new round of litigation over the Constitutional issues of due process and equal protection:

While, therefore, the Fifth Amendment forbids the destruction of a contract it does not prohibit bankruptcy legislation affecting the creditor's remedy for its enforcement against the debtor's assets, or the measure of the creditor's participation therein, if the statutory provisions are consonant with a fair, reasonable, and equitable distribution of those assets (fn. 221).

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

fn. 207: See, generally, Jack F. Williams, Rethinking Bankruptcy and Tax Policy, 3 Am. Bankr. Inst. L. Rev. 153, 194 (Spring, 1995). Jack F. Williams is Associate Professor of Law, Georgia State University College of Law. Professor Williams chairs the Advisory Committee.

fn. 208: In re Bossart, 201 B.R. 553 (Bkrtcy. E.D. Wash. 1996).

fn. 209: In re Hageman, 108 B.R. 1016 (Bkrtcy. N.D. Iowa 1989); In re Wakehill Farms, 123 B.R. 774 (Bkrtcy. N.D. Ohio 1990); In re Ridgley 81 B.R. 65, 69-70 (Bkrtcy. D. OR 1987); In re Kingsley, 86 B.R. 17 (Bkrcy. D. Conn. 1988).

fn. 210: While secured tax claims, like other secured claims may be entitled to postpetition interest, the allowance of such interest does not apply to priority tax claims because, by definition, priority taxes are unsecured. Bankruptcy Code Section 507(a)(8).

fn. 211: In re Lacovoni, 2 B.R. 256 (Bkrtcy. D. UT 1980).

fn. 212: Today, only approximately 32.89% of filed Chapter 13 plans succeed; National Association of Chapter Thirteen Trustess (NACTT) Statistical Data Survey, 1994.

fn. 213: Williams, Rethinking Bankruptcy and Tax Policy, supra at 203; "It is perceived as unfair to require the general unsecured creditors to pay for debtor misconduct."

fn. 214: Bruning v. United States, 376 U.S. 358, 362; 84 S. Ct. 906 (U.S. Supreme Court, 1964).

fn. 215: Williams, Rethinking Bankruptcy and Tax Policy, supra at 196.

fn. 216: Id.

fn. 217: Id., at 203.

fn. 218: For example, currently debtor's attorney's fees paid through the plan as administrative expenses are typically paid without interest; if the government's claim is entitled to interest, why not the lawyer's fees incurred to bring the taxpayer back into tax compliance through Chapter 13?

fn. 219: Id., at 203.

fn. 220: See, for example, Morgan D. King's article under the heading Financial Options: Clearing the Books of Back Taxes (The S.F. Recorder, Nov. 23, 1992). The article, explaining the benefits of reentering the system through Chapter 13, states among other things; "Still another advantage arises where the tax is a priority and must be paid through the Chapter 13 plan. That is, in the case of unsecured tax claims, such claims are orinarily paid through the Chapter 13 plan without interest. Frequently, this makes Chapter 13 the preferred remedy for paying off a priority tax, as opposed to a volunatry payment plan with the IRS, where interest always continues to run and can easily double or triple the total amount of money paid to satisfy the claims."

fn. 221: In re Purdy, 16 B.R. 847, 852 (N.D.Ga 1981).

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