Update on the Bankruptcy Review Task Force

By: Karrie L. Bercik, JD, LLM

In 1994, the President appointed the National Bankruptcy Review Commission (the "Commission") directing them to study the bankruptcy law and to recommend changes. The Internal Revenue Service, Department of Justice and the National Association of Attorneys General submitted proposals to the Commission lobbying for fundamental changes to the Bankruptcy and Internal Revenue Codes based upon abuses they perceived and to give them additional protection as a "forced" creditor. The ABA Tax Section formed a Task Force, co-chaired by Paul Asofsky and Robert McKenzie, to review the government proposals and to advise the Commission of any bankruptcy tax changes that the private bar believed necessary.

Although the government and the Task Force reached consensus on many of the proposals, there were several hot issues where the was a fundamental disagreement between the Task Force members and the government. The Commission voted in late August on the proposals and unanimously agreed with the Tax Force on almost all of the controversial issues.

The Commission will recommend to the President a new fresh start accounting system for corporations with NOLs to mitigate the damage from the repeal of the stock-for-debt exception to recognition of cancellation of indebtedness income. This proposal was actually drafted by an ad hoc committee of private tax practitioners that has been working on minimizing the impact of the repeal of the stock-for-debt exception since 1993. Molly Gallagher, a member of the ad hoc committee, was the principal author of the Task Force's proposal regarding fresh start accounting. Additionally, the Commission will recommend the Task Force's proposals, written by Bob Jacobs, to permit declaratory judgments in bankruptcy and to expand the ability to request a prompt determination of taxes under Section 505(b) of the Bankruptcy Code.

The response of the Task Force was instrumental in defeating two government proposals that would have imposed a heavy burden on individual taxpayers. The government proposed repealing the superdischarge of taxes in a Chapter 13 case. Currently, tax liabilities that were incurred because the taxpayer failed to file a required tax return, filed a late return within two years of filing for bankruptcy, or filed a fraudulent return are dischargeable in a Chapter 13. The Task Force response, written by Ken Weil, argued that the superdischarge permitted in a Chapter 13 must be retained because it is a valuable means of bringing non-filing and late-filing taxpayers "back into the system." The Commission voted to retain the superdischarge. Another government proposal would have repealed Energy Resources, a decision of the Supreme Court that permits the debtor to allocate tax payments to the trust-fund portion of any taxes owed by the corporation if necessary to the reorganization. Energy Resourcesminimizes the potential tax liability of responsible persons that have failed to pay the corporation's trust fund taxes. The Task Force response, written by Paul Asofsky, opposed the repeal of Energy Resources, and the Commission agreed.

Besides responding to the government's proposals, the Task Force recommended additional changes to the bankruptcy and tax codes that were unanimously approved by the Commission. Once proposal, principally drafted by Mark Wallace, requires that the disclosure statement in Chapter 11 cases discuss the tax consequences to the debtor as well as the creditors in order for the Chapter 11 plan to be approved by the court. Another proposal, drafted by Marc Grossberg and Marty Cowan, provides that if the trustee abandons an asset of the estate that is secured by debt in excess of its basis, the tax liability shall be treated as a prepetition priority tax rather than an administrative claim.

Questions, comments or suggestions? kbercik@taxcounsellor.com