Analysis of Tax Proposals in H.R. 3150
Testimony before the House Judiciary Committee
March 18, 1998

Written by:
Grant W. Newton
Chair, ABI Bankruptcy Taxation Committee


Web prepared, posted and Copyright © March 18, 1998, American Bankruptcy Institute.


H.R. 3150 contains several tax proposals that involve modifications of the Bankruptcy Code. Most of the proposals were recommendations made by the National Bankruptcy Review Commission ("NBRC"). However, several of the proposals contradict the recommendations of both the NBRC and the Tax Advisory Committee appointed by the Chairman of the NBRC. The objective of this analysis is to explain the tax provisions that are in H.R. 3150 and identify some of the issues that need to be addressed before these provisions become law. H.R. 3150 contains no recommended changes to the Internal Revenue Code because these provisions must originate in the House Ways and Means Committee rather than the Judiciary Committee to which H.R. 3150 has been referred. The proposed changes recommended by the NBRC to the Bankruptcy Code that were not addressed by H.R. 3150 are described in the final section.

The views expressed here are my own and not necessarily those of the American Bankruptcy Institute.

Listed below is a summary of the recommended changes to H.R. 3150.

H.R. 3150
Section and Topic

Recommendations

Sec. 501(a)(1). Exempting ad valorem tax from subordination under section 724.

No change recommended.

Sec. 501(a)(2). Subordination of tax liens to chapter 7 expense only.

Delete this provision. It will limit the recovery of assets for unsecured creditors. A chapter 11 trustee is often better equipped to recover assets than taxing authorities.

Sec. 501(a)(3). Trustee exhaust unencumbered assets, recover from secured lender reasonable and necessary costs and expenses to preserve or dispose of the property, and subordinate tax lines to wages and employee benefit plans.

No change recommended.

Sec. 501(b). Precludes determination of taxes where applicable period under any law other than a bankruptcy law has expired.

Modify to provide that bankruptcy court can determine the tax. Often debtors in financial difficulty do not object to tax claims that are based on assets that have declined in value or for which no return was filed resulting in tax being based on unreasonably high values.

Sec. 502. Section 522(c)(1) is modified to provide that exempt property shall be liable for debts of a kind specified in section 523(a)(1) or (5) of this title.

The meaning of this section is not clear. Since the impact this change will have is not known, it is difficult to comment on the proposed change.

Sec. 503. Provides for effective notice to Governmental Units.

Modify to provide that Rules Committee issues notice requirements.

Sec. 504. Requires proper notice before taxes determined under section 505(b).

No change recommended.

Sec. 505. Provides for use of the interest rate in IRS section 6621(a)(2) for prepetition taxes.

Modify to provided that it is the rate without reference to section 6621(c) and that it is the rate in effect as of the confirmation date. In a chapter 11 case the rate should not be allowed to fluctuate from quarter to quarter.

Sec 506. (1) Provides for tolling of priority of tax claim time periods during prior bankruptcy.

Agree with general provision, but suggest that to be consistent with the provision that the additional time gives the taxing authority time to respond once the stay has been removed, the wording should be greater of time the stay (or offer in compromise) was in effect or six months (30 days for offer in compromise).

(2) Extends the tolling to installment agreements.

Delete this provision. During the time period prior to or at the time the IRS enters into an installment agreement, the IRS has the right to place liens on the debtor's property. This change penalizes those individuals that in good faith extend the time period for payment of their claims, and an unfortunate events force them to file a bankruptcy petition resulting in their taxes not being discharged, but would have been if they had not entered into the agreement.

Sec. 507. Assessment defined.

No change recommended.

Sec. 508. Section 1328 would be modified to make chapter 13 nondischarge provisions consistent with chapter 7 provisions.

Delete this provision. Chapter 13 facilitates the workout of tax claims and is consistent with other provisions of H.R. 3150 that require taxpayers to pay some of their claims over the plan period.

Sec. 509. Section 1141(d) the confirmation of a plan does not discharge a corporation for a tax claim with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax.

Delete this provision. Management of the company that was involved with the fraud is generally replaced and a provision that prohibits a nonpriority tax from being discharged limits the ability of the creditors to reorganize the debtor and punishes employees and other interested parties.

Sec. 510. (1) The stay under section 362(a)(8) would be revised to apply only to a tax liability for a taxable period ending before the order for relief.

Modify provision to apply to only prepetition taxes. Taxes incurred after year-end, but before filing of petition may still be prepetition taxes.

(2) Provides that the stay does not apply to the appeal of a previous court.

No change recommended.

Sec. 511. (1) Establishes required payments of at least 15 % first five years and no more than 20% in final year.

Modify to follow the recommendation of the NBRC and the Tax Advisory Committee suggested that the payments should be periodic, but did not define periodic other than to suggest that the payments should be monthly or quarterly and that balloon payments be prohibited.

(2) Require secured claims to follow requirements of section 1129(a)(9).

No change recommended provided above suggestion is followed.

Sec. 512. Overrule cases that penalize the government due to certain benefits for purchasers provided for in the lien provision of the IRC.

No comments on this proposed change.  

Sec. 513. Payment of postpetition taxes is required when taxes are due in the course of such business.

No change recommended. However, the writer is concerned that this provision may on occasion place taxes above other administrative expenses.

Sec. 514 Provides that taxing authority must file a claim before the final order approving the trustee's report.

No change recommended.  

Sec. 515. Modifies section 523(a)(1)(B) to include tax return prepared by taxing authorities.

Delete last section of proposed law and follow both NBRC and Tax Advisory Committee to include returns filed under section 6020(b).

Sec. 516. Includes the word "estate" for purposes of tax determination under section 505(b).

No change recommended. However, section 505(b) should provide that IRS must determine tax for partnerships and S corporations.

Sec. 517. Requires tax returns for six years in chapter 13 cases.

Modify to provide that a return filed under IRC section 6020(b) or similar federal, state, or local law provisions, constitute a filed return for Bankruptcy Code dischargeability purposes.

Sec. 518. Requires tax disclosure.

No change recommended.

Sec. 519. Setoff of tax liability against tax refund.

No comments on this proposal.

Subordination of Tax Liens (H.R. 3150, Section 501(a))

Section 724 of the Bankruptcy Code provides for the subordination of tax liens to administrative expenses and other priority taxes. H.R. 3150 would modify the subordination provision by not subordinating perfected, unavoidable tax lien arising in connection with an ad valorem tax on real or personal property, as recommended by the NBRC. Additionally, administrative expense incurred after the petition is filed is restricted to chapter 7 expenses unless the claim is for wages, salaries or commissions. The subordination only to chapter 7 expenses was not included in the recommendation of the NBRC.

H.R. 3150, as recommended by the NBRC, would also add a subsection (e) to section 724, providing that before a tax lien may be subordinated, the trustee shall (1) exhaust the unencumbered assets of the estate, and (2) in a manner consistent with section 506(c) recover from property securing an allowed secured claim the reasonable, necessary costs and expenses of preserving or disposing of that property.

Subsection (f) provides that notwithstanding the exclusion of ad valorem tax liens claims for wages, salaries, and commissions that are entitled to a section 507(a)(3) priority and claims for contributions to an employee benefit plan entitled to a 507(a)(4) priority may be paid from property of the estate which secures a tax lien, or the proceeds of such property.

Comment: The proposals to not subordinate property taxes, to use unencumbered assets, and to subordinate property tax claims to wage holders, appears fair.

However, the provision to limit the subordination to chapter 7 expenses will limit the recovery of assets for unsecured creditors. A trustee appointed in a chapter 11 case, where there is a tax lien on all assets, has no incentive to go after known or potential recoveries because any costs that are incurred will not be allowed unless the tax claims are paid in full. Trustees are often better equipped to recover assets than the taxing authorities. Removing the incentive for the chapter 11 trustee may in fact result in less recovery to both the taxing authorities and to other creditors.

Studies have shown that state and local governments have suffered losses because of the subordination of ad valorem tax liens. However that generalization should not be applied to the IRS and other state income taxing authorities by not allowing the tax lien to be subordinated to chapter 11 administrative expenses. Abuses have occurred where administrative expenses have been in excess of what they should have been, resulting in less return to taxing authorities. In most cases, the U.S. trustee appoints chapter 7 and 11 trustees. The activities of trustees are monitored by the U.S. trustees and their involvement should help control the actions of the appointed trustee. No doubt a much greater abuse occurs when a chapter 11 case with no prospects of successful reorganization is allowed to continue until all of the free assets are consumed by professionals and then the case is converted to chapter 7. The change to section 724 that limits subordination to chapter 7 administrative expenses does nothing to deal with this abuse, however.

Determination of Tax Liability (H.R. 3150, Sections 501(b), 504 and 516))

H.R. 3150 modifies section 505(a)(2) to provide that the court may not determine an ad valorem tax if the applicable period for contesting or redetermining the amount under any law other than bankruptcy law has expired. Some bankruptcy courts have redetermined the tax because the bankruptcy court may determine all claims. The NBRC did not recommend this change.

H.R. 3150 also provides that the debtor-in-possession or trustee may request a determination of the tax at the time the tax return is filed. Upon payment of the amount shown on the return, the trustee, debtor, and any successor to the debtor is discharged unless the governmental unit notifies the trustee or debtor-in-possession within 60 days that the return has been selected for examination and completes the examination within180 days after the request was made. Note that the wording in section 505(b) does not discharge the estate. Courts have held that the IRS may assess additional taxes against the estate but not against the trustee or debtor. Thus, even though the estate received the letter stating that the taxes were accepted as filed, additional taxes may be assessed against the assets that remain in the estate. To correct this problem H.R. 3150 follows the recommendation of the NBRC and the Tax Advisory Committee and proposes to amend section 505(b) of the Bankruptcy Code by inserting "the estate."

Section 505(b) of the Bankruptcy Code would be amended by providing that the request for tax determination must be made in the manner designated by the governmental unit (see notice section below). This was recommended by the NBRC.

Comment: By not allowing the bankruptcy court to determine the ad valorem tax claim, the proposed change would allow a governmental unit to collect a tax that is greater than the amount allowed. If the tax were properly determined, the state will receive its priority payment. For example, in one case where a chapter 11 trustee was appointed, the debtor allegedly borrowed millions of dollars of debt under false pretense. The debtor did not file business tax forms and the taxing unit determined the tax based on values that were greater than the actual values of the assets. Under this proposal, since the time for redetermining the tax expired, the business tax would remain, even though all parties know the tax was incorrectly calculated. Taxes already have a priority over all other general unsecured claim holders and this change will allow the taxing authority to collect or retain taxes for amounts that are greater than the amount that should be allowed.

The inclusion of the "estate" in section 505(b) is a change that is needed.

The modification to section 505(b) requiring notice be made according to the manner designed by the governmental units seems reasonable; however, the section should also be modified to provide that a partnership and S corporation in bankruptcy and chapter 13 debtors are within the provisions of section 505(b). The IRS has issued a policy statement stating that section 505(b) does not apply to partnership and S corporations and has refused to apply section 505(b) to chapter 13 cases.

Use of Exempt Property (H.R. 3150, Section 502)

Section 522(c)(1) of title 11 is amended by inserting at the end of the paragraph: "except that, notwithstanding any other Federal law or State law relating to exempted property, exempt property shall be liable for debts of a kind specified in section 523(a)(1) or (5) of this title." This proposed change was not recommended by the NBRC.

Comment: The meaning of this section is not clear. Since the impact this change will have is not known, it is difficult to comment on the proposed change.

Effective Notice to Governmental Units (H.R. 3150, Section 503)

Section 342 of the Bankruptcy Code under H.R. 3150 would be modified to establish standards for effective notice and provide information about the taxpayer such as taxpayer identification number, loan, account or contract number, or real estate parcel number. H.R. 3150 also provides that the clerk shall keep and update quarterly, in the form and manner as the Director of the Administrative Office for the United States Courts prescribes, and makes available to debtors, the register in which a governmental unit may designate a safe harbor mailing address for service of notice in bankruptcy cases.

H.R. 3150 directs the Advisory Committee on Bankruptcy Rules of the Judicial Conference to adopt rules that provide notice to state, federal and local governmental units that have regulatory authority over the debtor and suggests selected items that should be included.

H.R. 3150 also provides that no sanction under section 362(h) of the Bankruptcy Code or any other sanction that a court may impose on account of violations of the stay under section 362(a) of this title or failure to comply with section 542 or 543 of this title may be imposed unless the action takes place after notice of the commencement of the case has been received as required by section 342.

Comment: The NBRC adopted the Tax Advisory Committee's recommendation that all issues affecting governmental unit notice be in the form of proposed changes to the Bankruptcy Rules. H.R. 3150 codifies part of the notice provisions and includes the revision to section 362(a) that was not part of the NBRC recommendations. This provision is intended to somewhat codify for the benefit of taxing authorities, In re Bloom, 875 F.2d 224 (9th Cir. 1989), which held that "the statute provides for damages upon a finding that the defendant knew of the automatic stay and that the defendant's actions which violated the stay were intentional."

Section 342(g) is troublesome in that it appears that this section would require the debtor to notify a governmental entity of a potential trust fund tax (100 percent penalty) even though the debtor was not aware of the potential liability.

Taxing authorities need to be notified of bankruptcy filings; however, the requirements for such notice including content, timing of notice, sanctions for non-compliance, etc. should be covered by the Rules Committee.

Rate of Interest on Tax Claims (H.R. 3150, Section 505)

H R. 3150 would add a new section 511 to the Bankruptcy Code that would provide for interest on claims existing before the order of relief to be applied at the rate provided in section 6621(a)(2) of the Internal Revenue Code of 1986. Section 6621(a)(2) provides that the rate should be the federal-short-term rate determined under subsection (b) plus 3 percentage points. Subsection (b) provides that the Secretary shall determine the Federal short-term rate for the first month in each calendar quarter. Subsection (c) provides that the rate for large corporations should be increased by 2 percentage points. It is assumed that subsection (c) would not apply.

Comment: The Bankruptcy Code does not specify the interest rate that is to be used for tax claims that are entitled to interest. Judicial consensus is that a market rate of interest should be used and that the federal statutory rate is relevant in determining the appropriate rate. To avoid the wasting of both judicial and debtor resources by litigating the rate, the NBRC followed the recommendation of the Tax Advisory Committee that the rate be fixed at the statutory rate under section 6621(a)(2), without reference to section 6621(c) and it should be the rate in effect as of the confirmation date. H.R. 3150 ignores the comment of the NBRC that the rate should not consider 6621(c) and that it should be set as of the confirmation date of the plan. If the rate in section 6621(a)(2) is allowed, it should be determined as of the confirmation date and should not be allowed to fluctuate from quarter to quarter. Since all other creditors generally must assume the risk of changes in the market rate of interest, the same consideration should also apply to the IRS. Regarding the rate under section 6621(c), since only the rate in section 6621(a) is mentioned, it is not clear if the section 6621(c) rate would also apply. These changes are needed, if for no other reason than to avoid the litigation necessary to clarify the point.

Tolling of Priority of Tax Claim Time Periods (H.R. 3150, Section 506)

The first changes would provide that the period of three years before the filing of the petition under section 507(a)(8)(A)(i) would be modified to provide for any time, plus 6 months, during which the stay of proceedings was in effect under a prior case.

The second change would provide a revised section 507(a)(8)(A)(ii): "(ii) assessed within 240 days before the date of the filing of the petition, exclusive of- (I) any time plus 30 days during which an offer in compromise or installment agreement with respect of such tax, was pending or in effect during such 240-day period, and (II) any time plus 6 months during which a stay of proceedings against collections was in effect in a prior case under this title during such 240-day period."

Comment: The majority of courts (justifiably) have allowed for tolling of priority time periods during prior bankruptcies because the stay was in effect and the IRS was limited as to the type of action it could take. This provision codifies the impact of the tolling. The added time allows the IRS time to respond once the stay has been removed. Thus, rather than extending the time period by six months or 30 days (in case of an offer in compromise), the extension should be the greater of any time during which the stay of proceedings was in effect in a prior case (or offer in compromise pending) or six months (or 30 days for an offer in compromise).

H.R. 3150 would extend the tolling to installment agreements. During the time period prior to or at the time the IRS enters into an installment agreement, the IRS has the right to place liens on the debtor's property. Even during the installment period, the IRS may reserve the right to place liens on the debtor's property and take other actions to protect its interest. Some tax practitioners have indicated that they will recommend a larger number of their clients file bankruptcy rather than apply for an installment agreement if this change goes into effect. This change penalizes those individuals that in good faith extend the time period for payment of their claims, and a major illness, loss of job or other unfortunate events force them to file a bankruptcy petition. Prior years' taxes for this individual would be a priority claim because of the tolling provision, but if this individual had no interest in paying the taxes and had not contacted the IRS to work out an installment payment plan, the taxes may be discharged.

The IRS seeks this change because it has seen numerous cases where a taxpayer entered into a minimal installment agreement to buy time until the 240-day measuring period passed thereby making the tax nondischargeable.

The NBRC stated in its report that the proposal for tolling during the period of compromise did not extend to installment agreements.

Assessment Defined (H.R. 3150, Section 507)

There has been some conflict with state law as to the meaning of the term "assessment." Section 101 of the Bankruptcy Code is amended by inserting a definition for assessment: "(3) 'assessment'- (A) for purposes of State and local taxes, means that action which is sufficiently final so that thereafter a taxing authority may commence an action to collect the tax, and (B) for Federal tax purposes has the meaning given such term in the Internal Revenue Code of 1986; and 'assessed' and 'assessable' shall be interpreted in light of the definition of assessment in this paragraph."

Comment: Assessment was defined in accordance with the recommendations of the NBRC.

Making Chapter 13 Nondischarge Provision Consistent with Chapter 7 (H.R. 3150, Section 508)

Section 1328(a)(2) of the Bankruptcy Code is amended by expanding the dischargeability of taxes to cover those taxes that are nondischargeable in chapter 7. Thus, the provisions for chapter 13 regarding tax discharge for fraudulent and unfiled tax returns under this proposal would be equivalent to those in chapter 7.

Comment: In general, it can be argued that there should be no difference between the dischargeability of taxes under chapter 7 and chapter 13. Chapter 13 facilitates the workout of tax claims and is consistent with other provisions of H.R. 3150 that require taxpayers to pay some of their claims over the plan period. Taxing authorities collect substantial taxes because chapter 13 requires that all priority taxes be paid during the plan period and it places on the tax rolls individuals that have not paid taxes in several years. On the other hand, in chapter 7, taxing authorities receive a very small percent of the taxes due and probably less than would have been received in chapter 13. This proposed change was debated by the NBRC, but the Commission was unable to obtain enough votes to pass the proposal. To assist the taxing authorities in determining the tax, especially the priority taxes, the Tax Advisory Committee recommended that tax returns for six years be filed as described below. This author supported the six-year requirement on the assumption that the discharge provisions in chapter 13 would not be repealed.

Nondischarge of Corporate Taxes (H.R. 3150, Section 509)

Section 1141(d) of the Bankruptcy Code is amended by adding the following provision: "(4) Notwithstanding the provisions of paragraph (1), the confirmation of a plan does not discharge a debtor which is a corporation from any debt for a tax or customs duty with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax."

Comment: The NBRC recommended that section 1141(d) be modified to deny a discharge to a corporation for which a fraudulent return was filed. There is considerable opposition to this recommendation on the basis that the management of the company that was involved with the fraud is often replaced and a provision that prohibits a nonpriority tax from being discharged limits the ability of the creditors to reorganize the debtor. Because of the inability to restructure the troubled business due to the inability to obtain a discharge of nonpriority taxes, the Service may even collect less. The Service should file criminal action against the corporate officer that filed a fraudulent return, but the creditors should not be punished because of the errors of prior management. It should, however, be recognized that there is a significant difference between what constitutes civil fraud and what constitutes criminal fraud.

Stay of Tax Proceedings (H.R. 3150, Section 510)

The stay under section 362(a)(8) would be revised to apply only to a tax liability for a taxable period ending before the order for relief. H.R. 3150 would revise section 362(b)(9) to provide that the stay does not apply to the appeal of a decision by a court or administrative tribunal that determines a tax liability of the debtor.

Comment: Although designed to apply to postpetition taxes, the stay as restricted in section 362(a)(8) would also apply to some prepetition taxes. For example, the Eight and Ninth Circuits, In re L.J. O'Neill Shoe Co., 64 F. 3d 1146 (8th Cir. 1995) and In re Pac-Alt. Trading Co., 64 F.3d 1292 (9th Cir. 1995), have held that the taxes of a corporation can be bifurcated into two parts&2151;the part prior to the filing of the petition (a prepetition tax with eighth priority) and the tax incurred after the filing (an administrative expense). This change would allow the taxing authorities to collect the prepetition tax even before the plan is developed because the stay does not cover these taxes. While it can be argued that both the O'Neill and Pac-Alt. Trading Co. decisions are judge-made law and do not follow the provisions of tax law, it is necessary for the bifurcation issues to be settled before the proposed change becomes law.

Additionally, based on the provisions in section 507(a)(8) it has become a common practice for employers' taxes and trust fund tax withholdings that were made prior to the filing of the petition to be classified as prepetition taxes even though the tax period may end after the petition is filed. While this type of tax is not actually a quarterly or yearly tax, but an each-pay-day- tax, it is important that the proposed change is clear that it only applies to postpetition taxes.

Thus, before this provision becomes effective, it needs to, at least, be revised to provide that it only applies to postpetition taxes.

Both the NBRC and the Tax Advisory Committee recommended that the relevant event for triggering the application of section 362(a) limitation is the filing of the petition and not the entry of the order for relief as advocated by H.R. 3150 and recommended the application of the stay to tax appeals as proposed in H.R. 3150.

Periodic Payment of Chapter 11 Taxes (H.R. 3150, Section 511)

H.R. 3150 proposes to amend the Bankruptcy Code to provide that the payments under section 1129(a)(9) must be periodic and must be "in at least quarterly installments designed to pay at least 15 percent of the claim in each of the first 5 years of the plan and no more than 20 percent of the claim in the final year of the plan."

H.R. 3150 follows the recommendation of both the NBRC and the Tax Advisory Committee in proposing that the requirements of section 1129(a)(9) should also apply to secured taxes that would be entitled to priority absent their secured status.

Comment: Both the NBRC and the Tax Advisory Committee suggested that the payments should be periodic, but did not define periodic other than to suggest that the payments should be monthly or quarterly and that balloon payments be prohibited. Because of the difficulty of establishing the time of assessment, both the NBRC and the Tax Advisory Committee recommend that the six-year period begin with the date of the order for relief. H.R. 3150 only deals with the issue of periodic and balloon payments. For some debtors, it is difficult for large payments to be made in the first year or two after emerging from bankruptcy. To facilitate that process, some creditors agree to limit the payments the first year or two to interest only or interest and limited principal payments. It seems reasonable that under these conditions the tax authorities should also receive less in the first year or two than is paid in the latter years. Thus, the recommendation of the NBRC provides, under these conditions, an opportunity for the court to approve payments that are less than equal payments, but would not allow plans to be approved that provide for one balloon payment at the end of the sixth year.

The 15 percent and 20 percent rule will not work. For example, assume that the taxes were assessed one year before the petition was filed and that the company was in chapter 11 for two years. Payments under the plan would be made over three years.

However, payments could not be evenly distributed because only 20 percent of the claim could be paid in the third year. Another problem, in using the word "claim", does it include interest that begins to accrue on the allowed claim as of the effective date of the plan? If not, would the service allocate the first part of the payment as interest and the balance as payment on the claim? If so, then the payments in the first year would involve interest on the full amount of the claim plus a payment of 15 percent of the principal (claim). Thus, payments spread over six years may be required to be larger in the first year than in any other year. This proposal in its current conditions will create more problems than solutions and should not become law.

Tax Avoidance of Statutory Tax Liens (H.R. 3150, Section 512)

H.R. 3150 amends section 545(2), as recommended by the NBRC and the Tax Advisory Committee, to overrule cases that penalize the government due to certain benefits for purchasers provided for in the lien provision of the IRC or similar provisions of state or local law.

Course of Business Payment of Taxes (H.R. 3150, Section 513)

Payment of postpetition taxes is required when taxes are due in the course of such business unless the tax is a property tax secured by a lien against property that is abandoned by the trustee under section 554 of the Bankruptcy Code within a reasonable time after the lien attaches as provided for in H.R. 3150. Also H.R. 3150 modifies section 503 to provide that property taxes are to be paid as an administrative expense and that it is unnecessary for a governmental unit to make a request to the debtor to pay taxes that are entitled to payment as administrative expenses.

Comment. These provisions were recommendations by both the NBRC and the Tax Advisory Committee.

2. Tardily Filed Priority Tax Claim (H.R. 3150, Section 514)

H.R. 3150 provides, as recommended by both the NBRC and the Tax Advisory Committee, that a taxing authority must file a claim for priority tax before the final order approving the trustee's report is entered by the court.

Comment: It is important that the claim be filed before the final order approving the trustee's report is entered to avoid requiring the trustee to recalculate the amount paid to creditors and equity holders, to rewrite the report, and to reschedule the hearings to approve the report. Filing a claim after the report is filed clearly impacts the efficient court administration of the case. See Pioneer Investment Servs. Co. v. New Brunswick Assocs. Ltd. 113 S. Ct. 1489 (1993).

Income Tax Returns Prepared by Tax Authorities (H.R. 3150, Section 515)

H.R. 3150 amends section 523(a)(1)(B) by providing a definition of a tax return for purposes of dischargeability as follows:

(iii) for purposes of this subsection, a return-

(I) must satisfy the requirements of applicable nonbankruptcy law, and includes a return prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986, or similar State or local law, or a written stipulation to a judgment entered by a nonbankruptcy tribunal, but does not include a return made pursuant to section 6020(b) of the Internal Revenue Code of 1986, or similar State or local law, and

(II) must have been filed in a manner permitted by applicable nonbankruptcy law.

The last provision "(II) must have been filed in a manner permitted by applicable nonbankruptcy law" is confusing; it muddles a provision that was clarified in (I) above.

Comment: Both the Tax Advisory Committee and the NBRC recommended that a return filed under IRC section 6020(b) or similar federal, state, or local law provisions, should constitute a filed return for Bankruptcy Code dischargeability purposes where the taxpayer has taken reasonable steps to sign and file the return, even though the taxing authorities fail to accept such return for filing.

Tax Returns Required to Confirm Chapter 13 Plans (H.R. 3150, Section 517)

Section 1325 of the Bankruptcy Code is amended by H.R. 3150 to provide that one of the requirements for plan confirmation is the filing of income tax returns required under section 1308 of the Bankruptcy Code. The proposed section 1308 is as follows:

11308. Filing of prepetition tax returns

(a) On or before the day prior to the day on which the first meeting of the creditors is convened under section 341(a) of this title, the debtor shall have filed with appropriate tax authorities all tax returns for all taxable periods ending in the 6-year period ending on the date of filing of the petition.

(b) If the tax returns required by subsection (a) have not been filed by the date on which the first meeting of creditors is convened under section 341(a) of this title, the trustee may continue such meeting for a reasonable period of time, to allow the debtor additional time to file any unfiled returns, but such additional time shall be no more than-

(1) for returns that are past due as of the date of the filing of the petition, 120 days from such date, and

(2) for returns which are not past due as of the date of the filing of the petition, the later of 120 days from such date or the due date for such returns under the last automatic extension of time for filing such returns to which the debtor is entitled, and for which request has been timely made, according to applicable nonbankruptcy law,

(3) upon notice and hearing, and order entered before the lapse of any deadline fixed according to this subsection, where the debtor demonstrates, by clear and convincing evidence, that the failure to file the returns as required is because of circumstances beyond the control of the debtor, the court may extend the deadlines set by the trustee as provided in this subsection for-

(A) a period of no more than 30 days for returns described in paragraph (1) of this subsection, and

(B) for no more than the period of time ending on the applicable extended due date for the returns described in paragraph (2).

(c) For purposes of this section, a return-

(1) must satisfy the requirements of applicable nonbankruptcy law, and includes a return prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986, or similar State or local law, or a written stipulation to a judgment entered by a nonbankruptcy tribunal, but does not include a return made pursuant to section 6020(b) of the Internal Revenue Code of 1986, or similar State or local law, and

(2) must have been filed in a manner permitted by applicable nonbankruptcy law.".

Section 1307 of the Bankruptcy Code would be amended under H.R. 3150 to provide that upon the failure of the debtor to file the returns required under section 1308, on request of a party in interest or the U.S. trustee and after and a hearing, the court shall dismiss or convert the chapter 13 case to chapter 7, whichever is in the best interest of the estate.

H.R. 3150 proposes to amend section 502(b)(9) to provide that an objection to the confirmation of a plan is considered to be timely if it is filed within 60 days after the debtors' tax returns were filed under section 1308. Additionally, H.R. 3150 proposes that Congress direct the Advisory Committee on Bankruptcy Rules of the Judicial Conference to propose rules that provide for an opportunity for governmental units to object to (1) the confirmation of a plan on or before 60 days after the debtor files all tax returns required under sections 1308 and 1325(a)(7) of the Bankruptcy Code and (2) that no objection can be filed in reference to a tax of a return required to be filed under section 1308 until such return has been filed as required.

Comment: The Tax Advisory Committee concluded that this provision would help reestablish the chapter 13 debtor as a "taxpayer" and would determine the priority tax that must be paid for a debtor to qualify for the chapter 13 super discharge. The Tax Advisory Committee concluded, after discussion with federal and local taxing authorities and with attorneys and accountants that render services for chapter 13 debtors, that requiring the chapter 13 debtor to file tax returns for six years, pay through the chapter 13 plan all of the priority taxes, and provide for some payment of the nonpriority taxes (realizing that some courts approve a zero plan for unsecured claim holders) along with other general unsecured claim holders will most likely result in the taxing authorities collecting more taxes now and in the future than would be collected with the filing of a chapter 7 petition. With the proposed repeal of the chapter 13 tax discharge provisions, tax professionals generally will not recommend that clients file chapter 13. As a result, this provision will not have the impact that was intended. This writer would not have supported the six-year chapter 13 filing requirement on the Tax Advisory Committee with a repeal of the chapter 13 discharge provisions.

As noted above, both the Tax Advisory Committee and the NBRC recommended that a return filed under IRC section 6020(b) or similar federal, state, or local law provisions, should constitute a filed return for Bankruptcy Code dischargeability purposes. H.R. 3150 would not treat a return filed under section 6020(b) as a filed return for tax discharge purposes.

1. Standard for Tax Disclosure (H.R. 3150, Section 518)

Section 1125(a) of the Bankruptcy Code dealing with the disclosure requirements is expanded by requiring the proponent of the plan to include full discussion of the potential material Federal and State tax consequences of the plan to the debtor, any successor to the debtor, and a hypothetical investor typical of the holders of claims or interests in the case.

Comment: In general, the disclosure requirements for income tax impact of the plan has not generated the desired results. Often, interested parties have been told to talk with their tax specialists to find out the income tax impact of the plan. Time will only tell if this requirement, if enacted, would result in the tax impact of the plan being explained in such a manner that readers of the disclosure statement would understand tax consequences. The purpose of the amendment is not to change existing law, but to make plan proponents adhere to the original intent of the law to effectively disclose the tax ramifications of the plan on the debtor.

Setoff of Tax Liability against Tax Refund (H.R. 3150, Section 519)

Section 362(b) of the Bankruptcy Code would be amended to provide that the setoff of an undisputed prepetition tax liability against an income tax refund does not violate the automatic stay. Setoff could not be taken if, prior to the setoff, an action was commenced under section 505(a) to determine the amount or the legality of the tax. However, if the setoff is tolled during the 505(a) hearing, the taxing authority may hold the refund.

Comment: The writer supported the recommendation of the Tax Advisory Committee. However, it has been pointed out by some writers that the impact of Seminole Tribe of Florida, 116 S. Ct. 1114 (1996), suggests that no change should be made regarding the tax setoff be considered because the debtor may be unable to recover tax refunds that were setoff improperly by a state taxing authority.

Summary of NBRC recommendations not included in H.R. 3150

Listed below are some of the changes that were recommended by the NBRC that were not a part of H.R. 3150 that should be considered.

Conform State and Local Tax Issues to Federal Laws

Conform section 346 of the Bankruptcy Code to the 1398(d)(2) election and conform state and local tax attributes that are transferred to the estate to those transferred for federal income tax purposes. Conform treatment of state and local claims to that provided for federal tax claims, including confirming state and local tax attributes to the federal list. Considerable conflicts exist between state and local taxes and federal taxes. Congress indicated at the time the Bankruptcy Reform Act of 1978 became law that the state and local tax issues would be changed when the Congress passed the federal bankruptcy tax laws. A few years later Congress passed the Bankruptcy Tax Act of 1980 and no action has been taken to eliminate the tax problems that arise because of the differences between the two federal laws. To correct these problems, changes need to be made only in the Bankruptcy Code, which means that these changes should be a part of the Bankruptcy Bill and not a Tax Bill. (NBRC Proposals 4.2.4, 4.2.16-4.2.17)

Bifurcation Corporate Taxes that Straddles the Petition Date

The NBRC recommended that corporations have the same right as individuals to elect to have taxes incurred prior to the filing for tax years that straddle the petition date to be considered a prepetition tax and tax incurred for the balance of the tax year after the petition is filed to be classified as an administrative expense. The Eighth and Ninth Circuits allow the debtor to bifurcate the taxes.

Tax Impact of Plan

Currently, section 1146(d) of the Bankruptcy Code gives the bankruptcy court the power to determine the tax impact of a plan for state and local tax purposes. The NBRC recommended that this power also be extended to cover federal income taxes as well. Section 1146(d) should be modified by removing the "state or local."

Subordination of Tax Penalties

The NBRC recommended that the payment of prepetition tax penalties in chapters 11, 12 and 13 be subordinated to payment of general unsecured claims the payment is in chapter 7 cases. The NBRC noted that granting a priority to penalties works unfairness on general unsecured creditors by, in effect, punishing them for the debtor's misconduct. This is, according to NBRC, inequitable, especially where creditors have limited access and ability to monitor a taxpayer's compliance with tax reporting requirements.