Working Group Proposal #8: Section 505 & the Burden of Persuasion


Section 505

Congress has, through provisions such as § 505 of the Bankruptcy Code, attempted to accommodate the goals of the federal bankruptcy system and laws relating to the collection of taxes. It is uniformly recognized that § 505(a)(1) grants bankruptcy courts the jurisdiction and plenary authority to hear and determine the amount or legality of "any" unpaid tax claim, regardless of whether or not the tax and its concomitant fines and penalties have been previously assessed or contested. [ FN: See 11 U.S.C. §505(a)(1) (1994). Section 505(a)(1) provides: Except as provided in paragraph (2) of this subsection, the court may determine the amount or legality of any tax, any fine, or penalty relating to a tax, or any addition to tax, whether or not previously assessed, whether or not paid, and whether or not contested before and adjudicated by a judicial or administrative tribunal of competent jurisdiction. Id.] The jurisdictional grant contained in § 505(a)(1) is sufficiently broad enough to include the determination or legality of any type of tax liability "whether or not paid" or previously adjudicated by a judicial or administrative tribunal of competent jurisdiction. [ FN: See infra note 8. See generally Perry v. District of Columbia , 314 A.2d 766, 766 (D.C.), cert. denied , 419 U.S. 836 (1974)(noting that the jurisdictional prerequisite to a judicial review of a tax assessment under the law of the District of Columbia hinges upon the actual payment of the disputed tax assessment together with interest and penalties).] Moreover, courts have construed the statute and its concomitant policy objective to permit the prosecution in a bankruptcy forum of a de novo appeal from an unpaid paid tax assessment. [ FN: See, e.g. , In re Laptops Etc. Corp. , 164 B.R. 506 (Bankr. D. Md. 1992)(ruling that the taxing authority ’s sales-tax assessment, as affirmed by the Department of Revenue postpetition, was an unconstitutional violation of the Commerce Clause and without force and effect; claims disallowed). By virtue of §505(a), a bankruptcy court may even determine the validity of a debtor ’s tax liability, if any, irrespective of whether it had previously granted relief from the automatic stay to permit the continuation of a tax court proceeding on the same issue. See, e.g. , United States v. Wilson , 974 F.2d 514, 517 (4th Cir. 1992), cert. denied , 507 U.S. 945 (1993); In re Swann Gasoline Co. , 46 B.R. 640, 642 (Bankr. E.D. Pa. 1985)(noting that even if relief from the automatic stay were afforded in order to permit a state court to make determinations of tax liability, such determinations would not have res judicata or collateral estoppel effect as to the bankruptcy court ’s own determination of liability under §505(a)).]

The limitation imposed upon the jurisdiction of the bankruptcy court to determine the amount or legality of a tax claim and resolve tax disputes is contained in paragraph (a)(2) of § 505. Pursuant to § 505(a)(2), a bankruptcy court is not permitted to redetermine the merits of a tax claim or question of tax liability which has been contested prior to the commencement of the bankruptcy case in a state, federal or quasi-judicial tribunal. [ FN: See 11 U.S.C. §505(a)(2) (1994). Section 505(a)(2) provides in pertinent part: (2) The court may not so determine-- (A) the amount or legality of a tax, fine, penalty, or addition to tax if such amount or legality was contested before and adjudicated by a judicial or administrative tribunal of competent jurisdiction before the commencement of the case under this title . . . . Id.] Section 505(b), by contrast, provides a trustee or debtor-in-possession with the ability to obtain a determination of any postpetition tax liability which arises during the pendency of the case. [ FN: Id. §505(b) ( "A trustee may request a determination of any unpaid tax liability of the estate for any tax incurred during the administration of the case . . . . ").]

Burden of Persuasion

The Bankruptcy Code is structured to achieve a relatively expeditious resolution with respect to disputes over the amount, validity and character of claims owed by the bankruptcy estate. A proof of claim executed and filed in accordance with § 501 of the Bankruptcy Code and applicable Bankruptcy Rules constitutes prima facie evidence of the amount and validity of the claim. [ FN: Fed. R. Bankr. P. 3001(f). See 11 U.S.C. §502(a) (1994) (providing that a claim is "deemed allowed " unless a party in interest objects). See also Whitney v. Dresser , 200 U.S. 532, 535-36 (1906)(opining that it is the objection, not the claim, which is heard in a claims contest and that the claim in bankruptcy is regarded as having a certain standing); 4 Collier on Bankruptcy ¶ 502.02[2][f], at 502-19 (Lawrence P. King et al. eds., 15th ed. revd. 1996)( "Unless the trustee, as objector, introduces evidence as to the invalidity of the claim or the excessiveness of its amount, the claimant need offer no further proof on the merits of the claim. ").] Upon objection to the claim and admission of probative evidence sufficient to rebut the prima facie validity of the claim, the burden shifts to the claimant who bears the ultimate burden of persuasion with respect to the amount and validity of its claim. [ FN: The burden of proof in bankruptcy is a shifting one: [A] claim is prima facie valid if it alleges facts sufficient to support a legal liability to the claimant; if the objector then produces evidence to refute at least one of the allegations essential to the claim ’s legal sufficiency, the burden of going forward shifts back to the claimant to prove the validity of the claim by a preponderance of the evidence. 3 Collier on Bankruptcy ¶ 502.01, at 502-18 n.19 (Lawrence P. King et al. eds., 15th ed. 1996)(citing In re Allegheny Int ’l Inc. , 954 F.2d 167 (3d Cir. 1992)). The underlying rationale for imposing the ultimate burden of persuasion upon the claimant in a dispute with the trustee or debtor- in-possession is that, from a purely procedural standpoint, the filing of a proof of claim is tantamount to the filing of a complaint in a civil action. See Nortex Trading Corp. v. Newfield , 311 F.2d 163 (2d Cir. 1962). As such, the claimant in a bankruptcy proceeding is essentially in the same posture as a plaintiff in a nonbankruptcy proceeding, who is generally assigned the burden of proving its claim against the defendant. In re Premo , 116 B.R. 515, 518 (Bankr. E.D. Mich. 1990).] In forums other than a bankruptcy court, however,the burden of persuasion as to the lack of validity of the sovereign’s tax claim generally falls upon the taxpayer, not the sovereign. [ FN: "[T]he usual procedure for recovery of debts is reversed in the field of taxation. Payment precedes defense, and the burden of proof, normally on the claimant, is shifted to the taxpayer. " Bull v. United States , 295 U.S. 247, 260 (1935). Accord United States v. Janis , 428 U.S. 433, 440 (1976); Helvering v. Taylor , 293 U.S. 507, 515 (1935); Welch v. Helvering , 290 U.S. 111, 115 (1933). See, e.g. , T. Ct. Rule Prac. & Proc. 142(a); D.C. Code Ann. §47-2010 (1990)(providing for a presumption of taxability and allocating the burden to the taxpayer to prove that a receipt is not subject to sales taxation). In proceedings before the Tax Court, the Court of Federal Claims or a district court, it is incumbent upon the taxpayer, as the party seeking a redetermination of liability, to discharge the burden of proof by a preponderance of the evidence. Moreover, when an assessment has been formally made by the taxing authority, it carries with it a presumption of correctness which must be overcome by the taxpayer. See Psaty v. United States , 442 F.2d 1154 (3d Cir. 1971); United States v. Molitor , 337 F.2d 917 (9th Cir. 1964).] Consequently, a conflict often arises which requires the bankruptcy court to determine whether the claim of a taxing authority is to be treated like all other claims, and accordingly whether the taxing authority must bear the ultimate burden of persuasion that it has a valid claim, or whether the debtor, debtor-in-possession, or trustee is required to bear the burden of persuading the bankruptcy court that the taxing authority does not have a valid claim. [ FN: Elmer Dean Martin III, Burden of Persuasion: The Overlooked Defense to Tax Claims , 21 Cal. Bankr. J. 117, 117 (1993).] The courts are sharply divided on the issue and have created a discordant body of law with respect to a fundamental and recurring issue.

The Courts of Appeals for the Third, Fourth and 7th Circuits have ruled that the Bankruptcy Code and Rules do not alter burden of proof rules attendant to tax claims under nonbankruptcy law. [ FN: See, e.g. , United States v. Charlton , 2 F.3d 237, 239 (7th Cir. 1993); IRS v. Levy ( In re Landbank Equity Corp. ), 973 F.2d 265 (4th Cir. 1992); Resyn Corp. v. United States , 851 F.2d 660 (3d Cir. 1988). "[U]pon review of the code and its legislative history, we find nothing which suggests that this dispute between a taxpayer and the IRS should be decided in a manner any different from that in which the case would be determined outside the bankruptcy context. " Levy , 973 F.2d at 270- 71.] Accordingly, those courts have placed the burden on the debtor-taxpayer ina claims contest. [ FN: See supra note 10.] The Courts of Appeals for the Fifth, Sixth, Ninth and 10th Circuits have reached the opposite conclusion, finding that the government should be treated the same as every other creditor in the claims objection process. [ FN: See, e.g. , Franchise Tax Bd. v. MacFarlane ( In re MacFarlane ), 83 F.3d 1041 (9th Cir. 1996), cert. filed , (Aug. 12, 1996); Placid Oil Co. v. IRS ( In re Placid Oil Co. ), 988 F.2d 554 (5th Cir.), reh ’g denied , 4 F.3d 992 (5th Cir. 1993); In re Fullmer , 962 F.2d 1463 (10th Cir. 1992); In re Fidelity Holding Co. , 837 F.2d 696 (5th Cir. 1988); Industrial Comm ’r v. Highway Constr. Co. ( In re Highway Constr. Co. , 105 F.2d 863 (6th Cir. 1939)(pre-Code case).] The confusion in the area can perhaps be best illustrated by the fact that the Court of Appeals for the 8th Circuit has weighed in on both sides of the issue. [ FN: Compare Gran v. IRS ( In re Gran ), 964 F.2d 822 (8th Cir. 1992); Paschal v. Blieden , 127 F.2d 398 (8th Cir. 1942)(pre-Code case)(imposing the burden on the government) with In re UNECO Inc. , 532 F.2d 1204 (8th Cir. 1976)(pre-Code case)(imposing the burden on the debtor- taxpayer).] Lower courts are equally divided. [ FN: Compare In re Wilhelm , 173 B.R. 398, 401-02 (Bankr. E.D. Wis. 1994); In re Premo , 116 B.R. 515, 524 (Bankr. E.D. Mich. 1990)(refusing to recognize an exception to the rule allocating the burden of ultimate persuasion upon the creditor for tax authorities in the context of a hearing on an objection to a claim); In re Federated Dep ’t Stores Inc. , 135 B.R. 950, 958 (Bankr. S.D. Ohio 1992), aff ’d , 171 B.R. 603 (S.D. Ohio 1994) with Abel v. United States ( In re Abel ), 200 B.R. 816, 819 (E.D. Pa. 1996); In re Thinking Machs. Corp. , 1996 WL 708364 *4 (Bankr. D. Mass. 1996)(concluding that rule that Bankruptcy Rule 3001(f) places the ultimate burden of proof and persuasion upon the government, improperly permits a tax litigant to shift the burden of proof by merely filing bankruptcy); In re Ford , 194 B.R. 583, 588-89 (S.D. Ohio 1995); Cobb v. United States ( In re Cobb ), 135 B.R. 640, 641 (Bankr. D. Neb. 1992)(concluding that Bankruptcy Rule 3001(f) does not allocate the burden of proof but simply establishes that a proof claim constitutes evidence: "The Rule, in effect creates a presumption which must be overcome by debtor. Once the presumption is overcome . . ., the proof of claim no longer constitutes evidence--the bubble is burst. The burden of proof is to then be allocated by applicable non-bankruptcy law. ").]


The Bankruptcy Code should be amended to clarify that the burden of proof rules and concomitant presumptions which would be applicable under nonbankruptcy law are equally applicable to bankruptcy court determinations under § 505.

Reasons for the Change

The allocation of the burden of persuasion in many tax controversies is often determinative. Absent an indentifiable federal interest which compels a different result, there is no sound reason why the efficacy of tax claims should be analyzed differently because of the advent of bankruptcy. Indeed, "[i]n resolving disputed claims against the bankruptcy estate, it is important to understand that theBankruptcy Code, in most instances, while providing a forum and procedures for an expedient dispute resolution, does not endeavor to supplant the substantive law under which the claim against the estate . . . arose." [ FN: Internal Rev. Serv. v. Levy ( In re Landbank Equity Corp. ), 973 F.2d 265, 270 (4th Cir. 1992)(citing Report of the Commission on the Bankruptcy Laws of the United States , H.R. Doc. No. 137, 93d Cong., 1st Sess. Pt. I 68-71, 76-78 (1973)). The United States Supreme Court has found that "presumptions (and their effects and burden of proof are ‘substantive, ’ " not procedural. See Dick v. New York Life Ins. Co. , 359 U.S. 437, 446 (1959).] To the contrary, it is axiomatic bankruptcy law that the validity of a creditor’s claim is determined by the rules of nonbankruptcy law. [ FN: See Grogan v. Garner , 498 U.S. 279, 283-84 & n.9 (1991). The United States Supreme Court has opined that it is imperative to distinguish between the standard of proof that a creditor must satisfy in order to establish a valid claim against the bankrupt estate and the standard that a creditor who has established a valid claim must still satisfy in order to avoid dischargeability. The validity of a creditor ’s claim is determined by rules of state law [defined] expansively . . . to refer to all nonbankruptcy law that creates substantive claims. . . . [H]owever, the issue of nondischageability has been a matter of federal law governed by the terms of the Bankruptcy Code. Id. (footnote inserted & citations omitted).]

There is no statutory provision or expression in the legislative history evidencing an intent by Congress that firmly-rooted precepts of tax law should be displaced by a special legal requirement that is only applied in the context of a bankruptcy proceeding. No principled policy objective is furthered by recognizing a distinction for purposes of claims allowance between bankrupt and nonbankrupt taxpayers. The signal under an alternative view is relatively clear: When a taxpayer seeks relief under the bankruptcy laws, it may be able to garner a distinct and frequently more advantageous treatment of its tax liability. The uniform treatment of tax claims through an adherence to nonbankruptcy law burdens and presumptions serves to reduce uncertainty, discourages forum shopping and prevents a party from receiving a windfall or result not otherwise obtainable merely because of the happenstance of bankruptcy.

The position that the government as a tax creditor occupies in a claims contest is fundamentally different than other creditors in a normal debtor-creditor relationship. Unlike most creditors, the taxing authority does not have the opportunity to independently maintain adequate records of transactions giving rise to liability. Indeed, federal, state and local taxing authorities are complete strangers to the transactions giving rise to the tax liability in virtually every case. It is generally the debtor, debtor-in-possession or trustee who has access to all of the relevant records, information and knowledge required to substantiate or contest the validity of a tax claim. As such, "[t]he common law rule placing the burden on the party with access to the facts seems particularly applicable in a self-assessment system which provides for the taxpayer to make the initialdetermination of liability" and bolsters the record-keeping requirement the Internal Revenue Code imposes upon taxpayers. [ FN: 15 Collier on Bankruptcy ¶ TX5.03[5], at TX5-24 (Lawrence P. King et al. eds., 15th ed. revd. 1996).]

Competing Considerations

Although there is general egalitarian appeal to the premise adopted by those courts that alter nonbankruptcy law rules in a claims contest and reason that the policies underlying the bankruptcy laws compel equal treatment among creditors. This position, however, overlooks or ignores the frequent disparate and favorable treatment that Congress has accorded taxing authorities in the Bankruptcy Code and the unique nature of their claims. [ FN: See, e.g. , 11 U.S.C. §§507(a)(8), 523(a)(1) (1994). In a broad sense, the goals of rehabilitating debtors and giving equal treatment to private voluntary creditors must be balanced with the interests of governmental tax authorities who, if unpaid taxes exist, are also creditors in the proceeding. Since tax authorities are creditors of practically every taxpayer, another important element is that tax collection rules for bankruptcy cases have a direct impact on the integrity of Federal, State and local tax systems. These tax systems, generally based on voluntary assessment, work to the extent that the majority of taxpayers think they are fair. This presumption of fairness is an asset which should be protected and not jeapardized by permitting taxpayers to use bankruptcy as a means of improperly avoiding ther tax debts. To the extent that debtors in a bankruptcy are freed from paying their tax liabilities, the burden of making up the revenues thus lost must be shifted to other taxpayers. S. Rep. No. 989, 95th Cong., 2d Sess. 13-14 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5799- 5800.]