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FINAL REPORT
OF THE TAX ADVISORY COMMITTEE
to the
NATIONAL BANKRUPTCY REVIEW COMMISSION

August 1997
Washington, D.C.

SECTION 1

This proposal would require an amendment to 11 U.S.C. §901 making 11 U.S.C. §1129(a)(9)(C) applicable to chapter 9 cases and would conform chapter 9 practice to that under chapter 11 of the Bankruptcy Code. Because chapter 9 debtors are not generally taxpayers, most of the taxes involved will be employment or other trust fund taxes. The Commission may expect this proposal to be controversial from a political perspective. Furthermore, there is some concern that including a payment provision in chapter 9 may pose Tenth Amendment concerns even though the proposal applies to municipalities only.

105, 106 & 109 Clarify provisions of the Bankruptcy Code on providing reasonable notice to governmental units.

The Advisory Committee has agreed that notice provisions in the Bankruptcy Code must be clarified as those provisions relate to governmental units. There is a consensus that the government should not lose its rights against the debtor or the bankruptcy estate in a bankruptcy case because of the debtor's failure to provide notice reasonably calculated to reach the proper representatives of the government. Although the details as to what constitutes reasonable notice are not self-evident, the Advisory Committee has reviewed the Tax Related Information items contained in the Justice Department’s letter of March 7, 1997, to the Advisory Committee on Bankruptcy Rules (Appendix IV) and generally finds these requests reasonable. The Advisory Committee suggests that the Commission consider three parts to any proposal on notice to the government. First, notice to the government must be reasonably calculated to reach the proper representatives of the government and must reasonably identify the debtor. Without a reasonably targeted notice requirement under the Bankruptcy Code or Rules, one can continue to expect the government to experience special difficulties because of the large and diffuse nature of governmental units and the difficulty governments may have in identifying claims and interests in the bankruptcy case. Improved notice would enhance the fairness and efficiency of the bankruptcy process. Improved notice should also reduce inadvertent violations of the automatic stay and reduce costs associated with the bankruptcy case. Second, to facilitate proper notice, the Commission should recommend some mechanism to provide sufficient information to permit a debtor to properly identify the relevant federal, state, or local governmental authority for purposes of providing reasonable notice under the circumstances. For example, a debtor’s attorney may be aware of the governmental department to provide notice regarding state sales tax in Nevada, where that attorney practices, but may be unaware of the department with sales tax responsibility in Georgia, a state where the client has done business. However, there is a strong belief among the majority of the Advisory Committee members that a national central registry for all government units is impractical. When one considers thevast array of local governmental units, one quickly envisions reams of phone book-like volumes of listings that may quickly become outdated. Presently, there is no logical entity to support such a system. The consensus of the Advisory Committee is that the bankruptcy clerks' offices compile and maintain the registry (that would presumably be available nationally on PACER). A district or local approach, as opposed to a national registry, should lead to more manageable lists. The clerk's offices are capable of organizing a notice list into appropriate subdivisions (federal agencies, state agencies, local governmental agencies) in an effort to make the district registries user-friendly. The creation and maintenance of a local registry provides a necessary resource to aid in giving adequate notice. If a governmental unit is not listed in the registry, the debtor would be expected to provide reasonable notice and would be protected if the debtor made a good faith effort to provide reasonable notice. Third, failure to provide reasonable notice should result in some sanction, including exception to any bar date and the nondischargeability of tax claims where the debtor has not provided notice in a manner consistent with the applicable Bankruptcy Code section or Rule. Finally, the Advisory Committee recommends that all notice issues affecting governmental units should be taken up as one overall proposal with amendments coming in the form of changes to the Bankruptcy Rules. Although it may be more appropriate for the Rules Committee to address the notice issues, the Advisory Committee wants to emphasize that reasonable notice is a key consideration running throughout the proposals in this Final Report.

The Bankruptcy Code does not specify the interest rate to which tax claims are entitled over the life of a chapter 11 reorganization plan. Emerging judicial consensus is that a market rate of interest must be determined and that the statutory rate is relevant to that determination, but not binding. It is the consensus of the Advisory Committee that judicial resources are wasted litigating the issue of what rate of interest is appropriate for tax claims entitled to interest in bankruptcy. Therefore, the Advisory Committee recommends that the Bankruptcy Code be amended to provide for interest at a stated statutory rate where the claim is in fact entitled to interest. This proposal is not intended to enlarge the universe of claims entitled to interest in bankruptcy. It is also the consensus of the Advisory Committee to provide the same stated statutory rate for all governmental units in the bankruptcy case. Although short of a consensus, a majority of members of the Advisory Committee suggest that the fixed federal deficiency rate under IRC §6621(a)(2), without regard to IRC §6621(c), be employed. [ FN: The Advisory Committee representatives of the federal government believe that the interest rate described under IRC §6621(c) should apply in the case of "large corporate underpayments, " as that term is used in the IRC.]

Section 505(b) permits a trustee to request a prompt audit from a taxing authority. If the taxing authority fails to respond within sixty days to the request, the trustee is discharged from liability for any taxes beyond the taxes shown on the return. Presently, the Internal Revenue Service has directed that §505(b) requests be filed with the local District Director. See Rev. Proc. 81-17, 1981-1 C.B. 688. Nonetheless, some courts have held that a trustee may ignore the IRS directive and file a §505(b) request with the IRS Service Center. See In re Carie Corp., 128 B.R. 266 (Bankr. D. Alaska 1989). It is the consensus of the Advisory Committee that governmental units are entitled to timely and reasonable notice in the bankruptcy process. However, adequate and timely notice is often dependent on obtaining information in order to identify the appropriate governmental representative. Consequently, it is the consensus of the Advisory Committee that the Commission propose the creation and maintenance of a local or district registry maintained by the bankruptcy court clerks that would provide sufficient information so that a debtor may comply with more stringent notice requirements. See comments to Proposal #106. Finally, the Advisory Committee recommends that all notice issues affecting governmental units should be taken up as one overall proposal.

The treatment of state and local taxes should be conformed to that of federal taxes regarding a debtor's tax year election and regarding those tax attributes that are transferred to the bankruptcy estate upon the filing of the petition in bankruptcy. There is no justification to maintain two systems in the Bankruptcy Code that provide for the transfer of different tax attributes based on federal versus state and local tax questions. There is also no justification for the period of a federal tax year or years being different from a state and local tax year or years.

Several tax claims that are identified in the Bankruptcy Code as priority claims or as claims that are nondischargeable are tied to certain time limits, for example, tax claims assessed within 240 days of the filing of the petition are priority claims under §507(a)(8) and nondischargeable under §523(a)(1). Where the debtor has filed successive bankruptcy petitions, the issue posed is whether the first filing tolled the running of these time periods, thus maintaining the priority and nondischargeable character of the tax claims in the subsequent bankruptcy case. The consensus of the Advisory Committee is that in the event of successive bankruptcy filings, the time periods specified in §507(a)(8) shall be suspended during the period in which a governmental unit was prohibited from pursuing a claim by reason of the prior case. A debtor should not be entitled to stay the collection of a tax by filing a bankruptcy petition and then benefit from the pendency of the abortive case by reducing or eliminating the time in which the government’s tax claims would otherwise have been entitled to priority, or altering the nondischargeability of a tax. Clarification of the law would eliminate unnecessary litigation and provide uniformity in the law. Compare In re Waugh, 1997 W.L. 135626 (8th Cir. Mar. 26, 1997); West v. United States, 5 F.3d 423 (9th Cir. 1993); In re Richards, 994 F.2d 763 (10th Cir. 1993); Montoya v. United States, 965 F.2d 554 (7th Cir. 1992); In re Brickley, 70 B.R. 113 (9th Cir. B.A.P. 1986) (all tolling the §507(a)(8) time periods, with In re Quenzer, 19 F.3d 163 (5th Cir. 1993); In re Gore, 182 B.R. 293 (Bankr. N.D. Ala. 1995). At present, there is no consensus among members of the Advisory Committee on whether IRC §6503(h) provides a reasonable tolling mechanism that should be expressly applied to tax claims under §§507(a)(8) and 523(a)(1) or whether the more appropriate additional period is the 30-day period in §507(a)(8)(A)(ii).

Under current law, income or gross receipts taxes that are assessed within 240 days of the date the petition in bankruptcy is filed are entitled to an eighth priority. See 11 U.S.C. §507(a)(8). If an offer in compromise is made by the taxpayer within 240 days of the assessment date, the time during which the offer in compromise was outstanding plus 30 days, is added to the 240 day period. This mirrors the reality that during a pending offer in compromise, the IRS refrains from taking collection action. In United States v. Aberl, 78 F.3d 241 (6th Cir. 1996), the court held that the 240-day period is not suspended for offers in compromise made before the assessment date for those taxes. This proposal speaks directly to some of the problems posed by pending offers in compromise. It is the consensus of the Advisory Committee that any offer in compromise pending within the 240-day period should toll that period whether the offer in compromise was made before or after assessment. The proposal removes an arbitrary distinction between assessments that could have been made within days of each other. This proposal does not extend to installment agreements.

It is the consensus of the Advisory Committee that the Bankruptcy Code should be amended to require that "small business debtors" create and maintain separate bank accounts for trust fund taxes and nontax deductions from employee paychecks. Present law does not require the trustee or the debtor in possession to segregate funds for the payment of trust fund taxes and nontax deductions from employee paychecks. The result is that these taxes may go unpaid when the reorganization fails and the case is converted to a case under chapter 7 of the Bankruptcy Code. As to the sanction imposed for failure to comply with this requirement, the Advisory Committee strongly suggests that the Bankruptcy Code differentiate between failure on the part of the debtor and failure on the part of the trustee in maintaining segregated accounts. Where a debtor fails to comply with the segregation requirement, then the court should have the power to dismiss the bankruptcy case. Where a trustee fails to comply with the segregation requirement, such as in a chapter 7 case or in some chapter 11 cases, then dismissal is inappropriate. Rather, more appropriate sanctions in these circumstances include denial of fees to the trustee, surcharge against the trustee's bond or personal liability for willful failure, or removal from the trustee panel. There is an emerging consensus to include all business debtors under this requirement. However, expanding the proposal to include large business debtors needs more thought.

The consensus of the Advisory Committee is to amend §1141(d)(3) to except from discharge taxes unpaid by a business debtor where the nonpayment arose from fraud. The Advisory Committee, however, has not reached a consensus on what conduct and intent are sufficient to constitute fraud.

Section 362(a)(8) stays the commencement and continuation of a proceeding before the United States Tax Court concerning the debtor. The Tax Court held in Halpern v. Commissioner, 96 T.C. 895 (1991), that §362(a)(8) stays the commencement or continuation of a proceeding involving an individual debtor’s postpetition tax liabilities, even though the IRS may not file a proper request for payment of an administrative expense for the individual debtor’s own postpetition tax liabilities. It is the consensus of the Advisory Committee to amend §362(a)(8) to overrule the Tax Court's decision in Halpern v. Commissioner, 96 T.C. 895 (1991). Additionally, the Advisory Committee suggests that the law be clarified by permitting the appeal of tax court decisions without violating the automatic stay. The Advisory Committee also suggests that the relevant event for triggering the application of §362(a)(8)'s limitation is the filing of the petition in bankruptcy and not the entry of the order for relief.

A consensus has been reached that as to secured tax claims that, without the security, would otherwise be payable as priority, the period over which payments should be made and the manner of their payment shall be the same as if the claims were merely priority. For all other purposes, the requirements of §1129(b)(2) shall continue to be required to be met.

Section 6323 of the Internal Revenue Code provides protection to certain purchasers of property even after a notice of federal tax lien has been filed in accordance with federal tax law. IRC §6323 defines "purchaser" as a person who, for adequate consideration, acquires an interest (other than a lien or security interest) in property, which is valid under local law against subsequent purchasers without notice. Applicable purchases include securities, motor vehicles, personal property purchased at retail, and personal property purchased at casual sales. Section 545(2) of the Bankruptcy Code permits a trustee to avoid a tax lien that is either not perfected or not enforceable at the time of the filing of the petition against a bona fide purchaser, "whether or not such purchaser exists." Trustees and debtors in possession have attempted to employ §545(2) to avoid tax liens on certain of the above-described assets, on the basis that the trustee or debtor steps into the shoes of the hypothetical bona fide purchaser entitled to superpriority under the Internal Revenue Code. The purpose of the exceptions in the Internal Revenue Code is to facilitate the flow of these goods in commerce. Applying §545(2) to tax liens may result in an unintended windfall to the debtor. Additionally, while no reported cases have yet attempted to apply the same legal arguments to state tax liens with similar provisions, the same legal argument could be made to penalize state taxing authorities. Thus, any amendment should not be limited to the federal government but should also include state and local governments. One member of the Advisory Committee believes this amendment should be tied to providing some de minimis exemptions to the federal tax lien for bankruptcy purposes. Such an amendment would prevent a debtor from having to buy off the tax lien in clothing, furniture, personal effects, and tools of the trade. Other members of the Advisory Committee oppose such an amendment for the reasons described with respect to Track 506.

Because governmental units are creditors in the vast majority of bankruptcy cases, this issue has been a real problem for taxing authorities. The proposal would eliminate the need to make a request to the debtor to pay taxes that are entitled to payment as an administrative expense and are required to be paid under 28 U.S.C. §§959(b) and 960.

The treatment of postpetition ad valorem real estate taxes in bankruptcy has posed substantial problems for local taxing authorities. The proposal suggests that these taxes should be treated as administrative expenses, whether secured or unsecured, and should be paid in the ordinary course of the debtor's affairs. The proposal is not intended to overrule the limitation on paying property taxes imposed by 11 U.S.C. §502(b)(3) (prohibiting the payment of a tax assessed against property if the claim exceeds the estate's interest in the property). Three members of the Advisory Committee believe that postpetition ad valorem taxes should be charged to secured creditors as a §506 expense. A §506 surcharge prevents the secured creditors from receiving a windfall. Cf. E & C Holding Co. v. Piscataway (In re E. Steel Barrel Corp.), 164 B.R. 477 (D.N.J. 1994)(secured creditor would receive windfall if not charged with assessed property taxes and sewer charges), with New Brunswick Sav. Bank v. Scranton Elecs. Inc. (In re Scranton Elecs.), 163 B.R. 740 (Bankr. M.D. Pa. 1994)(court stated that estate has burden of proving that taxes paid benefited the secured creditor and estate did not carry its burden); In re Swann, 149 B.R. 137 (Bankr. D.S.D. 1993)(tax due on sale of oversecured estate property not chargeable against secured creditors under §506(c)).

The consensus of the Advisory Committee is that postpetition ad valorem real-estate taxes are a reasonable and necessary cost of preserving the estate and are entitled to treatment as administrative expenses payable in the ordinary course of affairs of the debtor. Cases that provide to the contrary should be overruled.

The consensus of the Advisory Committee is that postpetition ad valorem real-estate taxes are incurred by the estate and are a reasonable and necessary cost of preserving the estate and are entitled to treatment as administrative expenses payable in the ordinary course of affairs of the debtor.

&

702 Amend 11 U.S.C. §346 to conform state and local tax attributes to the federal list in IRC §1398.

The Advisory Committee recommends the following changes to 11 U.S.C. §§346, 728, 1146, and 1231.

Section 346

1. Section 346(a) should be revised to provide that for state and local tax purposes the provisions of the Internal Revenue Code of 1986 are to be used:
   • to determine when a separate estate is created as the result of the filing of a bankruptcy petition.
   • to determine which attributes, that are available under state and local tax laws, are transferred to the estate on the filing of a bankruptcy petition and are transferred back to the individual on termination of the estate.
   • to determine how income (to the extent provided for under state and local laws) from the estate (when created) is taxed or deductions (to the extent provided for under state and local laws) are allowed.
   • to determine how income from the cancellation of debt is to be reported and how basis and other tax attributes (to the extent they are available under state law) are reduced.
   • to determine the tax consequences of transfers between bankruptcy estate and individual debtor.
2. A new subsection should be added to provide that the applicable state and local tax rates (rather than federal rates) should be used to determine any tax liability or refund for state and local taxes.
3. A new subsection should be added to provide that it is the responsibility of the trustee to file federal, state and local tax returns (when required under applicable federal, state and locallaws) for a separate estate created by the filing of a bankruptcy petition and for partnerships and corporations filing bankruptcy petitions.
4. Section 346(b) should be repealed. (Section 1398 addresses the applicable issues - when an estate is created, how an estate is taxed and the accounting methods to use).
5. Section 346(c) should be repealed. (Sections 1398 and 1399 and proposed change in section 346 addresses these issues - filing status for corporations and partnerships and responsibilities for filing tax returns (item 3 above)).
6. Section 346(d) should be repealed (Section is not needed if section 1398 applies - a separate estate is not created in chapter 13).
7. Section 346(e) should be repealed (Section is not needed since 1398 provides for how income is handled by the estate and the allowance of expenses).
8. Section 346(f) should be modified to provide that the same provisions apply to federal tax law as well - deals with payment of withheld items.
9. Section 346(g) should be repealed (Section 1398 addresses the applicable issues - transfers between bankruptcy estate and individual debtor).
10. Section 346(h) should be repealed (Section 1398 addresses the applicable issues - preservation of NOL and provides that short tax years do not create a separate year for NOL carryover periods (Note the current §346(h) is inconsistent with IRC.)).
11. Section 346(I) should be repealed (Section 1398 addresses the applicable issues - attribute carryover and use of NOL carryovers).
12. Sections 346(j) should be repealed (Sections 1398 and 108 address the applicable issues - income from cancellation of debt, tax attributed reduction, etc.)

Section 728

1. Section 728(a) should be repealed. (Section 1398 provides that the estate's year ends the day before the petition is filed if the election for a short year is timely filed).
2. Section 728(b) should be repealed (provisions regarding the requirement of the filing of returns are now included in §346 (see item 3).
3. Section 728(c) and (d) should be repealed. (With the suggested changes above, we see no useful purpose for these provisions).

Section 1146

1. Section 1146(a) should be repealed. (Section 1398 provides that the estate's year ends the day before the petition is filed if the election for a short year is timely filed).
2. Section 1146(b) should be repealed (provisions regarding the requirement of the filing of returns are now included in § 346 (see item 3)).
3. Section 1146(c) dealing with stamp and similar taxes is not addressed.
4. Section 1146(d) dealing with the request to determine the tax impact of a plan is listed as a separate item and should not be dealt with here. (It is a controversial issue.)

Section 1231

• Section 1231 should be repealed - a separate estate is not created in chapter 12.

This proposal is a direct response to the situation created by the commencement of an involuntary bankruptcy case under chapter 7 or 11 of the Bankruptcy Code. Presently, IRC §1398(d)(2) links the period by which an election must be made to the date the petition in bankruptcy is filed. This poses no problem in a voluntary case commenced under 11 U.S.C. §§301-302 (the date the petition is filed is also the date an order for relief is entered in the bankruptcy case). However, in an involuntary case commenced under 11 U.S.C. §303, the petition may be filed sometimes months before the order for relief is entered by the court, if ever. During the involuntary gap period, the debtor may continue to operate as though no bankruptcy case has been filed. There appears no reason to link the election under IRC §1398(d)(2) to the filing of the petition in these circumstances. Rather, the more appropriate event to link the beginning of the time period by which to make the (d)(2) election is the entry of the order for relief.

Some confusion exists as to whether the bankruptcy estate is exempt from the Alternative Minimum Tax ("AMT"). Presently, some bankruptcy trustees take the position that the bankruptcy estate is exempt from the AMT but may employ capital gains treatment. These inconsistent positions should be reconciled.

Some confusion has surrounded the use of the term "assessment" in the Bankruptcy Code when used in reference to state and local taxing authorities. Some taxing authorities have no assessment procedure whatsoever, some taxes are self-assessed, etc. The purpose of this proposal is to provide to the extent possible a universal definition of assessment, regardless whether conventional "assessment" procedures are employed. The problem at which this proposal is addressed arises only with respect to state or local tax collections. Thus, any definition of the term "assessment" should be specifically limited to state and local tax purposes to avoid any confusion about the meaning of the term for federal purposes. The proposal is not meant to define "assessment" in §1129(a) or to imply that the event of "assessment" or some other trigger is more or less appropriate under that section.

The Advisory Committee recommends that 11 U.S.C. §1125(b) be amended to require a discussion of the potential material federal and state tax consequences of the plan to the debtor and any entity created pursuant to the plan, and a discussion of the potential material federal tax consequences of the plan to a hypothetical investor typical of the holders of claims or interests. A failure to discuss the potential tax consequences of a plan of reorganization in the disclosure statement can result in seriously misleading creditor constituencies and other parties in interest about the plan's economic effects. See Smith v. Bank of New York, 161 B.R. 302 (Bankr. S.D. Fla. 1993). There is no justification for allowing a plan proponent to ignore a plan's tax consequences in the disclosure statement. A plan's tax consequences represent an important aspect of the plan and should be fully discussed to the extent they are material. A chapter 11 debtor or other plan proponent who possesses the financial resources to propose a plan of reorganization and draft a disclosure statement is likely to possess the necessary resources to analyze the plan's tax effects. A debtor or other plan proponent cannot be expected to provide each creditor with individually tailored tax information; it would be impractical and unreasonably expensive. On the other hand, addressing the material federal tax matters affecting a hypothetical creditor or equity security holder in each class created under the plan is not burdensome, and a plan proponent fairly can be required to supply such information in its disclosure statement.

In chapter 7, §726(a)(1) allows a tardily filed claim for a priority tax if the claim is "filed before the date on which the trustee commences distribution." One court held that the date the trustee commences distribution is the date when the court approves the final report and accounting of the trustee. In re Wilson, 190 B.R. 860 (Bankr. E.D. Mo. 1996). The court rejected the State of Missouri's argument that the date the trustee commenced distribution was the date the checks were mailed and rejected the trustee's argument that distribution commenced when the trustee's final report was sent to the United States Trustee for approval. The Advisory Committee proposes that the language to §726(a)(1) be changed from "the date on which the trustee commences distribution" to "the date on which the court approves the final report and accounting of the trustee." The Advisory Committee's proposal is a housekeeping amendment designed to minimize future litigation that may arise from a literal reading of the statute.

Consensus on additional chapter 13 requirements regarding, among others, the filing of returns:

The Advisory Committee has reached a consensus on filing return requirements in chapter 13 cases. [ FN: Comment by SC: Tax return filing has been a significant problem in a large number of chapter 13 cases. Track No. 441 would require the filing of tax returns as a condition of confirmation of a chapter 13 plan. The proposal also has a number of other elements, including postponement of confirmation until the returns are filed. I am concerned that the Consumer Working Group or the Commission may view some of these other elements as overly burdensome and may recommend that the package of proposals be modified. I would like to take this opportunity to express my views that the essential elements of any proposal relating to tax return filing requirements in chapter 13 are as follows: (1) the filing of prepetition tax returns should be an express requirement of chapter 13; (2) the failure to file such returns should be treated in the same manner as the failure to file schedules, a budget, or information requested by the chapter 13 trustee; (3) the chapter 13 trustee should police compliance with this requirement either at the §341 meeting as proposed or otherwise; (4) confirmation should be postponed, as proposed, but the taxing authority should be allowed to waive this requirement by agreement with the debtor in return for a firm deadline for filing the returns and such other consideration as may be agreed upon; (5) if a plan may be confirmed before all returns are filed, the confirmation should be considered conditional and the debtor should be required to amend the plan when the returns are filed; and (6) the debtor should not be permitted to file an objection to a proof of claim for a tax for which the debtor has not filed a tax return.] Following is an outline of the proposal.

1. As a prerequisite for confirming a chapter 13 plan, a debtor must have filed tax returns for all tax periods ending within six years prior to the petition date. A debtor's written consent to a substitute for return prepared by a tax authority or written stipulation to a judgment in a nonbankruptcy tax tribunal will constitute a "filed return" for purposes of this proposal.
2. Prepetition tax returns must be properly filed with the appropriate tax authorities at least one day prior to the conclusion of the first meeting of creditors. At or before the conclusion of the first meeting of creditors, the debtor must file with the court a statement certifying, under penalty of perjury, that all required tax returns for the relevant periods have been properly filed with the appropriate tax authorities. The chapter 13 trustee may require that a debtor submit copies of returns to the trustee.
3. If tax returns have not been filed by the date on which the first meeting of creditors commences, the trustee may continue the first meeting to allow additional time to file returns. The additional time allowed shall be no longer than (1) 120 days from the order for relief for returns that are past due as of the order for relief, or (2) for returns not past due as of the order for relief date, the latter of (i) 120 days from the petition date or (ii) the automatic extension date for filing a return under applicable tax law.
4. Failure to timely file tax returns by the above deadline for prepetition returns, or by due dates (including extensions pursuant to applicable tax laws) for postpetition returns, shall constitute cause for conversion or dismissal under §1307(c).
5. The court, for good cause shown due to circumstances for which the debtor should not justly be held accountable, may extend the return-filing deadline. Dismissal or conversion would be automatic if such extended deadline were missed.
6. The deadline for objecting to plan confirmation shall be at least sixty days after prepetition tax returns are filed with the tax authorities.
7. A debtor may not file an objection to a proof of claim for a tax required to be reported on a return unless the debtor has filed a return for that tax.
8. The §502(b)(9) "governmental bar date" will be modified (for tax claims only) to allow tax authorities sixty days from the filing oftax returns by debtors to file proofs of claim; provided, however, that this modification will not have the effect of shortening the governmental bar date in any case.

Rationale. Part 1 - The requirement for six years of returns reflects a compromise on the part of tax authorities, who generally oppose discharge in bankruptcy for any period for which a debtor/taxpayer has failed to file returns. In response to concerns expressed by debtor and trustee representatives at the Commission sessions in Santa Fe and San Diego that requiring an unlimited number of returns to be filed would discourage bankruptcy non-filers from "re-entering the system," tax authority representatives indicated a willingness to compromise on a limited number of years if return filing was an absolute prerequisite for confirmation and thus, indirectly, discharge. Six years was generally agreed to be a reasonable period for requiring returns to be filed.

Part 2 - The requirement that returns be filed at least one day before the completion of the §341 meeting would allow chapter 13 trustees to ask two important questions at §341 meetings:

1. Have you filed your tax returns for the six-year prepetition period?
2. Does your plan provide for payment of the amount of taxes reflected in your returns?

If returns have been filed at least one day before the §341 meeting, a trustee (or tax creditor) may ask for copies or other evidence of filing. The debtor would not be in a position to say, "I’m filing them today" (or tomorrow or next week or next month), but would have to answer yes or no as to an event occurring in the past. If the answer to the second question is that the preliminary plan does not provide for payment matching the returns, then the trustee would presumably not recommend confirmation until the discrepancy had been corrected.

Part 3 - Part 3 also reflects a compromise on the part of tax authorities and debtors. A stricter standard of requiring that tax returns be current as of the petition date might delay or deny bankruptcy relief to debtors who need it for nontax reasons (pending home foreclosure or carrepossession, for example). A looser standard of allowing returns to be filed up until the government claim bar date (180 days from petition date) would put large-volume tax authorities under an unrealistically short deadline to file or amend claims and create havoc or delays in the confirmation process. The anticipated procedure in cases would be that the trustee would determine at the initial §341 meeting if a debtor has filed necessary tax returns. If not, but the trustee is satisfied that the debtor is making a reasonable effort to get the returns prepared and filed, the trustee may continue the §341 meeting for up to 120 days or until the last available extension for a prepetition return. (For example, a chapter 13 debtor filing a bankruptcy petition on January 1, 1997, would have the option under tax law of obtaining an extension through August 15, 1997, to file a 1996 income tax return. Extensions for earlier years would have expired by the petition date).

Part 4 - Rather than automatic dismissal for failure to file tax returns (a position tax authorities had originally advocated), the failure to file returns would be added to the other "causes" for dismissal or conversion contained in §1307. Most courts now dismiss or convert cases when debtors have failed to file tax returns. That practice would be codified.

Part 5 - Part 5 provides a "safety valve" in case the debtor has made a good faith effort to get returns prepared and filed, but for unanticipated reasons beyond the debtor’s control (delay in receiving necessary information from tax authorities or incapacitating injury, for example) has been unable to do so. Again, this provision is a compromise on the part of tax authorities, whose initial preference was for an absolute cutoff point for filing returns.

Part 6 - Part 6 addresses two issues: (1) How long should tax authorities be given to act upon filed returns?; (2) Can confirmation proceed before priority tax debts have been determined? From the perspective of debtors and other creditors, problems are created when the entire bankruptcy process must be put on hold while tax authorities determine what they are owed. The proposed sixty-day period would force tax authorities to act in a reasonably prompt manner to protect their claims at confirmation. From the tax authorities’ perspective, it is a considerable waste of time and effort to either have to estimate (and later amend) claims for tax periods for which no returns have been filedor to file a "place-holding" confirmation objection that says, in essence, "We don’t know how much we’re owed, so don’t confirm a plan until we find out." Part 4 of the proposal attempts to strike a reasonable balance: debtors must file returns before confirmation can proceed, but the confirmation process can proceed fairly quickly after returns are filed. Part 6 would end the practice in some districts of confirming chapter 13 plans before the amount of priority tax debt is known. Such practice creates a number of legal and practical issues. First and foremost, how can a court assess feasibility of a plan under §1325(a)(6) if the amount of priority tax debt that must be paid in full cannot be determined? The practice of taking the debtor’s word for the amount owed, or simply ignoring the issue, is contrary to reason and common sense. From a procedural standpoint, confirmation of a plan before tax debts are determinable results in a "preliminary confirmation order." Are such orders appealable as final orders? Do they have res judicata effect on tax creditors, or on other creditors if modification is required in the future? Who is responsible for undoing or modifying the preliminary confirmation order after tax claims are filed? Such questions are eliminated under this proposal. Part 6 of the proposal takes debtors who are delinquent in filing prepetition returns off the "confirmation fast track" as long as the delinquency continues. Debtors who are current on their returns as of the order for relief date or, at least the date of the §341 meeting, would remain on the "fast track" in jurisdictions that do early confirmations. The disparate treatment does not seem out of line, since it rewards debtors who have complied with the tax laws (or who promptly cure noncompliance) and delays those who are delinquent. From a procedural and policy standpoint, more time should be taken to deal with debtors who have difficulty bringing their tax returns current. Failure to file tax returns is often indicative of other financial problems that need to be addressed, and the proposal above would serve to red flag potential problem cases needing extra attention, appropriately taking them off the confirmation "fast track".

Parts 7 and 8 - As noted above, the practice of filing estimated, "place holding" proofs of claim for periods for which no returns have been filed creates a number of problems for tax authorities, debtors and courts. Tax authorities must spend considerable time and effort preparing debtor-specific estimated proofs of claim, which is a monumental task given the volume of chapter 13 filings. The task is unnecessary ifdebtors comply with return-filing obligations applicable to non-debtors, and the effort is simply wasted if returns are later filed and processed into amended proofs of claim, thereby mooting the estimated claims. Further, tax authorities are in a "no-win" situation on estimated proofs of claim. Some courts have directed tax authorities to file claims labeled as estimates to protect their position, while other courts have sanctioned tax authorities for filing incorrect estimates. Debtors resent estimated proofs of claim that may overestimate the amount of taxes owed, and "burden of proof" procedural battles often erupt in such cases. Courts are faced with hearing claim disputes with a dearth of evidence (due to returns being unfiled). To avoid such difficulties, a simple rule is proposed: returns must be brought current before debtors can proceed with claim objections. Note: this would not prevent debtors from objecting to audit claims covering periods for which returns have been filed. Consistent with the intent to eliminate "place-holding" estimated proofs of claim, the governmental claims bar date is proposed to be adjusted to allow tax claims to be filed based upon the returns filed by debtors, rather than estimates. [ FN: Comment by JP: While I strongly support requiring the filing of tax returns as a prerequisite to the confirmation of a chapter 13 plan, I prefer the details of implementation to be left to the discretion of the court. I do, however, see the necessity of a statutory enactment modifying the bar date for taxing authorities, as proposed in paragraph 8.]

Three additional notes to proposal: 1. "Filing of returns" presumes returns are properly filed -- i.e., with the right agency, at the right address, with the right tax identification numbers, with the requisite signatures, and subject to penalties of perjury/false filing. If not taken up in the context of discussion on "notice rules", such presumptions may need to be added to this proposal. 2. This proposal impacts Track No. 441(a), captioned "Obligation of a chapter 13 debtor to pay all priority taxes when a proof of claim for such taxes is not filed," but does not purport to resolve Track No. 441(a) altogether. 3. "Returns" for purposes of this section would include substitutes for return that the debtor has signed and nonbankruptcy tax tribunal stipulations ofliability. [ FN: The representative of the IRS has reservations on the issue of what constitutes a filed return. For dischargeability purposes under Bankruptcy Code §523, the IRS position is that the Internal Revenue Code definition controls See Track No. 513(b).]

There is consensus on the Advisory Committee that an income tax return prepared by the taxing authority should not be considered a filed income tax return for purposes of the Bankruptcy Code.

If there is no proposal from the Consumer Working Group on this subject, the Advisory Committee, by consensus, recommends the following proposal to dismiss and enjoin certain chapter 13 cases:

There is a wide variance among districts around the country in terms of whether serial filing is a problem. The particular focus of tax authorities is on chapter 13 repeat filers, although the problem can also occasionally arise in individuals' chapter 11 cases. In some districts, effective monitoring of "serial filers" by chapter 13 Trustees and/or courts limits the numbers of such cases to minimal levels. In other districts, it is not uncommon for debtors, particularly small business debtors, to file 4 or 5 or more cases in a 5-10 year span, incurring substantial new tax debts all the while and without a material change in the debtors' circumstances. Such cases require an inordinate amount of resources of chapter 13 trustees, the court system and tax creditors. Some serial filers essentially use the bankruptcy system as a revolving door through which to duck when tax authorities undertake collection efforts. Many "serial filers" have no real hope of ever repaying constantly-increasing tax debts in full, as required by §§ 1322(a)(2) and 1129(a)(9). Bankruptcy Judge Polly Higdon of Oregon presented data substantiating this problem at the September 1996 Commission meeting in Santa Fe.

The present Bankruptcy Code provides only limited tools to creditors, trustees and judges to deal with abusive serial filers. Bankruptcy Code § 109(g) prevents serial filings only if (1) a prior case was dismissed by the court for "willful failure" to abide by court orders or to appear before the court in prosecution of the case, or (2) the debtor voluntarily dismissed the case after a creditor's filing of a request for stay relief. Although the case law is split, some courts have held that the limited circumstances described in §109(e) constitute the only grounds for dismissing a case with prejudice. In re Merrill, 192 B.R. 245, 252 (Bankr. D. Colo. 1995)("Although abuse of the bankruptcy system and creditors by frequent or repeat filers is a well-known problem, Congress has not chosen to combat the problem by authorizing courts to barabusive debtors from future bankruptcy relief." Debtor had filed 7 bankruptcy cases (6 chapter 13's and 1 chapter 7) between 1987 and 1995, incurring substantial additional tax liability during that time. Case dismissed on motion of state tax authority, but without prejudice to refiling.); In re Jones, 192 B.R. 289 (Bankr. N.D. Ga. 1996) ("The Court is persuaded that it cannot deny a debtor future access to bankruptcy protection except as provided by the Bankruptcy Code.... The Court understands the frustration of the IRS caused by repetitive filings. But, it is not the role or power of the judiciary to remedy a legislative statute by opinion. Congress easily can change the statute whenever it is so inclined." The Debtor was an optometrist who had filed 3 cases in 3 years, accumulating more than $277,000 of tax debt to the IRS.) Alternative remedies. One way to address the problem of abusive serial filers would be to provide for dismissal with prejudice if a certain number of cases have been unsuccessfully attempted within a certain period of time --e.g., no more than 3 petitions within 5-year period. The primary downside to such arbitrary limits is obvious, however. Not all serial filings are abusive. A debtor legitimately pursuing chapter 13 rehabilitation may lose his or her job, go through a divorce, incur a serious personal injury or face similar uncontrollable circumstances that may require starting over to achieve a discharge. To avoid inflexibility, but to provide courts the ability to police abusive filers, a less-draconian remedy is possible. Proposed solution. Amend §§ 1307 and 1112 to give bankruptcy judges discretion to dismiss cases with prejudice to refiling under chapter 13 or 11 for a period determined by the court. A non-exclusive laundry list of relevant factors for courts to consider in dismissing with or without prejudice would give courts some guidance, without compelling a result in a particular case. The factors to be considered would include:

(i) the number of prior cases filed by the debtor;

(ii) the extent to which new debts to creditors, including tax debts, have accrued during the present case or prior cases;

(iii) the good faith, or lack thereof, of the debtor in pursuing plan confirmation and plan compliance in the pending case or prior cases; and

(iv) the reasons why successful completion of prior cases did not occur.

This would give judges the flexibility to keep the bankruptcy courts open to the "honest, but unfortunate" debtor who suffers job loss, personal injury, etc., but would at the same time allow judges to exclude from the bankruptcy system for a period of time the "revolving door" debtors.

Other proposals before the Commission. None at present, although the Consumer Working Group is believed to be discussing the "serial filer" problem. Preliminary discussion in the Consumer Working Group has focused on possible "up front" hurdles that a repeat-filer debtor would have to clear before proceeding in a new case. The foregoing proposal addresses the "back end" of a case -- i.e., whether the case is dismissed with or without prejudice -- and is designed to be complimentary to any "front end" proposal that the Consumer Working Group may make. The "back end" focus is particularly appropriate in the tax area, because it is at the end of the case that a court can determine if a debtor has incurred postpetition tax liability in violation of 11 U.S.C. §364(b) (that requires court authorization to incur postpetition debt out of the ordinary course of business) and 28 U.S.C. § 959(b) and 960 (that require trustees and debtors in possession to operate businesses in compliance with state law, including tax laws). In summary, this proposal is made independently of any "front end" controls on serial filers that may be proposed by the Consumer Working Group, but it should work in tandem with any proposal that may come from that group.

SECTION 2

A date of discharge in bankruptcy cases should be fixed for purposes of tax attribute reduction.

Under present law, it is unclear whether when the estate pays estate assets to the debtor those payments should be treated as ordinary income, 1099 income, or a distribution. See PLR 8728056 (April 15, 1987). The proposal provides that payments of estate assets to the debtor for services performed are to be treated as ordinary income, providing the estate with a corresponding deduction. It is not the intent of the Advisory Committee to suggest that income from future services performed postpetition by the individual debtor is itself property of the estate. See 11 U.S.C. §541(a)(6). Rather, this clarification speaks to property that is already property of the estate that the estate seeks to use to pay the debtor for services performed.

&

436(a)Tax treatment of the sale by the estate of a debtor’s homestead.

Under current law, an individual over the age of fifty-five can sell a personal residence and exclude $125,000 of gain. There is bipartisan support in Congress to raise the exclusion amount, make it available to all taxpayers, regardless of age, and make it available every two years. See Dep't of Treasury, Taxpayer Bill of Rights 3 and Tax Simplification Proposals 19 (April 16, 1997). The exclusion is not available to bankruptcy estates because a bankruptcy estate cannot have a personal residence. Pergament v. United States (In re Barden), 105 F.3d 821 (2d Cir. 1997).

If Congress increases the amount of the exclusion and eliminates the age restriction, the Committee believes the exclusion should be available to bankruptcy estates. Not allowing the exclusion to the bankruptcy estate creates a hidden, nonuniform exemption and runs counter to the proposals to create uniform exemptions. All else being equal, debtors with low-basis residences receive a larger exemption than debtors with high-basis residences. Trustees recognize this and are less likely to sell the low-basis residence. Also, a hidden incentive is created to file for bankruptcy, if the debtor recognizes that the trustee will have to abandon the residence because of the burdens of secured debt, homestead, and tax gain on sale. For example, assume a capital gain on sale of $56,000 (.28 x $200,000). If the debtor sells the residence after filing for bankruptcy, the debtor keeps the $56,000 gain, in lieu of a payment to the unsecured creditors.

If Congress does not change the exclusion rule, the Advisory Committee believes the over fifty-five, once-in-a-lifetime exclusion should still be available to the bankruptcy estate, provided the estate's use of the exclusion does not eliminate the debtor's right to a once-in-a-lifetime use of the exclusion. The Advisory Committee suggests that the subsequent use of the exemption by the debtor be limited to the amount of the exclusion not used by the bankruptcy estate. For example, if the bankruptcy estate excludes $50,000 of gain from income, the debtorwould be limited to a $75,000 exclusion.

Under current law, if the trustee sells the personal residence, the trustee is responsible for 100% of the tax due. Waldschmidt v. I.R.S. (In re Lambdin), 33 B.R. 11 (Bankr. M.D. Tenn. 1983); and In re Card, 114 B.R. 226 (Bankr. N.D. Cal. 1990). This is true even if a substantial portion of the proceeds are distributed to the debtor in the form of an exemption. If uniform exemptions are adopted and if the exclusion rule is expanded and made available to bankruptcy estates, then the Committee believes current law should not be changed and the homestead should not carry tax. However, if wide variations in the personal residence exemption remain in the Bankruptcy Code, the Committee believes a pro rata share of the gain should be taxed to the debtor. The following ratio could be used: exemption paid to debtor is to amount realized from sale, as tax allocable to debtor is to total tax due on sale.

Statement for modified stock for debt exception to recognition of cancellation of indebtedness income and the preservation of tax attributes:

Under current law, if a corporation is reorganized pursuant to a chapter 11 plan, that corporation will not include in income any cancellation of indebtedness realized as a result of the plan. It will, however, be required to reduce its tax attributes, including net operating loss carryforwards ("NOLs"), capital loss and credit carryforwards, and assets basis in excess of post reorganization liabilities. Prior to the Omnibus Budget and Reconciliation Act of 1994 ("OBRA 1993"), the stock for debt exception provided an exception to the requirement that tax attributes be reduced by the amount of any excluded cancellation of indebtedness. Under current law, however, a corporation that issues stock to its creditors realizes substantial income from debt cancellation that must then be applied to reduce tax attributes. Thus, companies emerging from bankruptcy may have a tax balance sheet lower than their financial balance sheet with greater levels of income for tax purposes and a greater likelihood of liquidation over reorganization.

It is proposed that IRC § 108 be amended to provide that a corporation undergoing a reorganization in bankruptcy be permitted to make a fresh start election when undergoing bankruptcy reorganization. The election is identical to the proposed election of the ABA Tax Section Task Force on the Tax Recommendations of the National Bankruptcy Review Commission ("ABA Task Force") dated April 15, 1997, at 202-207.

Statement against:

Elimination of the stock for debt exception to the recognition of cancellation of indebtedness income generates tax revenue and preserves horizontal equity.

There is consensus among the members of the Advisory Committee that the Commission should recommend that Congress modify IRC § 1001 to provide that tax consequences of the transfer (for example, foreclosure or transfer in lieu of foreclosure) of an asset to satisfy a nonrecourse debt should be the same as a transfer to satisfy a recourse debt.

Under this proposal, the difference between the basis of the property and the fair market value of the property would be a gain or loss on transfer and the difference between the fair market value and the amount of the nonrecourse debt would be income from the cancellation of debt under IRC § 61. The tax treatment of income from cancellation of debt would be governed by IRC § 108. This treatment is consistent with the tax consequence of the transfer of property to satisfy recourse debt.

This change would overrule Commissioner v. Tufts, 461 U.S. 300 (1983), and follow the position taken by Professor Wayne G. Barnett in an amicus to the Tufts case. It would eliminate the problems that arise when recourse debt is converted to nonrecourse debt over which the taxpayer has no control such as when the trustee abandons property to the debtor. For example, in Private Letter Ruling 8918016 (January 31, 1989), the IRS ruled that the abandonment was not a taxable event to the estate but held that the recourse debt became nonrecourse as a result of the discharge.

Taxpayers that plan to transfer property to satisfy a nonrecourse debt often work out an agreement with the creditor to forgive all or part of the debt in excess of the value of the property as a separate transaction prior to transferring the property to avoid all of the gain being taxed as a gain on transfer. (Of course, if the taxpayer has capital loss carryovers, this agreement would be unnecessary.) This proposed change to § 1001 would eliminate action of this nature and the problems associated with attempting to determine if debt is recourse or nonrecourse or attempting to convert nonrecourse debt to recourse or visa versa depending on the needs of the taxpayer.

SECTION 3

Statement in support of proposal to retain present 11 U.S.C. §724(b), which requires subordination of tax liens to administrative expenses and priority claims in a chapter 7 case:

Under bankruptcy law, there is a long-standing bankruptcy policy beginning with the 1938 Chandler Act amendments that has subordinated tax liens to administrative expenses. On each subsequent occasion in which Congress has revisited the issue, it has broadened the extent of such subordination. If the bankruptcy system is to be viable, all administrative expenses must be paid. Failure to provide for administrative expenses will undermine the system in all cases. In some cases, failure to provide funds will prevent the trustee from recovering for all creditors, including governmental creditors, substantial assets. The Bankruptcy Code creates its own set of priorities, in which administrative expenses are superior to tax claims. In chapter 7 cases, this fundamental structure should not be nullified because a state legislative body gives itself a tax lien that results in circumventing the system of priorities created by the federal Bankruptcy Code. It may be that in some cases consensual secured creditors should contribute to administrative expenses of the estate, including property taxes. The Commission, if it feels that such change is needed, should deal with this question directly, rather than undermining the bankruptcy system through repeal of § 724(b)(2). Additionally, complexity in the current statute is not a ground for repealing it. If its underlying principles can be validated through simplification, let the Commission do it.

Statement against the proposal to retain §724(b):

The section is complicated and obscure, making it difficult to understand and apply. Thus, it is applied inconsistently or not at all, creating disparate results in different districts. The section imposes a hardship upon individual debtors because property that would havebeen used to pay nondischargeable tax debts, is instead used to pay dischargeable accountant’s and attorney’s fees. The section also works a particular hardship on local school districts and city/county governments that may be very dependent on the revenue at risk under §724(b). Additionally, §724(b) presents an ethical dilemma for tax authorities by discouraging them from moving to convert chapter 11 cases to chapter 7 cases in otherwise appropriate instances because of the availability of §724(b). The section encourages debtors and their attorneys to allow unsuccessful cases to linger in chapter 11 because they know that even if the case is converted to chapter 7, unpaid salary and attorney’s fees accrued in the case will ultimately be paid out of prepetition tax liens.

Expanding the scope of §506(c) would be a fairer method of dealing with the need to allow for the payment of truly necessary administrative expenses. Alternatively, if neither expansion of §506(c) nor an outright repeal of §724(b) is possible, it should at least be modified to limit its applicability to administrative and/or priority wage and benefit claims.

RECOMMENDATION:

By a vote of 5 to 4 (with 1 abstention), the Advisory Committee recommends to the Commission the repeal of 11 U.S.C. §724(b).

Vote:

For proposal to retain §724(b): PA, RMcK, GN, MS

Against proposal to retain §724(b): MB, SC, RM, JP, JW

Abstain: KW

Proposal 1:

IRS position that burden of proof in bankruptcy should follow applicable nonbankruptcy law:

Clarify that when an IRS determination of tax is challenged, the burden of proof is on the debtor or trustee unless the Internal Revenue Code shifts the burden. In our system of self-assessment and voluntary compliance with tax laws, because the taxpayer has control of the facts that govern the determination of tax, the taxpayer generally has the burden of proof in tax cases litigated outside of bankruptcy. In the Tax Court, generally the burden of proof is on the taxpayer for all issues raised in the statutory notice. Similarly, in refund or collection cases, an IRS assessment is presumed to be correct and the taxpayer has the burden of proving otherwise. In a bankruptcy proceeding, a proof of claim filed by a creditor is presumed to be correct, but the presumption essentially disappears when the debtor files an objection to the proof of claim. Some courts have concluded that this allocation of burdens overrides the allocation of burdens that generally applies in tax litigation and have placed the burden of going forward and the burden of persuasion on the United States. See Franchise Tax Bd. of Cal. v. MacFarlane (In re MacFarlane), 83 F.3d 1041, 1044-1045 (9th Cir. 1996), cert. denied , __ U.S. __ (March 17, 1997); Placid Oil Co., 988 F.2d 554 (5th Cir. 1993), non acq. 1995-1 C.B. 1; In re Premo, 116 B.R. 515 (Bankr. E.D. Mich. 1990); In re Fullmer, 962 F.2d 1463, 1466 (10th Cir. 1992); In re Gran, 108 B.R. 668 (Bankr. E.D. Ark. 1989), aff’d, 131 B.R. 843 (E.D. Ark. 1991), aff’d., 964 F.2d 822 (8th Cir. 1992); United States v. Coleman, 26 B.R. 825 (Bankr. D. Kan. 1983). Other courts have concluded that the burden of proof remains with the taxpayer/debtor. See In re Landmark Equity Corp., 973 F.2d 265 (4th Cir. 1992); Resyn Corp. v. United States, 851 F.2d 660, 663 (3d Cir. 1988). The proposal specifically provides that when an IRS determination of tax is challenged, the burden of proof is to be on the party who would have it under nonbankruptcy law.

Proposal 2:

Proposal to conform the government's burden of proof with the burden of proof for other creditors:

The government should not receive treatment different from other creditors in bankruptcy courts. The prevailing rule in circuits where the government has the identical burden as other creditors can be expressed as follows: A properly filed claim constitutes prima facie evidence of a claim's validity; the debtor has the burden of rebutting this prima facie validity; if that burden is met, the creditor must present evidence to prove the claim. Franchise Tax Bd. of Cal. v. MacFarlane (In re MacFarlane), 83 F.3d 1041, 1044-1045 (9th Cir. 1996), cert. denied , __ U.S. __ (March 17, 1997). A primary objection to leaving the ultimate burden on the government is that the taxpayer has the records. However, if the taxpayer does not produce those records, then the taxpayer cannot rebut the prima facie validity of the proof of claim. Thus, the issue of "who has the records" is a red herring. The proposed burden shifting rule also adds unnecessary work for the creditor or trustee who objects to the government's claim. The government's burden of proof should be identical to any other creditor's.

Proposal 3:

Proposal shifting burden to taxing authority upon proper showing:

A debtor should not be able to gain an advantage in a tax controversy with the government by litigating his claims in the bankruptcy court rather than a traditional tax tribunal. The allocation of the burden of proof should generally mirror the burden outside the bankruptcy court, including placement on the government in cases of fraud or where new issues are raised by the government at trial. The allocation of the burden of proof in tax matters results from the debtors personal knowledge of its own transactions. That rationale does not support uniformly placing the burden on the party objecting to a tax claim where the debtor is not the real party in interest. Where the trustee or a creditor files the objection, upon motion to the court, the court should be able to place the burden of proof on the government if, based uponprior audits of the debtor's return or other factors, shifting the burden would be equitable. In such case, the trustee or other objector should be required to turn over all records in its possession to the government.

RECOMMENDATION:

By a vote of 9 to 1, the Advisory Committee recommends the rejection of Proposal 2, which follows the McFarlane rule. By a vote of 9 to 1, the Advisory Committee endorses Proposal 1, the IRS proposal, and by a vote of 8 to 2, endorses Proposal 3, the burden shifting proposal. When asked to state a preference for one of the Proposals, 5 of the 10 members favored Proposal 3, 4 members favored Proposal 1, and 1 member favored Proposal 2.

Vote:

For Proposal 1: All Committee Members except KW

Against Proposal 1: KW

For Proposal 2: KW

Against Proposal 2: All Committee Members except KW

For Proposal 3: PA, MB, RMcK, GN, JP, MS, KW, JW

Against Proposal 3: SC, RM

Statement in support of the proposal:

Add as grounds for conversion or dismissal in chapter 11, 12, and 13 cases the following: failure to file prepetition tax returns; failure to file postpetition tax returns; and failure to file postpetition returns and pay postpetition taxes. The purpose of this proposal is to encourage a bankruptcy court to grant motions to dismiss or convert when the debtor fails to meet its tax obligations. While the failure on the part of the debtor to pay prepetition taxes would not be a basis for dismissal or conversion, the proposal contemplates that the continued failure to file prepetition tax returns, and the failure to file postpetition tax returns or pay postpetition taxes can be legitimate bases for dismissal or conversion, depending on the facts and circumstances. A debtor’s inability to become current will indicate problems for the feasibility of a reorganization plan. Passage of this proposal may also help to prevent a debtor from pyramiding employment taxes, a practice that insures the failure of many chapter 11 plans.

Statement against the proposal:

The devil is in the details. If Track 212 proposes that the nonpayment of postpetition tax for more than one period can be considered as one of many factors for converting or dismissing a chapter 13 case, then there is no objection. If Track 212 proposes making a chapter 13 case dismissable if any postpetition tax goes unpaid, then the objection is strong. Consider also the effects of such a proposed rule on 11 U.S.C. §1305(a)(1), which allows a governmental unit to file a claim for unpaid postpetition taxes.

RECOMMENDATION:

By a vote of 7 to 3, the Advisory Committee recommends that the Commission adopt the proposal.

Vote:

For proposal: MB, SC, RMcK, RM, GN, JP, JW

Against proposal: PA, MS, KW

Proposal 1:

Proposal to retain the current chapter 13 superdischarge:

The current superdischarge in chapter 13 should be retained. Chapter 13 provides a more robust discharge in return for greater recovery for creditors then they would have received in a chapter 7 case. The superdischarge breathes life into the fundamental bankruptcy policy of providing an individual debtor a fresh start. The major problem with Proposal 3 is that a court could read the requirement of an affirmative act to mean only a de minimis act.

Proposal 2:

IRS proposal to conform the discharge of chapter 13 to that of chapter 7:

Eliminate the superdischarge of priority taxes in a chapter 13 case, and clarify that postpetition taxes for which a proof of claim is filed under § 1305(a)(1) are not subject to discharge. The proposal would align the chapter 13 exceptions to discharge to those of chapter 7 and an individual chapter 11. The Bankruptcy Code now discharges a chapter 13 debtor from taxes that are provided for by the plan or are disallowed under § 502. Several courts have held that priority taxes mentioned in the plan are "provided for" and can be discharged whether or not they are actually paid. Similarly, claims for priority taxes that have been disallowed in the bankruptcy proceeding under § 502 and would not be dischargeable in a chapter 7 or 11 proceeding have been held to be dischargeable because they were mentioned in the chapter 13 plan. The problem most often arises in those cases where the Service’s claim was untimely filed or where the Service failed to file a claim at all. See In re Tomlan, 102 B.R. 790 (E.D. Wash. 1989), aff’d, 907 F.2d 114 (9th Cir. 1990) (untimely claim disallowed, then discharged); In the Matter of Border, 116 B.R. 588 (Bankr. S.D. Ohio 1990) (unfiled claim discharged); In re Ryan, 78 B.R. 175 (Bankr. E.D. Tenn. 1987) (prepetition tax claims assessed postpetition were discharged because noclaim filed). The most serious concern of the Service occurs with derivative liabilities, such as the trust fund recovery penalty, where the debt is prepetition but the determination of liability does not occur until after the bar date. Additionally, under present law a chapter 13 debtor may obtain a discharge for taxes fraudulently underreported or evaded more than 3 years ago. Certain tax penalties can also be discharged under chapter 13, although those same taxes and penalties would not be dischargeable for individuals in a chapter 7 or 11 case.

Proposal 3:

Proposal for modest modifications to the superdischarge of chapter 13:

Amend 11 U.S.C. §1328(a) to deny a discharge to those chapter 13 debtors who have filed fraudulent returns or who have engaged in an affirmative act or acts in an attempt to willfully and fraudulently evade a tax where the governmental unit proves in accordance with applicable nonbankruptcy law the fraudulent conduct in the bankruptcy case. Evidence suggests that taxing authorities receive a greater recovery in chapter 13 cases than they do in chapter 7 cases. In fact, the Bankruptcy Code recognizes this consequence in chapter 13 cases and provides incentives for individual debtors to seek relief under chapter 13. These incentives include relief from postpetition interest on unsecured tax claims, an expanded scope of the automatic stay, and the broad discharge in §1328(a). These incentives for filing under chapter 13 as opposed to chapter 7 should be continued. Thus, a broader scope of discharge is justified under chapter 13. At the same time, however, the chapter 13 process should not result in a haven from tax liabilities for those taxpayers that have defrauded a governmental authority. Although the requirement that any chapter 13 plan must be proposed in good faith may operate as a gate to prevent abuses of the bankruptcy process by tax protestors and defrauders, courts are not in agreement on the meaning of good faith in these circumstances and present law lacks clarity. Thus, a specific amendment to 11 U.S.C. §1328(a) is necessary to except from the scope of the chapter 13 discharge tax claims with respect to which the debtor made a fraudulent return or with respect to which the debtor engaged in an affirmative act or acts in an effort to willfully and fraudulently attempt to evade a tax where thegovernmental unit proves in accordance with applicable nonbankruptcy law the fraudulent conduct in the bankruptcy case.

Two related issues are directly affected by this proposal and are considered here. The first related issue is the strong argument by governmental units relating to notice of derivative tax liabilities. Presently, a chapter 13 plan may be confirmed in an expedited fashion without proper notice to taxing authorities regarding trust taxes. A notice provision along the lines as proposed in the Final Report should address this concern. The second but related issue concerns non-filers. Again, a related proposal seeks to address the nonfiler issue.

RECOMMENDATION:

By a vote of 8 to 2 and 6 to 4, respectively, the Advisory Committee recommends the rejection of Proposals 2 and 3, which state the IRS proposal and the proposal suggesting modest changes to the chapter 13 discharge, respectively. However, the Advisory Committee failed to reach a majority on remaining Proposal 1, which would retain the chapter 13 superdischarge in all respects. As to Proposal 1, 4 members voted for, 4 voted against, and 2 abstained. When asked to state a preference for one of the Proposals, 4 members favored Proposal 1, 4 members favored Proposal 3, and 2 members favored Proposal 2.

Vote:

For Proposal 1: PA, RMcK, MS, KW

Against Proposal 1: MB, SC, RM, JP

Abstain: GN, JW

For Proposal 2: SC and RM

Against Proposal 2: All Committee Members except SC and RM

For Proposal 3: MB, GN, JP, JW

Against Proposal 3: PA, SC, RMcK, RM, MS, KW

Statement by KW: At some point the door must open for tax debtors to reenter the system. I remain deeply concerned over the Government’s dischargeability proposal that would close the door or, at best, leave it only slightly ajar.

Proposal 1:

A proposal to amend §1129(a)(9) to require periodic payment for deferred payments of tax under §1129(a)(9), designation of interest rate used while making those deferred payments, and establishing a six-year period from the date of the order for relief by which such taxes are to be paid:

Section 1129(a)(9) should be amended. It has been agreed that to prevent unnecessary and time consuming litigation, the section should provide that where interest is required to be paid on priority taxes that the rate be determined by §6621(a)(2) of the Internal Revenue Code, without regard to IRC §6621(c), in effect as of the confirmation date. There is a consensus that because of prejudice to the taxing authorities and the greater risk of non-payment, the section should expressly provide for periodic payments (monthly or quarterly), and that balloon payments be prohibited. There has been a discussion that the statute be amended to provide for a fixed period over which payments should be made, regardless of whether the tax has been "assessed". It is agreed that the use of the word "assessment" can be confusing and sometimes difficult to apply to the types of taxes asserted by states (such as sales taxes). Thus, the proposal provides a period of up to six years from the date of the order for relief regardless of the age of the tax owed as the length of time over which payments may be made.

Proposal 2:

A proposal to maintain present §1129(a)(9):

Proposal 1 weakens the priority status of taxes by giving debtors an unreasonably long period of time to pay taxes that are past-due on the petition date. Under Proposal 1, if trust fund taxes are 4 years old on the petition date, debtors would have 10 years total to repay the taxes, including 6 years from the petition date, compared to 2 years under current law. This undermines the historic priority treatment Congresshas given taxes and encourages prepetition delay and abuse of the tax system. Further, the proposal allows "stairstep" payment plans, with no increase in post-confirmation interest rates to reflect the heightened risk compared to straight-line amortization payments. There is no prohibition on payments to general unsecured creditors in cash or stock (which can be sold for cash) while so-called "priority" tax creditors are being stretched out. Essentially, the "priority" and risk of default as between general unsecured and "priority" creditors have been reversed. By comparison, general unsecured creditors in Chapters 7, 12 and 13 get paid nothing until priority claims are paid in full. Finally, the asserted need to abandon "assessment" as the commencement date for measuring the tax pay-back period is greatly exaggerated. "Assessment" is a well-defined and well-understood term under federal tax law, and adequate case law has developed to deal with state and local tax laws that do not define "assessment." Cases have generally considered the tax return due date or date of audit liability notification as being "assessments" under state and local law, and the state of the law in this respect is adequate.

Proposal 3:

IRS proposal to modify §1129(a)(9):

The appropriate interest rate should be the IRC § 6621 rate. Section 1129(a)(9)(C) should be clarified to require that payments pursuant to the plan must be in equal payments, no more than three months apart, with no authority for a plan term providing for a balloon payment or the back-loading of distributions. No change should be made in the current requirement that deferred payments must be completed no later than six years from the date of assessment for prepetition assessments and the confirmation date for assessments made postpetition and preconfirmation.

RECOMMENDATION:

By a vote of 7 to 3, the Advisory Committee recommends that the Commission adopt Proposal 1. All 7 members who voted for Proposal 1 also identified the Proposal as their preferred proposal, whereas 1 member preferred Proposal 2, and 2 members preferred Proposal 3.

Vote:

For Proposal 1: PA, RMcK, GN, JP, MS, KW, JW

Against Proposal 1: MB, SC, RM

For Proposal 2: MB, GN, JW

Against Proposal 2: PA, SC, RMcK, RM, JP, MS, KW

For Proposal 3: MB, SC, RM, JP

Against Proposal 3: PA, RMcK, GN, MS, KW, JW

Proposal 1:

Proposal to modify the stay to permit setoff of prepetition tax refunds against prepetition tax claims:

Permit taxing authorities to setoff prepetition refunds against prepetition taxes without first seeking relief from the automatic stay. Under §362(a)(7), the filing of a petition in bankruptcy stays the setoff of any debt owed to the debtor that arose before the commencement of the bankruptcy case against any claim against the debtor. None of the exceptions to this stay apply to setoffs of tax liabilities against tax credits or refunds. Thus, while the stay is in effect, a taxing authority is not allowed to setoff a prepetition refund owed to a taxpayer regardless of whether the taxpayer owes taxes of a different nature or for different taxable periods. A proposed change to §362(b) would remedy this situation by allowing a taxing authority to setoff prepetition refunds against prepetition taxes owed by the debtor.

Outside the context of a bankruptcy proceeding, tax overpayments are routinely and systematically credited by the IRS against outstanding tax liabilities by computer, pursuant to I.R.C. § 6402(a). Notice that an overpayment has been credited against a tax liability is automatically issued to the taxpayer by the Service Center.

When the IRS receives notice of a bankruptcy proceeding, the Service Center is notified by the local Special Procedures Function (SPF), and routine offsets by the computer at the Service Center are prevented by the input of a freeze code. The actions taken by the IRS with respect to the overpayment vary depending upon the judicial district. In most judicial districts, the overpayment is simply frozen and remains so until court action is initiated by the IRS or the debtor and/or trustee. IRS instructions provide that these cases may be referred to counsel for lifting of the automatic stay so the amount can be collected by setoff during the pendency of the bankruptcy.

The IRS function responsible for preparing and filing proofs of claim inbankruptcy cases is the Special Procedures Function ("SPF"). When a proof of claim is prepared by SPF, the taxpayer’s account is researched by reading the computer file of that taxpayer maintained at the Service Center. If this research reveals the existence of an overpayment, the amount of the overpayment is listed on the proof of claim form. The debtor/trustee can dispute the application of the overpayment by filing an objection to the proof of claim. Even if the setoff has already occurred, there is no question that relief can be provided if the court so determines.

In many jurisdictions, local rules or standing orders authorize the IRS or other taxing authorities to offset tax refunds against tax liabilities subject to different local law imposed conditions.

Proposal 2:

IRS proposal to modify stay to permit setoff of tax refunds against prepetition tax claims and postpetition nondischargeable tax claims:

The IRS proposal would go further by permitting the setoff of postpetition tax refunds against taxes excepted from discharge. Section 553 refers specifically to the offset of prepetition debts owed to a debtor against prepetition claims. Thus, it allows only the setoff of prepetition tax refunds against prepetition tax claims. It is not equitable to require a taxing authority to make a refund to a debtor at a time when the debtor owes a nondischargeable tax. The proposed amendment would allow a government unit to offset a postpetition refund against a prepetition nondischargeable tax.

Proposal 3:

Proposal that no change in the law is necessary:

Where the need for an order permitting setoff of tax refunds is necessary and appropriate, a particular district may enter into a standing order permitting such setoff. Otherwise, the taxing authority may seek relief from the stay in appropriate circumstances. A major problem with Proposal 1 is that it does not contain a notice provision for the debtor or other creditors who might have a claim to the refund. Proponents forchange have failed to make their case.

Proposal 4:

Proposal to overrule all standing stay orders and to retain the stay against setoff:

The taxing authority should have no greater rights to setoff than any other creditor. Overruling standing stay orders that exist in some districts would promote uniformity. The taxing authority may seek relief from the stay in appropriate circumstances.

RECOMMENDATION:

By a vote of 8 to 1 (with 1 abstention), the Advisory Committee recommends that the Commission adopt Proposal 1. The Advisory Committee recommends that the Commission reject Proposal 2 by a vote of 6 to 4 and Proposal 4 by a vote of 9 to 1. The Advisory Committee is split 5 to 5 on the merits of Proposal 3. As to preferences, the Advisory Committee is split, with 4 members preferring Proposal 1 and 4 members preferring Proposal 2.

Vote:

For Proposal 1: MB, SC, RMcK, RM, GN, JP, MS, JW

Against Proposal 1: PA

Abstain: KW

For Proposal 2: SC, MB, RM, JP

Against Proposal 2: PA, RMcK, GN, MS, KW, JW

For Proposal 3: PA, RMcK, GN, MS, KW

Against Proposal 3: MB, SC, RM, JP, JW

For Proposal 4: PA

Against Proposal 4: All Committee Members except PA

Proposal 1:

Proposal to preserve status of tax claims in subsequent bankruptcy plans or liquidation cases following a failed plan or dismissal:

Existing law is unclear with respect to whether a taxing authority can take administrative collection action when a plan is dismissed or the debtor defaults on payment of taxes. The taxing authorities take the position that tax claims remain collectable as taxes in the event of a dismissal of a bankruptcy or a default by the debtor as to the terms of payment of taxes under the plan. Some debtors have argued, however, that the only remedies upon dismissal or default are contractual. The uncertainty regarding the rights of taxing authorities leads to needless litigation and requires clarification. The rights of taxing authorities to collect tax debts as taxes rather than as contractual claims in the event a bankruptcy is dismissed or the debtor defaults by failing to comply with the terms of payment of taxes under a plan should be clarified.

Statement against the proposal:

The priority status of a tax claim provides certain negotiation rights that are limited to the initial confirmed plan. Once the plan has been confirmed, the priority tax claim is replaced with a contract claim based on the terms of the plan.

Proposal 2:

Proposal 1 above with the addition that the taxing authorities may not begin to collect the tax after default on payment of taxes until the taxing authority has provided thirty-days’ notice of the default to the taxpayer:

The thirty-day notice requirement provides the taxpayer reasonable notice without unduly burdening the taxing authorities. A notice provision should also permit the debtor/taxpayer an opportunity to cure any default and promote the reorganizational efforts of the debtor. Also, status of a tax claim as priority, or not, should not be frozen by theChapter 11 plan if there is a subsequent default.

RECOMMENDATION:

By a vote of 7 to 3, the Advisory Committee recommends to the Commission the adoption of Proposal 2. By a vote of 6 to 4, the Advisory Committee recommends to the Commission the adoption of Proposal 1. As to preferences, the Advisory Committee prefers Proposal 1 to Proposal 2 by a vote of 6 to 4.

Vote:

For Proposal 1: MB, SC, RM, GN, JP, JW

Against Proposal 1: PA, RMcK, MS, KW

For Proposal 2: PA, RMcK, GN, MS, KW, JP, JW

Against Proposal 2: MB, SC, RM

IRS proposal to extend tolling to installment agreements:

Provide that the 240-day period after the filing of a petition, in which taxes must be assessed in order to be entitled to priority treatment, is suspended for installment agreements in the same manner as it is suspended for offers in compromise. Under current law, taxes that are assessed within 240 days of the date of petition in bankruptcy are entitled to eighth priority. If an offer in compromise is made by the taxpayer within 240 days of the assessment date, the IRS refrains from taking collection action during the pendency of the offer, the time during which the offer was pending plus 30 days is added to the 240 days. There is nothing under current law that similarly applies if an installment agreement is entered into within 240 days of the assessment date, even though the IRS is prohibited from collection action while the installment agreement is in effect. The purpose of this proposal is to treat installment agreements the same as offers in compromise. Otherwise, the IRS is disadvantaged by entering into an installment payment agreement in return for a deferral of collection.

Statement against tolling priority periods where an installment agreement is outstanding:

The IRS recommendation to stay the 240-day period for installment agreements should be rejected unequivocally. Given the frequency with which installment agreements are entered, this rule could make the nondischarge period for a tax unlimited. This is especially true since the collection division of the IRS is very skilled at convincing taxpayers that installment agreements are in their best interest and the statute of limitation on collection must be extended as part of the installment agreement process.

The IRS's proposed rule would harm compliant taxpayers who are try