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Government Working Group

Proposal # 9: Repeal Bankruptcy Code Section 1231(b)


Bankruptcy Code section 1231 generally sets forth special tax provisions applicable to cases filed under chapter 12. [ FN: 8 L AWRENCE P. K ING , C OLLIER ON B ANKRUPTCY ¶ 1231.01 (15th ed., revised 1996).] Section 1231(a) states that, for state and local income taxes, the petition date terminates the taxable period applicable to the individual debtor. [ FN: In cases converted from chapter 7, the relevant date for 1231(a) purposes is the day on which an order for relief is entered. 11 U.S.C. §1231(a).] Section 1231(b) directs the chapter 12 trustee to:

". . . make a State or local tax return of income for the estate of an individual debtor in a case under this chapter for each taxable period after the order for relief under this chapter during which the case is pending."


Repeal 11 U.S.C. § 1231(b).

Reasons for Change

Internal Revenue Code section 1398 creates a separate taxable entity for the chapter 7 and chapter 11 case of the individual debtor. [ FN: 26 U.S.C. §1398(a) ( "[T]his section shall apply to any case under chapter 7 (relating to liquidations) or chapter 11 (relating to reorganizations) of title 11 of the United States Code in which the debtor is an individual ").] Income from the new taxable entity, the estate, is earned by the estate. Accordingly, the estate must file tax returns and pay taxes rather than the debtor. In this instance, it is obvious and appropriate for the trustee to file state and local tax returns on income from property of the estate, as the trustee is the named fiduciary.

On the other hand, Internal Revenue Code section 1399 precludes creation of a separate taxable entity in other cases, such as chapters 12 and 13. [ FN: 11 U.S.C. §1399 (Except in any case to which section 1398 applies, no separate taxable entity shall result from the commencement of a case undert title 11 of the United States Code ").] This is because in both chapters, postpetition income of the debtor is used both for "estate" purposes, such as to fund payments under the plan of reorganization, and for personal purposes, such as to buy groceries. Thus, neither the chapter 12 or chapter 13 bankruptcy estate is liable for taxes. This obligation remains with the individual debtor.

Sections 1398 and 1399 pre-date the enactment of chapter 12. [ FN: Bankruptcy Judges, United States Trustees and Family Farmer Bankruptcy Act of 1986, Pub..L. No. 99-554, 100 Stat. 3088.] At the time of the adoption of the "separate entity" rules for certain debtors, Congress intentionally omitted chapter 13 cases, reasoning that chapter 13 plans are funded with the debtor’s postpetition earnings and after-acquired property. [ FN: S. R EP . No. 1035, 96th Cong., 2d Sess. 25 (1980). See also , H.R. R EP . No. 833, 96th Cong., 2d Sess. 20 n.2 (1980)( "In a chapter 13 case. . . both future earnings of the debtor and exempt property may be used to make payments to creditors, and hence the bankruptcy law does not create the same dichotomy between after- acquired assets of the individual debtor and assets of the bankruptcy estate as in chapter 7 or chapter 11 cases ").]

The income of the chapter 12 individual debtor, like that of the chapter 13 debtor, is not exclusively part of the estate being used to pay creditors. Accordingly, there is no reason for the chapter 12 trustee to prepare the individual farmer’s state and local tax returns. Repealing section 1231(b) would thus conform the practice in chapter 12 to that of chapter 13, which does not require the trustee to file state and local tax returns for the debtor.

The Working Group’s understanding is that all interested constituencies regard this as an erroneous inclusion in chapter 12. There is no known opposition to its repeal. At least one group has commented favorably on the issue of reform of this section. [ FN: National Bankruptcy Conference, Reforming the Bankruptcy Code at 71 (May 1, 1994) (unpublished report on file with the National Bankruptcy Conference).]

Competing Considerations

The Working Group is aware of no competing considerations.


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