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Government Working Group

Proposal # 17: Require Taxpayers to Comply with Special Notice Procedures for Taxing Authorities When Special Audits are Requested Under Code Section 505(b)


It is often important in winding up the affairs of insolvent estates to achieve early closure with taxing authorities. Waiting out long periods for lapse of a governmental authority to initiate audits can keep money tied up and away from creditors for lengthy periods, even when no tax is payable. [ FN: With certain exceptions, the IRS is required to assess any tax imposed by the Internal Revenue Code within three (3) years after the return is filed. 26 U.S.C. §6501.] For this reason, Bankruptcy Code section 505(b) [ FN: 11 U.S.C. §505(b).] permits trustees to request very prompt audits and shuts off the government’s rights unless it acts very, very quickly. Section 505(b) allows a trustee to:

". . . request a determination of any unpaid liability . . .for any [post-petition] tax by submitting a tax return. . . and a request for [audit] . . . to the governmental unit [which collects the tax]. . . . [Except for fraudulent returns so filed], the trustee [and] debtor . . . are discharged from any liability for such tax. . . upon payment of the tax shown on such return if . . . such governmental unit does not notify the trustee, within 60 days after such request, that such return has been selected for [audit]". (emphasis added).

Additional provisions of section 505(b) require swift completion of the audit, i.e., within 180 days after the request, unless the time period is extended by the court.

These fast time frames and automatic shutoffs put a heavy burden on governmental units to identify filings made under section 505(b) in time to meet the fast-track deadlines. Thus, the Internal Revenue Service has adopted procedures which require that section 505(b) requests be filed with special identification on the envelope, and be sent to the local District Director [ FN: See Rev. Proc. 81-17, 1981-1 C.B. 688. Publication No. 908 of the Internal Revenue Service, which is entitled "Bankruptcy Tax Guide " and is intended to explain bankruptcy taxation in plain English to taxpayers, [implementing Rev. Proc. 81-17, 1981-1] expressly requires the following special-handling language to be put on the front of the envelope of every Section 505(b) request made to the IRS: "Personal Attention of the Special Procedures Function. DO NOT OPEN IN MAILROOM . "] .

Nevertheless, at least one court has held that a trustee can ignore these special-handlingdirectives, allowing the debtor to file with the central IRS Service Center. [ FN: See In re Carie Corp., 128 B.R. 266 (Bankr. D. Alaska 1989). But see, In re Flaherty , 169 B.R. 267 (Bankr. D. N.H. 1994) (reaching the opposite conclusion of Carie in holding that a trustee is required to file a section 505(b) request with the District Director and the Director ’s Special Procedure ’s Unit).] There is a danger that envelopes filed in these centers will be commingled with thousands of other routine filings and therefore not even discovered for proper handling until after the deadline has run against the government. More importantly, however, the IRS has promulgated a specific procedure for submitting a request for a prompt audit in a bankruptcy case, and has designated that such requests be mailed to its Special Procedures office. Even if the IRS were to adopt a specific procedure for identifying, collecting, and transmitting improperly addressed § 505(b) requests, the delay such a procedure would cause is inherently prejudicial.

Accordingly, to overrule a court decision which seemingly would allow taxpayers to exploit sometimes-overwhelmed back offices of taxing authorities, the Working Group proposes that the statute or the rules be amended to require that demands for examination under section 505(b) be sent to the office designated, in the manner prescribed, by the affected taxing authority.


The Commission should submit to the Advisory Committee on Bankruptcy Rules of the Judicial Conference ("Rules Committee") a recommendation that the Federal Rules of Bankruptcy Procedure require that notices demanding the benefits of rapid examination under section 505(b) be sent to the office specifically designated by the applicable taxing authority for such purpose, in any reasonable manner prescribed by such taxing authority [ While this proposal is currently cast as a recommendation to the Rules Committee, the Commission may later determine that it should be cast as a statutory amendment.] .

Competing Considerations

The Working Group is aware of no competing considerations. As long as the requirements for a prompt audit in bankruptcy are clear and reasonable, the precise location to which a § 505(b) request must be mailed should be of no consequence to the trustee or debtor in possession.


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