The extent to which taxes are dischargeable in bankruptcy is a matter of considerable confusion – not just with general practitioners but with bankruptcy lawyers alike. As bankruptcy Judge Dana Rasure noted a few years ago, “The law concerning dischargeability of taxes and penalties is confusing at best, starting with the relevant statutes that are characterized by double and triple negative constructions and incorporate other statutes by reference.”[1] Many believe taxes simply are not dischargeable under any circumstances. This used to be the case, but not anymore.[2] The purpose of this article is to provide practitioners with a general overview of the basic rules concerning the treatment of taxes in bankruptcy.

THE TYPE OF TAX AND THE AGE OF THE TAX

The starting point is §523(a)(1)(A) of the Bankruptcy Code,[3] which states, among other things, that any tax or customs duty that constitutes a priority unsecured claim under §507(a)(8) of the Bankruptcy Code – including income, property, employment, excise, trust fund taxes and tax penalties – subject to certain time limitations, are nondischargeable. By contrast, nonpriority taxes are generally dischargeable. Beginning with income and gross receipts taxes, §507(a)(8) describes these priority taxes as follows:

(A) [taxes] on or measured by income or gross receipts for a taxable year ending on or before the date of the filing of the petition –

(i) for which a return, if required, is last due, including extensions, after 3 years before the date of the filing of the petition;

(ii) assessed within 240 days before the date of the filing of the petition, exclusive of –

(I) any time during which an offer in compromise with respect to that tax was pending or in effect during that 240-day period, plus 30 days; and

(II) any time during which a stay of proceedings against collections was in effect in a prior case under this title during that 240-day period, plus 90 days; or

(iii) other than a tax of a kind specified in section 523(a)(1)(B) or 523(a)(1)(C) of this title, not assessed before, but assessable, under applicable law or by agreement, after, the commencement of the case.

Three time periods are in play with respect to the dischargeability of income and gross receipts taxes: the three-year lookback, the two-year lookback and the 240-day lookback:

• Three-year lookback: the due date of the return (note: the due date, not the filing date), which must be more than three years prior to the bankruptcy filing for the tax to be dischargeable;
• Two-year lookback: as discussed in greater detail below, a return must be filed more than two years prior to the bankruptcy filing for the tax to be dischargeable; and
• 240-day lookback: the date of the assessment,[4] which, subject to certain exclusions for offers of compromise and stays of proceedings against collections (during which time the period is tolled), must be more than 240 days prior to the bankruptcy filing for the tax to be dischargeable.

The two-year rule is encompassed by §507(a)(8)(A)(iii)’s reference to §523(a)(1)(B), which is discussed further below. A narrower category of generally nondischargeable taxes are those assessed and assessable, under applicable law or by agreement, after the commencement of a bankruptcy case.[5] The former references §507(a)(3) (which, in turn, references §502(f)) and addressees tax claims arising in involuntary bankruptcy cases between the date the petition is filed and the earlier of the appointment of a trustee or entry of an order for relief. The latter addresses income or gross receipts taxes “not assessed before, but assessable, under applicable law or by agreement, after the commencement of the case.” Both are nondischargeable.

Additional priority tax claims that are nondischargeable pursuant to Bankruptcy Code §523(a)(1)(A) and listed as priority claims under Bankruptcy Code §507(a)(8) include:

(B) [property taxes] incurred before the commencement of the case and last payable without penalty after 1 year before the date of the filing of the petition;

(C) [taxes] required to be collected or withheld and for which the debtor is liable in whatever capacity [including trust fund or withholding taxes];

(D) [employment taxes] on a wage, salary, or commission of a kind specified in paragraph (4) of this subsection[6] earned from the debtor before the date of the filing of the petition, whether or not actually paid before such date, for which a return is last due, under applicable law or under any extension, after 3 years before the date of the filing of the petition;

(E) [excise taxes[7]] on –

(i) a transaction occurring before the date of the filing of the petition for which a return, if required, is last due, under applicable law or under any extension, after 3 years before the date of the filing of the petition; or

(ii) if a return is not required, a transaction occurring during the 3 years immediately preceding the date of the filing of the petition;

(F) [customs duties] arising out of the importation of merchandise –

(i) entered for consumption within 1 year before the date of the filing of the petition;

(ii) covered by an entry liquidated or reliquidated within 1 year before the date of the filing of the petition; or

(iii) entered for consumption within 4 years before the date of the filing of the petition but unliquidated on such date, if the Secretary of the Treasury certifies that failure to liquidate such entry was due to an investigation pending on such date into assessment of antidumping or countervailing duties or fraud, or if information needed for the proper appraisement or classification of such merchandise was not available to the appropriate customs officer before such date; or

(G) [penalties] related to [claims] of a kind specified in this paragraph and in compensation for actual pecuniary loss.

As alluded to above, the time periods stated in §507(a)(8) may be tolled in certain instances. The Bankruptcy Code contains tolling provisions in §507(a)(8)(A)(ii)(I) and (II),[8] with respect to the 240-day rule, as well as a more general tolling provision in the last “hanging” paragraph of §507(a)(8), which states as follows:

An otherwise applicable time period specified in this paragraph shall be suspended for any period during which a governmental unit is prohibited under applicable nonbankruptcy law from collecting a tax as a result of a request by the debtor for a hearing and an appeal of any collection action taken or proposed against the debtor, plus 90 days; plus any time during which the stay of proceedings was in effect in a prior case under this title or during which collection was precluded by the existence of 1 or more confirmed plans under this title, plus 90 days.

Notably, as provided in §§523(a)(1)(A) and 507(a)(8)(C) and (G) above, certain taxes are nondischargeable regardless of age – including “trust fund” taxes the debtor is legally required to withhold or collect from others and certain compensatory (as opposed to punitive) tax penalties. The Bankruptcy Code has a separate nondischargeability provision for a “fine, penalty, or forfeiture payable to and for the benefit of a governmental unit,” which applies to noncompensatory fines, penalties or forfeitures but notably excludes those relating to taxes that are dischargeable or that are “imposed with respect to a transaction or event that occurred” more than three years before the filing of the bankruptcy petition.[9]

Note that a filing extension – extending the due date for a tax return – may impact the applicable time periods. In In re Hermann,[10] the Bankruptcy Court for the Northern District of Oklahoma held that a filing extension rendered a debtor’s income tax liability nondischargeable when it may have otherwise been dischargeable due to the three-year limitations period provided in §523(a)(8)(A)(i).

FAILURE TO FILE A RETURN IN ACCORDANCE WITH NONBANKRUPTCY LAW

As referenced above, taxes owed for which a return (or equivalent report or notice) is required and remains unfiled or not given or was filed or given late and within two years before the bankruptcy filing are nondischargeable.[11] While the word “return” may seem straightforward, it is important to understand what is – and what is not – considered a “return” for bankruptcy purposes. According to another “hanging” paragraph in §523(a), which immediately follows §523(a)(20) of the Bankruptcy Code (sometimes cited as §523(a)(*)), “‘return’ means a return that satisfies the requirements of applicable nonbankruptcy law (including applicable filing requirements).”[12] ^[13]

In Mallo, the 10th Circuit held that “the plain and unambiguous language of §523(a) excludes from the definition of ‘return’ all late-filed tax forms, except those prepared with the assistance of the IRS under [26 U.S.C.] §6020(a).”[14] Additionally, under §6020(a), a return must be signed by the taxpayer to be accepted as a filed return. While in some cases, the IRS will file a return on behalf of a taxpayer, the 10th Circuit has also previously held that a return filed by the IRS but not signed by the taxpayer does not qualify as a filed return under §523(a)(1)(B).[15] Notably, the issue of when a late-filed return qualifies as a “return” for purposes of dischargeability is one on which courts disagree.[16]

FRAUD AND WILLFUL TAX EVASION

Pursuant to Bankruptcy Code §523(a)(1)(C), taxes “with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat such tax” are nondischargeable. Unsurprisingly, there is no time limit associated with this provision. Note that nonpayment alone will not result in a finding that the debt is nondischargeable; however, “nonpayment is relevant evidence which a court should consider in the totality of conduct to determine whether or not the debtor willfully attempted to evade or defeat taxes.”[17] A debtor’s ability to pay is also relevant. “A debtor's actions are willful under § 523(a)(1)(C) if they are done voluntarily, consciously or knowingly, and intentionally.”[18]

TAX PENALTIES

Finally, under §523(a)(7) of the Bankruptcy Code, certain tax penalties are nondischargeable:

(7) to the extent such debt is for a fine, penalty, or forfeiture payable to and for the benefit of a governmental unit, and is not compensation for actual pecuniary loss, other than a tax penalty –

(A) relating to a tax of a kind not specified in paragraph (1) of this subsection [i.e., a tax that is dischargeable]; or

(B) imposed with respect to a transaction or event that occurred before three years before the date of the filing of the petition.

The 10th Circuit has held that §523(a)(7)(B) “creates an arbitrary cutoff of three years, after which all uncollected tax penalties may be discharged in bankruptcy.”[19] But because of the “transaction or event” language in §523(a)(7)(B), the 10th Circuit Bankruptcy Appellate Panel has concluded that penalties arising from a frivolous filing are not dischargeable even if the taxes relate to tax years more than three years prior to the filing of the bankruptcy petition if the filing of the frivolous documents – which was the “transaction or event” – occurred within that three-year period.[20]

CONCLUSION

Generally, in the absence of fraud or willful tax evasion, the Bankruptcy Code allows debtors to discharge many taxes that are beyond a certain age and for which a return, if required, has been filed in accordance with applicable nonbankruptcy law. The outcome turns on the type of tax – alas, there are many – as well as the timing of the filing of the return and other relevant events related to the tax. Knowing how to navigate the maze of applicable statutes and regulations is critical for attorneys to be able to competently represent bankruptcy debtor clients who owe taxes.

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ABOUT THE AUTHOR

Brandon Bickle is a shareholder at GableGotwals in Tulsa, where he practices in the areas of general commercial litigation and bankruptcy, with an emphasis on Chapter 11 bankruptcy matters, foreclosures and collateral liquidation, as well as other debtor-creditor disputes.

 

 

 

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ENDNOTES

[1] In re Moore, 2017 WL 934641, at *3 (Bankr. N.D. Okla. March 8, 2017).

[2] “Prior to 1966, tax debts were not dischargeable. In 1966, ‘consisten[t] with the rehabilitory purpose of the Bankruptcy Act,’ amendments were enacted ‘to make dischargeable in bankruptcy debts for taxes which became legally due and owing more than 3 years preceding bankruptcy, and to limit the prior accorded to taxes.’” Dalton v. I.R.S., 77 F.3d 1297, 1300 (10th Cir. 1996) (quoting S.Rep. No. 1158, 89th Cong., 2d Sess. (1966), 1966 U.S.C.C.A.N. 2468, 2468, 2469).

[3] References to the “Bankruptcy Code” are to Title 11 of the United States Code. Unless otherwise identified, section references (§) are to the Bankruptcy Code.

[4] See 26 C.F.R. §301.6203-1 (Method of Assessment): “The district director and the director of the regional service center shall appoint one or more assessment officers. The district director shall also appoint assessment officers in a Service Center servicing his district. The assessment shall be made by an assessment officer signing the summary record of assessment. The summary record, through supporting records, shall provide identification of the taxpayer, the character of the liability assessed, the taxable period, if applicable, and the amount of the assessment. The amount of the assessment shall, in the case of tax shown on a return by the taxpayer, be the amount so shown, and in all other cases the amount of the assessment shall be the amount shown on the supporting list or record. The date of the assessment is the date the summary record is signed by an assessment officer. If the taxpayer requests a copy of the record of assessment, he shall be furnished a copy of the pertinent parts of the assessment which set forth the name of the taxpayer, the date of assessment, the character of the liability assessed, the taxable period, if applicable, and the amounts assessed.”

[5] See 11 U.S.C. §§523(a)(1)(A) and 507(a)(8)(A)(iii).

[6] Bankruptcy Code §507(a)(4) describes the priority claim for wages, salaries and commissions as follows:

(4) Fourth, allowed unsecured claims, but only to the extent of $15,150 [originally “$10,000,” adjusted effective April 1, 2022] for each individual or corporation, as the case may be, earned within 180 days before the date of the filing of the petition or the date of the cessation of the debtor's business, whichever occurs first, for—

• wages, salaries or commissions, including vacation, severance, and sick leave pay earned by an individual; or
• sales commissions earned by an individual or by a corporation with only 1 employee, acting as an independent contractor in the sale of goods or services for the debtor in the ordinary course of the debtor's business if, and only if, during the 12 months preceding that date, at least 75 percent of the amount that the individual or corporation earned by acting as an independent contractor in the sale of goods or services was earned from the debtor.

[7] An excise tax is “[a] tax imposed on the manufacture, sale, or use of goods (such as a cigarette tax), or an occupation or activity (such as a license tax or an attorney occupation fee).” United Parcel Serv., Inc. v. Flores-Galarza, 318 F.3d 323, 326 (1st Cir. 2003) (quoting Black's Law Dictionary 585 (7th ed. 1999)).

[8] Supra.

[9] §523(a)(7).

[10] See In re Hermann, 221 B.R. 944 (Bankr. N.D. Okla. 1998).

[11] 11 U.S.C. §523(a)(1)(B).

[12] See In re Mallo, 774 F.3d 1313, 1318 (10th Cir. 2014) (“the plain language of the statute requires us to consult nonbankruptcy law, including any applicable filing requirements, in determining whether the tardy tax forms ... are returns for purposes of discharge”).

[13] See also In re Wogoman, 475 B.R. 239 (10th Cir. BAP 2012) (discussing various tests for interpreting this “hanging” paragraph and what constitutes a “return”).

The hanging paragraph further provides that “[s]uch term [‘return’] includes a return prepared pursuant to section 6020(a) of the Internal Revenue Code of 1986 [‘IRC’], or similar State or local law, or a written stipulation to a judgment or a final order entered by a nonbankruptcy tribunal, but does not include a return made pursuant to section 6020(b) of the [IRC], or a similar State or local law.” “Section 6020(a) of the [IRC] refers to a return prepared by the IRS with the assistance of the taxpayer, and when signed by the taxpayer, may be treated as a return filed by the taxpayer. On the other hand, IRC § 6020(b) refers to a return prepared by the IRS without the assistance of the taxpayer and executed by the IRS.” In re Wogoman, 475 B.R. 239, 243–44 (10th Cir. BAP (Colo.) 2012).

The hanging paragraph was added to the Bankruptcy Code by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). Prior to BAPCPA, the primary test used to determine whether a “return” was filed, which is still used today, is known as the Beard test, and has four elements: “[f]irst, there must be sufficient data to calculate tax liability; second, the document must purport to be a return; third, there must be an honest and reasonable attempt to satisfy the requirements of the tax law; and fourth, the taxpayer must execute the return under penalties of perjury.” Mallo, 774 F.3d at 1318 (quoting Beard v. Comm'r, 82 T.C. 766, 777 (1984), aff’d, 793 F.2d 139 (6th Cir.1986) (per curiam)).

[14] 774 F.3d at 1327; see also note vi, supra.

[15] In re Bergstrom, 949 F.2d 341, 343 (10th Cir. 1991).

[16] See, e.g., In re Shek, 947 F.3d 770, 781 (11th Cir. 2020) (Discussing the issue, citing cases and disagreeing with the 10th Circuit in Mallo).

[17] Dalton v. I.R.S., 77 F.3d 1297, 1301 (10th Cir. 1996).

[18] Id. at 1302; see also In re Lowrance, 324 B.R. 358, 364 (Bankr. N.D. Okla. 2005).

[19] In re Roberts, 906 F.2d 1440, 1443 (10th Cir. 1990).

[20] In re Wilson, 407 B.R. 405 (10th Cir. BAP 2009).