The New Code's Effect on Taxes

Interest on Tax Claims

A new ' 511 provides that the payment of interest on a tax claim will be determined in accordance with applicable non-bankruptcy law.

Priority of Tax Claims and Tolling Periods

Section 507(a)(8) is modified to provide that any otherwise applicable time period relating to the look back for tax claims is suspended for any period during which a governmental unit is prohibited under applicable non-bankruptcy 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. In addition, the time period is tolled for any time during which the debtor was in a preceding bankruptcy case during that same 3-year or 240-day day period plus an additional 90 days.

Incurred v. Assessed Taxes

Section 507(a)(8)(B) is amended by replacing the word “assessed” with the word “incurred” to make it clear that unsecured tax claims by governmental units will be given priority from the date the tax is “incurred” by the debtor.

Automatic Stay

The automatic stay continues with respect to a corporate debtor's tax pre- and post-petition liability so long as the Bankruptcy Court determines that it has the ability to actually determine what the tax liability should be.

Fuel Tax Claims

A fuel tax claim arising under ' 31705 of Title 49 of the U.S. Code may now be filed by the base jurisdiction designated pursuant to the International Fuel Tax Agreement. This claim would then be on behalf of all states that had a fuel tax claim in the case.

Tax Liability Determination: Time Period

Section 505 is amended to provide that a bankruptcy court may not determine the amount or legality of any amount arising in connection with an ad valorem tax on real or personal property if the applicable period for contesting on re-determining the amount under any law (other than a bankruptcy law) has expired.

Fraudulent Taxes

The discharge provisions of Chapter 11 have been modified to provide that a debtor may not obtain a discharge for taxes with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat the tax. Section 1141(d)(6)(A) provides that a Chapter 11 debtor may not obtain a discharge of any debts owed to a governmental unit for debts incurred under false pretences or fraud.

Payment of Taxes in Chapter 11 Cases

Section 1129(9)(C) now provides that such payments must be made over a period no longer than 5 years and in a manner not less favorable than the most favored non-priority unsecured claim provided for by the plan other than an unsecured class of claims which was created merely for administrative convenience.

Avoidance of Statutory Liens

Section 545(2) has been amended to provide that the trustee may not avoid an unperfected lien against a bona fide purchaser if the purchaser qualifies as such under ' 6323 of the Internal Revenue Code or any other similar provision of state or local law.

Payment of Taxes in the Conduct of Business

Section 960 of Title 28 of the U.S. Code is modified to clarify that post petition taxes must be paid on or before when the tax is due under applicable non-bankruptcy law with certain exceptions.

Late Filed Tax Claims

Section 726(a)(1) is amended to provide that a tax claim which has not already been filed will still be entitled to distribution if the claim is filed before the date that is 10 days after the mailing to creditors of a summary of the trustee's final report or the date on which the trustee commences file and distribution under the section.

Discharge of Taxes Arising from Government Failure to Audit

Section 505 presently provides that failure of a governmental entity to respond to a request for a tax audit or to provide an extension of time to audit automatically discharges the trustee and the debtor and any successor of the debtor from the tax liability. Due to some ambiguity about whether this discharge releases the estate from the tax liability, ' 505(b) is amended to clarify that the estate is also protected.

Disclosure Statement Requirements

Section 1125(a)(1) is modified to provide that adequate information in a disclosure statement includes a discussion of the potential material federal tax consequences of the plan to the debtor, any successor to the debtor and a hypothetical investor typical of the type of creditors holding claim in the case.

Set-off of Tax Refunds

The automatic stay will now not prohibit the set-off under applicable non-bankruptcy law on an income tax refund by a governmental unit with respect to a taxable period that ended before the filing of the case, unless the set-off is not permitted under applicable non-bankruptcy law because of a pending action to determine the amount or the legality of the tax liability. In the latter case, the governmental unit may hold the refund pending the resolution of the action unless the bankruptcy court grants the taxing authority adequate protection within the meaning of ' 361 of the Code.

Special Provisions Related to the Treatment of State and Local Taxes

Section 346(a) provides that whenever the Internal Revenue Code provides that a separate estate or entity is created in a case concerning a bankruptcy debtor and the income, gain, losses or deductions, etc. are taxed to or claimed by the estate, a separate taxable estate is also created for purposes of any local or state law imposing tax on income, gain, loss etc. In such an event the income, gain, loss, etc., will be taxed or claimed by the estate and may not be taxed or claimed by the debtor. This will only apply if the bankruptcy case is not dismissed.

Section 346(b)(1) of the Code provide that whenever under the Internal Revenue Code, no separate taxable estate is created in a bankruptcy case, then the income may not be taxed to or claimed by the estate. The trustee is authorized to make the tax returns of income of corporations and of partnerships as are required under any state and local law but with respect to partnerships, the trustee shall only make returns to the extent that such returns are also required to be made under the Internal Revenue Code.

The amendments to ' 346 also provide that the taxable period of a debtor for the purposes of imposing any local or state taxes measured by income, shall terminate only if and to the extent that the taxable period of the debtor terminates under the Internal Revenue Code. Thus, for example, under applicable federal law, bankruptcy petition or filing on March 5 has 2 tax years (Jan. 1 to March 4, and March 5 to Dec. 31). Previously, for state and local tax years, the time period would be from Jan. 1 to March 5 and then from March 6 to Dec. 31. An amendment to ' 346 makes the application of the tax year under federal, local and state laws the same. Further conformity is found in ' 346(f) which provides that for purposes of any local or state law proposing a tax on income, a transfer of property form the debtor or form the estate to the debtor will not be treated as a disposition of any local or state law assigning taxing consequences to such disposition unless an to the extent that the transfer is treated as a disposition under the Internal Revenue Code. '346 does not affect the tax rates imposed under non-bankruptcy law.

Dismissal for Failure to Timely File Tax Returns

Failure of a Chapter 11 debtor to file its tax returns may give cause to dismiss the case or convert it to Chapter 7.

Conclusion

There are numerous other small changes to the Code as well so it is advisable to examine the new amendments carefully for ways it may additionally impact the treatment of taxes.

There are many sections of the new Bankruptcy Act that address various tax issues; some of the most important and relevant corporate changes are explored below.

Improved Treatment of Ad Valorem Tax Claims

Section 724 has been amended by adding a new subsection (f) to provide that ad valorem tax liens will be subordinated only to: 1) wage and salary claims entitled to priority under ' 507(a)(4); and, 2) claims arising for contributions to employee benefit plans entitled a priority under ' 507(a)(5). Section 724 is further amended by adding a new subsection (e) to provide that no tax lien on real or personal property of the estate will be subordinated unless the trustee has first exhausted the unencumbered assets of the estate. Section 506(c) is amended to add the payment of all ad valorem property taxes to those costs and expenses that may be assessed against the property. Section 505 is amended to provide that a court may not determine the amount or legality of a tax liability arising out of an ad valorem tax on real or personal property if the applicable period for contesting or re-determining the amount under applicable state law has expired.

Interest on Tax Claims

A new ' 511 provides that the payment of interest on a tax claim will be determined in accordance with applicable non-bankruptcy law.

Priority of Tax Claims and Tolling Periods

Section 507(a)(8) is modified to provide that any otherwise applicable time period relating to the look back for tax claims is suspended for any period during which a governmental unit is prohibited under applicable non-bankruptcy 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. In addition, the time period is tolled for any time during which the debtor was in a preceding bankruptcy case during that same 3-year or 240-day day period plus an additional 90 days.

Incurred v. Assessed Taxes

Section 507(a)(8)(B) is amended by replacing the word “assessed” with the word “incurred” to make it clear that unsecured tax claims by governmental units will be given priority from the date the tax is “incurred” by the debtor.

Automatic Stay

The automatic stay continues with respect to a corporate debtor's tax pre- and post-petition liability so long as the Bankruptcy Court determines that it has the ability to actually determine what the tax liability should be.

Fuel Tax Claims

A fuel tax claim arising under ' 31705 of Title 49 of the U.S. Code may now be filed by the base jurisdiction designated pursuant to the International Fuel Tax Agreement. This claim would then be on behalf of all states that had a fuel tax claim in the case.

Tax Liability Determination: Time Period

Section 505 is amended to provide that a bankruptcy court may not determine the amount or legality of any amount arising in connection with an ad valorem tax on real or personal property if the applicable period for contesting on re-determining the amount under any law (other than a bankruptcy law) has expired.

Fraudulent Taxes

The discharge provisions of Chapter 11 have been modified to provide that a debtor may not obtain a discharge for taxes with respect to which the debtor made a fraudulent return or willfully attempted in any manner to evade or defeat the tax. Section 1141(d)(6)(A) provides that a Chapter 11 debtor may not obtain a discharge of any debts owed to a governmental unit for debts incurred under false pretences or fraud.

Payment of Taxes in Chapter 11 Cases

Section 1129(9)(C) now provides that such payments must be made over a period no longer than 5 years and in a manner not less favorable than the most favored non-priority unsecured claim provided for by the plan other than an unsecured class of claims which was created merely for administrative convenience.

Avoidance of Statutory Liens

Section 545(2) has been amended to provide that the trustee may not avoid an unperfected lien against a bona fide purchaser if the purchaser qualifies as such under ' 6323 of the Internal Revenue Code or any other similar provision of state or local law.

Payment of Taxes in the Conduct of Business

Section 960 of Title 28 of the U.S. Code is modified to clarify that post petition taxes must be paid on or before when the tax is due under applicable non-bankruptcy law with certain exceptions.

Late Filed Tax Claims

Section 726(a)(1) is amended to provide that a tax claim which has not already been filed will still be entitled to distribution if the claim is filed before the date that is 10 days after the mailing to creditors of a summary of the trustee's final report or the date on which the trustee commences file and distribution under the section.

Discharge of Taxes Arising from Government Failure to Audit

Section 505 presently provides that failure of a governmental entity to respond to a request for a tax audit or to provide an extension of time to audit automatically discharges the trustee and the debtor and any successor of the debtor from the tax liability. Due to some ambiguity about whether this discharge releases the estate from the tax liability, ' 505(b) is amended to clarify that the estate is also protected.

Disclosure Statement Requirements

Section 1125(a)(1) is modified to provide that adequate information in a disclosure statement includes a discussion of the potential material federal tax consequences of the plan to the debtor, any successor to the debtor and a hypothetical investor typical of the type of creditors holding claim in the case.

Set-off of Tax Refunds

The automatic stay will now not prohibit the set-off under applicable non-bankruptcy law on an income tax refund by a governmental unit with respect to a taxable period that ended before the filing of the case, unless the set-off is not permitted under applicable non-bankruptcy law because of a pending action to determine the amount or the legality of the tax liability. In the latter case, the governmental unit may hold the refund pending the resolution of the action unless the bankruptcy court grants the taxing authority adequate protection within the meaning of ' 361 of the Code.

Special Provisions Related to the Treatment of State and Local Taxes

Section 346(a) provides that whenever the Internal Revenue Code provides that a separate estate or entity is created in a case concerning a bankruptcy debtor and the income, gain, losses or deductions, etc. are taxed to or claimed by the estate, a separate taxable estate is also created for purposes of any local or state law imposing tax on income, gain, loss etc. In such an event the income, gain, loss, etc., will be taxed or claimed by the estate and may not be taxed or claimed by the debtor. This will only apply if the bankruptcy case is not dismissed.

Section 346(b)(1) of the Code provide that whenever under the Internal Revenue Code, no separate taxable estate is created in a bankruptcy case, then the income may not be taxed to or claimed by the estate. The trustee is authorized to make the tax returns of income of corporations and of partnerships as are required under any state and local law but with respect to partnerships, the trustee shall only make returns to the extent that such returns are also required to be made under the Internal Revenue Code.

The amendments to ' 346 also provide that the taxable period of a debtor for the purposes of imposing any local or state taxes measured by income, shall terminate only if and to the extent that the taxable period of the debtor terminates under the Internal Revenue Code. Thus, for example, under applicable federal law, bankruptcy petition or filing on March 5 has 2 tax years (Jan. 1 to March 4, and March 5 to Dec. 31). Previously, for state and local tax years, the time period would be from Jan. 1 to March 5 and then from March 6 to Dec. 31. An amendment to ' 346 makes the application of the tax year under federal, local and state laws the same. Further conformity is found in ' 346(f) which provides that for purposes of any local or state law proposing a tax on income, a transfer of property form the debtor or form the estate to the debtor will not be treated as a disposition of any local or state law assigning taxing consequences to such disposition unless an to the extent that the transfer is treated as a disposition under the Internal Revenue Code. '346 does not affect the tax rates imposed under non-bankruptcy law.

Dismissal for Failure to Timely File Tax Returns

Failure of a Chapter 11 debtor to file its tax returns may give cause to dismiss the case or convert it to Chapter 7.

Conclusion

There are numerous other small changes to the Code as well so it is advisable to examine the new amendments carefully for ways it may additionally impact the treatment of taxes.