The following is an article reprinted with permission from the Summer 2010 edition of Viewpoint (WWR’s Governmental Collections newsletter):
Whether or not the taxes owed to a municipality have been reduced to Judgment, there remains the ever-present possibility that the taxpayer will file bankruptcy. While there is a stay on all collections during the bankruptcy, a municipality may have the ability to collect once the debtor does receive his or her discharge. What taxes can a municipality collect post-discharge? The answer lies in determining which taxes are excepted from discharge or are “non-dischargeable.”
This article will address two questions:
1) Under what circumstances can a taxpayer discharge the taxes owed to a municipality in bankruptcy?
2) What can a municipality do to protect itself when a bankruptcy has been filed?
Federal law, codified in 11 U.S.C. §523, sets forth the exceptions to discharge available to a creditor by virtue of a completed bankruptcy filing, whether Chapter 7 or Chapter 13.
Taxes Not Discharged in Either a Chapter 7 or 13
1) Taxes involving a tax return which was not filed;
2) Taxes involving a tax return that was filed late and filed less than two years before the bankruptcy filing date;
3) Taxes relating to a fraudulent return or relating to the debtor willfully attempting to evade or defeat such taxes; and
4) Withholding taxes for which the debtor is liable.
In a Chapter 7 bankruptcy, there are additional taxes excepted from discharge.
Taxes Not Discharged in a Chapter 7
1) An income tax for the taxable year ending on or before the bankruptcy filing date where the return is last due (including extensions) three years before the bankruptcy filing date;
2) An income tax for the taxable year ending on or before the bankruptcy filing date where the tax is assessed within 240 days before the bankruptcy filing date (excluded during the 240 days is any time in which an offer in compromise was pending plus 30 days);
3) Any other tax as described in #1 and #2 above, which was not assessed before but is assessable after the bankruptcy case commences;
4) A property tax incurred before the bankruptcy filing date and that was last payable without penalty less than one year before the date of the bankruptcy filing;
5) Certain employment taxes earned from the debtor prior to the bankruptcy filing date for which a return was last due less than three years before the bankruptcy filing date;
6) Excise taxes where a transaction occurred prior to the bankruptcy filing date for which a return was last due less than three years before the bankruptcy filing or if a return is not required, a transaction occurring during the three years immediately preceding the bankruptcy filing date;
7) Certain customs duties; and
8) Penalties related to an above-listed tax that provides for compensation for an, “actual pecuniary loss.”
Keep in mind that the three-year or 240-day time frame may be suspended for any period when the municipality is stayed from collecting the tax under applicable, non-bankruptcy law (i.e. when a debtor requests a hearing or appeal) plus 90 days. Also, the time frame may be suspended for any period of time when the municipality is stayed from collecting a tax pursuant to the bankruptcy- automatic stay plus 90 days.
The Bankruptcy Code treats taxes and interest resulting from them differently than the penalties assessed on the underlying unpaid taxes. Situations may arise where penalties for certain taxes are dischargeable, while the underlying taxes and interest are not. In summary, all penalties are non-dischargeable except:
1) Those assessed to the taxes listed above that do not involve compensation for an actual, pecuniary loss, or
2) Those imposed with respect to a transaction or event that occurred prior to three years before the bankruptcy filing date.
Post-petition interest on a non-dischargeable tax is also non-dischargeable. Likewise, pre-petition interest on otherwise non-dischargeable taxes is also non-dischargeable.
“Return” and “Tax”
What constitutes a “return” and the proper filing of that return is governed by each municipality’s code or local ordinance. What constitutes a tax has been defined as “(1) involuntary pecuniary burden, regardless of name, laid upon individuals or property, (2) imposed by or under authority of legislature (3) for public purposes of defraying expenses of government or undertakings authorized by it (4) under police of taxing power of state. The chief distinction between ‘tax’ and ‘fee’ is that tax is exaction for public purpose, while fee relates to individual privilege or benefit to taxpayer.”
The best course of action when a bankruptcy petition has been filed by a taxpayer is to review the total debt due with an experienced bankruptcy attorney in order to determine whether or not the debt, or parts of the debt, is dischargeable. Weltman, Weinberg & Reis Co., L.P.A. has provided bankruptcy representation to municipalities for many years. We are available to discuss all bankruptcy issues at your convenience.
Amanda R. Yurechko is an Associate in the Consumer Collections; Governmental Collections and Healthcare Groups and Commercial Collections; Commercial Business Group. She can be reached at (216) 685-1060 or firstname.lastname@example.org.
Beth Ann Schenz is an Associate in Bankruptcy; Commercial and Consumer Bankruptcy Groups and is based in the Brooklyn Heights office. She can be reached at (216) 739-5645 or email@example.com.