The bankruptcy code, in Section 505(a), gives the bankruptcy courts the authority to hear the merits of a tax liability. That authority, however, is not limitless – at least in the eyes of some courts. The reason for the grant of jurisdiction over tax claims to the bankruptcy courts stems from the need of speedy resolution of tax claims in order to keep them from slowing down the distribution of assets. Sometimes, tax cases can take quite a long time to resolve, and allowing the bankruptcy court to resolve them can clear the path for a more expeditious distribution of assets. The recent bankruptcy case of In re Bush, provides insight on a limitation to the bankruptcy court’s jurisdiction over tax claims. In reversing the bankruptcy court, the district court makes a logical decision. Not all courts view the issue presented here as jurisdictional. Some courts consider this issue within the discretion of the bankruptcy court. On these facts, I think most bankruptcy courts would abstain from hearing the tax matter. In the Southern District of Indiana, and perhaps in the 7th Circuit, the bankruptcy court may simply lack the discretion to decide where no bankruptcy purpose exists for making the tax determination.read more...
The Bushes brought a case in Tax Court to determine their tax liability for 2009, 2010 and 2011. For those years, the IRS asserted a deficiency in tax of about $107,000 and fraud penalties of about $80,000. Before trial of the Tax Court case, the parties reached agreement that the Bushes owed the IRS $100,138 in additional income taxes for the years at issue. The parties did not settle the fraud penalty issue and it was set to go to trial with petitioners arguing that their actions were merely negligent, which would substantially reduce the applicable penalty.
On September 14, 2014, the morning the trial in Tax Court was set to begin, the Bushes just happened to file a Chapter 13 bankruptcy petition. The opinion does not comment on the coincidence of the timing of this filing; however, it does bring out that the filing stayed the Tax Court proceeding under B.C. 362(a)(8). The IRS did not appreciate the stay and requested that the bankruptcy court lift the stay to allow the Tax Court case to proceed. The bankruptcy court declined. The Tax Court left town. The Tax Court case has sat in animated suspension since the day of September 14, 2014, waiting for something to lift the stay or waiting for a bankruptcy court determination that it could incorporate into a decision of the Tax Court. (Here the stay was lifted in March 2015 when the Bushes received their discharge and then the Tax Court continued the case because of the possibility that the bankruptcy court would decide the penalty issue.) Once a petitioner properly invokes the jurisdiction of the Tax Court, the subsequent filing of a bankruptcy case and the subsequent decision of the case by the bankruptcy court does not terminate the Tax Court case. The Tax Court still enters a decision when the stay is lifted. If the case comes back to it for the Tax Court to decide all or part of the issues, it will enter the decision at the conclusion of the case as is normal. If the bankruptcy court decides the case, the Tax Court will enter a decision to reflect the decision of the bankruptcy court because it has decided that the 505(a) decision of the bankruptcy court does not relieve it of the obligation to do so.
So, with the Tax Court case in suspended animation, the Bushes ask the bankruptcy court to decide whether they owe the fraud penalty or the negligence penalty for the years 2009-2011. They did not attempt to disavow the agreement reached on the underlying liability before filing their bankruptcy petition. The IRS objects to the bankruptcy court deciding the case and makes two arguments. First, it argues that the bankruptcy court lacks jurisdiction and alternatively, it asked the bankruptcy court to abstain. The bankruptcy court denied the request by the IRS that it hold it lacked jurisdiction and similarly declined to abstain; however, it did agree to allow the IRS to appeal its rulings.
The District Court, noting the lack of uniformity on this issue among various bankruptcy courts, districts, and circuits, found that B.C. 505 does not allow a bankruptcy jurisdiction over “matters that do not otherwise satisfy 28 U.S.C.A. 1304, the statute that establishes bankruptcy jurisdiction.” It found that B.C. 505 is not an independent grant of jurisdiction. The determination of the amount that the debtors owe for their tax penalties does not satisfy the “arising in” jurisdiction of the bankruptcy court. The debtors seek to have a substantive tax matter decided by the bankruptcy court based on the B.C. 505 procedure.
In addition to the problem of core proceeding, the tax decision is not related to the bankruptcy proceeding. Critical to this consideration is the fact that the decision of the bankruptcy court on the debtors’ penalties in this situation is not going to change the outcome of the bankruptcy case. The Bushes did not have enough assets to distribute to the IRS for the penalties they will owe whether those penalties turn out to be the fraud penalties or negligence penalties. Since the decision by the bankruptcy court will have no impact on the bankruptcy case, the District Court does not believe that the taxes, in this circumstance, meet the requirement of core proceeding or related proceeding.
Because the District Court finds that the bankruptcy court cannot exercise Section 505 jurisdiction over the taxes, the case will eventually get kicked back to the Tax Court for a determination of the applicable penalties. That raises the question of discharge and what difference will the Tax Court’s decision make here. I have discussed the discharge provisions as they relate to penalties before here and here. The taxes at issue in the case cannot be discharged because they are income taxes entitled to a priority either under B.C. 507(a)(1)(A) or (C) because, at the time of filing the petition in the bankruptcy case on September 14, 2014, less than three years had passed since the due date of the 2011 return excepting the taxes for that year from discharge under the application of B.C. 507(a)(1)(A) and 523(a)(1)(A). Because the taxes for 2009 and 2010 could still be assessed at the time of the bankruptcy petition due to the statutory notice of deficiency and the Tax Court petition, B.C. 507(a)(1)(C) and 523(A)(1)(A) except those two years from discharge.
The penalties travel a different path since they cannot achieve priority status. To determine the dischargeability of the penalties, it is necessary to look at 523(a)(7) which has a three year look back period from the time of the filing of the bankruptcy petition to the time the penalties arose. The penalties arose on the filing of the returns. If the returns for each year were filed on or before the due date, the penalty claim for 2009 and 2010 will be discharged by the bankruptcy and only the 2011 penalty claim would survive bankruptcy. If the 2010 return was filed using an extended due date, it too may be excepted from discharge since the extended due date would have been October 15, 2011, which was within three years of the filing of the bankruptcy petition.
If only one year of the penalties matters, why did petitioners go to all of this trouble? An even greater question is why didn’t they wait until April 16, 2015 to file the bankruptcy petition and then they could have eliminated all of the penalties with the filing of a bankruptcy petition. The Tax Court trial taking place on September 14, 2014, would almost certainly not have resulted in an assessment until after April 16, 2015 absent a bench opinion. By sticking with the Tax Court case and then filing a bankruptcy petition after April 15, 2015, the Bushes could have eliminated all of the penalty liabilities, whether fraud or negligence. The timing of the filing of their bankruptcy case clearly seemed motivated by the timing of the Tax Court trial, yet the timing was bad for them. The only sound basis for the timing of their filing was the greater possibility that the bankruptcy court would find negligence than the Tax Court would have found. The penalty determination may not have made much difference on the Bushes obligation to pay the penalties themselves but it does have an impact on whether they can discharge the taxes. If the Tax Court or Bankruptcy Court determines they committed fraud on their returns, the taxes can never be discharged as long as the statute of limitations on collection keeps the liabilities open for collection because of B.C. 523(a)(1)(C). I do not know the strategy driving the decision to file bankruptcy on the day of the penalty trial. Unless the Bushes had a lot more faith in the bankruptcy judge finding their actions negligent rather than fraudulent, it seems misplaced.