The effect of the pandemic continues to play out with tax issues. In yesterday’s post regarding the timing of filing a refund claim for 2019 Bob Probasco explained how the extension of time to file the 2019 return impacts the three year rule for timely filing a claim.
Another impact of the extension of time to file the 2019 return plays out for individuals waiting out the three year rule for income tax liability to transform from priority claims in bankruptcy to general unsecured claims eligible for discharge. This post raises questions regarding the timing of bankruptcy filings in 2023 seeking to gain the benefit of what is normally a cut and dry time period.
Bankruptcy Code section 507(a)(8)(A)(i) provides that the IRS is entitled to priority claim status for
A) a tax 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 three years before the date of the filing of the petition
Ordinarily, this provision grants priority status to taxes owed when a person goes into bankruptcy for the periods in which the return due date fell less than three years before the filing of the bankruptcy petition.
For example, if an individual filed bankruptcy on April 10, 2023, the taxes for the years 2019 through 2022 would have priority status since the due dates for the returns for those years fell less than three years before the filing of the bankruptcy petition.
Why does this matter? Unless the bankruptcy estate will fully pay the taxes for these years, the individual debtor will exit bankruptcy still owing the taxes for these years because of the operation of Bankruptcy Code section 523(a)(1) which excepts from discharge all taxes entitled to priority status.
So, a debtor with outstanding taxes who wants to rid themselves of a tax liability will wait until April 16 of the year three years after the due date of the return for the year of the tax liability to file their bankruptcy petition. (If they obtained an extension of time to file the return they will wait until October 16.)
Now, enter the pandemic and the global extension of time to file tax returns for 2019. How does that global extension of time impact the debtor’s decision on when to file their bankruptcy petition in order to obtain the benefit of a discharge. On the refund side the post by Bob Probasco argues that the global extension provides additional time for a taxpayer to file their refund claim for 2019. Taxpayers who need debt relief want an earlier date to apply. Unlike its pronouncement in Notice 2023-21 that seeks to provide guidance regarding the timing of refund claims for 2019, the IRS has issued no guidance on its view of when a tax claim turns from a priority claim into a general unsecured claim. It must have internally issued this guidance because it will start filing claims taking a position on this issue almost immediately.
This question was recently posed to me by a tax clinician. Like any good lawyer, I declined to answer the question and instead consulted someone else. In this case I consulted Ken Weil who has written several bankruptcy posts for PT and to whom I bring all of my thorny bankruptcy questions.
Ken said he had given the issue much thought and he felt strongly that unless a taxpayer had filed for an extension of time to file their 2019 return, the three year rule for priority claims should cause 2019 taxes to turn into general unsecured claims on April 16, 2023. He also thought that since the IRS had not issued guidance on this issue taxpayers should wait until July 16, 2023 to file their bankruptcy petition out of an abundance of caution. I agree with Ken’s conclusion regarding the timing of the priority status and also with his advice to wait, if possible, until the sure thing.
He cited to IRM § 5.9.17.8(14) (07-25-2022) and said “I think it is pretty clear that the IRS issued its extension under the emergency rules. IRS Notice 2020-18 (March 20, 2020).” He also cited to Bryan Camp’s “Lesson From The Tax Court: Counting the Days,” TaxProf Blog (May 23, 2022).”
There will ways in which the pandemic extension impacts tax procedure other than refund claims and bankruptcy discharge but these are two obvious and immediate areas of concern raised by the special events in the spring of 2020. Just as getting vaccinated can assist you in preventing the worst consequences of COVID, thinking about a planning the timing issues presented by the special extension of time to file in 2020 can keep you from an unpleasant tax result.