Bankruptcy for Sales Tax, Payroll Tax, Trust Fund Tax, Unfiled Tax Returns & Tax Fraud

Tax Lawyers Group, A Law Corporation, has more than 20 years of handling complicated tax & tax bankruptcy cases for sales tax, payroll tax, trust fund tax, unfiled tax returns, and cases involving tax fraud and tax evasion. We are well known in the tax and bankruptcy legal communities as the premier tax and bankruptcy law firm in the greater Los Angeles area and throughout California.

Tax Lawyers Group, A Law Corporation, has a wealth of experience in handling complex tax and tax related bankruptcy cases for individuals and businesses alike. We have a deep understanding of the complex laws and regulations governing sales tax, payroll tax, income tax, trust fund tax, unfiled tax returns, and fraud related tax matters. Other attorneys and sophisticated business clients rely on our experience and expertise to guide them and navigate the complex legal landscape at the intersection of business, tax and bankruptcy laws. The laws in this area of tax practice changes regularly and is very fact specific so it is important review your case with a qualified tax attorney.

Some of the challenging situations that arise in tax bankruptcy and tax fraud cases are discussed below in the context of handling these tax matters in a Bankruptcy Case filed under Chapter 7, 11 or 13.

1. UNFILED TAX RETURNS or LATE FILED TAX RETURNS

   Tax bankruptcy for a tax debt which arises from situations where no return was filed or for which a delinquent return was filed creates a special circumstance in Chapter 7, 11 or 13 Bankruptcy cases. In addition to excepting bankruptcy discharge of priority taxes under 11 USC §507(a)(8), 11 USC §523 (a)(1)(B) also excepts a tax debt for which no tax return was filed or, if filed late, was filed less than 2 years prior to the filing of bankruptcy. Typically, the determination as to whether the taxpayer filed an IRS tax return will be clear, for example, the taxpayer either filed a tax return using the IRS’ forms and schedules or he filed no tax returns at all. In other instances, the determination as to whether a filing occurred may be less certain, for example, where the taxpayer filed inadequate schedules or where the IRS estimated and prepared the returns on behalf of the taxpayer 11 USC §6011(a) and the regulations thereunder.

   1. IRS Tax Returns Prepared by IRS Under Internal Revenue Code §6020(b) -

      Where the taxpayer has failed to file an IRS tax return, the IRS can prepare a substitute or “dummy” or “SFR” return from which a subsequent tax assessment can be made. With respect to income taxes, a Statutory Notice of Deficiency must be mailed to the taxpayer at his last known address. However, with respect to payroll taxes, no such tax procedure is required and in fact, the IRS may make the assessment after reasonable notice.

   1. Bankruptcy Discharge of Tax Debt Based on IRC §6020(b) Returns -

      It is now well settled tax and bankruptcy law that IRS tax debt which result from tax returns prepared by the IRS on behalf of the taxpayer are excepted from tax bankruptcy discharge and hence are not dischargeable under 11 US §523(a)(1)(B)(i) on the premise that such returns were not filed by the IRS tax debtor but rather the taxing agency itself. However, there has been some older bankruptcy case law which provides that in an unusual circumstance IRS tax return prepared under IRC §6020(b) may qualify as a tax return under 11 USC §523(a)(1)(B)(i) where the taxpayer cooperates with the IRS, provides the necessary data to compute the tax, and thereafter, executes a Form 870-AD or a stipulated decision. In re Carpella, 84 BR 799(BC MD Fla 1988). This is not the norm in most tax bankruptcy cases. In most jurisdictions including California, taxpayer will not be able to discharge taxes in Chapter 7, 11 or Chapter 13 bankruptcy cases where the tax return was not timely filed.

   2. Tax Discharge Under Chapter 13 Bankrupt cy - Prior to 2005, even though no IRS tax return was filed or the return was prepared by the taxing agency/IRS or the return was filed within two years of the contemplated bankruptcy filing date, if no IRS or FTB tax lien has been filed (or if filed, the IRS or FTB tax lien attaches to no property) and the subject tax claim is more than three years old and assessed more than 240 days prior to the contemplated bankruptcy filing date, it was capable of being discharged in a chapter 13 bankruptcy case. However, with further restrictions on discharging taxes in bankruptcy courtesy of IRS and Congress, Chapter 13 debtor may no longer discharge income tax from IRS, FTB, or sales tax from CDTFA where the tax claims arise from a non-filed tax return or a substitute return “sfr” in a Chapter 13 bankruptcy case. In essence, Bankruptcy Code 11 USC §1322(a) provides that any Chapter 13 Plan must provide for full payment of all claims entitled to priority under 11 USC §507 unless otherwise agreed upon with a bankruptcy creditor. In effect, this means a taxpayer with unfiled IRS tax returns or returns filed within two years of the intended bankruptcy filing may not file Chapter 13 and obtain discharge of the taxes if they constitute as priority tax claims under 11 USC §507(a)(8) .
2. FRAUDULENT TAX RETURNS & TAX EVASION IN BANKRUPTCY

   Term fraudulent tax returns or tax evasion applies where a tax debtor makes a fraudulent tax return or willfully attempts in any manner to evade or defeat the tax. 11 USC §523(a)(1)(C) therefore excepts from discharge a situation where, as part of a dishonest scheme, the debtor seeks to evade a tax liability ie tax evasion.

   A tax liability attributable to a fraudulent tax return or a fraud penalty addition to tax under the Internal Revenue Code is capable of being litigated in a bankruptcy court to determine discharge status along with a successful completion of a Chapter 13 Bankruptcy Plan assuming that the individual debtor otherwise qualifies for Chapter 13 relief.

   Also, Chapter 13 Bankruptcy provides an opportunity under certain circumstances which the fraud penalty (as distinguished from a tax liability attributable to a fraudulent tax return) is capable of being discharged in a Chapter 13 tax bankruptcy case. Even though Congress significantly narrowed the scope of Chapter 13 “super discharge” by limiting the type of debts dischargeable under 11 U.S.C. § 1328(a)(2) by specifically noting the bankruptcy code subsections of section 523(a) that are deemed non-dischargeable. Bankruptcy Code specifically omits section 523(a)(7) debts - governmental penalties or certain tax penalties - from the discharge list in section 1328(a)(2). The bankruptcy courts in many jurisdictions side with the position that by omitting penalty debts from the winnowing of the Chapter 13 super discharge, Congress intended and did not object to the certain tax penalties to remain dischargeable under Chapter 13 Bankruptcy proceedings. This is potentially true even if the penalty debt arises from fraud.

3. PAYROLL TAXES & TRUST FUND TAXES IN BANKRUPTCY

   Any tax which is required to be collected or withheld and for which the tax debtor is liable in whatever capacity regardless of the age of the tax claim is a “trust fund tax” and is typically not dischargeable under 11 USC §507(a)(8) under Chapter 7,11 or 13 bankruptcy filing. Moreover, when such a trust fund tax is assessed against a responsible person as a “100 percent penalty” it is a priority tax and not a non-priority penalty which debt may be eliminated in a bankruptcy proceeding for tax discharge.

   Thus, it is important to understand that category of “trust fund” types of taxes are far different from the standard IRS tax penalties for late filed IRS tax returns or IRS late payment penalties. For example, this category covers income taxes which an employer is required to withhold from the pay of its employees, as well as certain excise and sales taxes (treatment of sales tax in bankruptcy vary by the laws of the state) which the seller of goods or services is required to collect from a buyer and hold “in trust” before paying over to the taxing agency.

   1. 100 Percent Penalty or Trust Fund Penalty

      (1) What is 100 Percent Penalty - The 100 percent penalty involves a situation where a corporation, LLC or small business owner has failed to pay over employment trust fund taxes withheld or required to have been withheld from its employees to the IRS, for which the IRS then seeks payment from a “responsible person” within the corporation who has acted “willfully” in failing to collect or pay over the trust fund taxes - IRC §6672. Thus, before any liability for the 100 percent penalty or trust fund penalty can be assessed, a determination must first be made that the targeted individual was a “responsible person,” that is, someone required to collect, account for, and pay over trust fund taxes to the IRS. In addition, a determination must be made that the “responsible person” acted willfully in failing to remit the funds to the IRS or government tax agency in charge. Once determined, the liability is assessed in an amount equal to 100 percent of the employees' share of Federal income tax withheld and social security tax withheld.

      (2) Bankruptcy Discharge of 100 Percent Penalty or Trust Fund Taxes - any person found liable for the 100 percent penalty cannot discharge the tax liability by filing bankruptcy under any tax bankruptcy chapter. Thus, the liability for the 100 percent penalty is entitled to priority under 11 USC §507(a)(8)(C) and is therefore excepted from discharge under 11 USC §523 (a)(1)(A). However, a bankruptcy proceeding can be a useful tool for the individual against whom a 100 percent penalty has been assessed by the IRS, FTB, CDTFA or EDD in order to dispute the elements of “responsibility” and “willfulness” and to stop interest and penalties from accruing post-petition in a Chapter 13, to the extent the underlying 100 percent penalty is unsecured.

      Important Note: If a debtor fi1es a petition for relief under Chapter 13 (and possibly under Chapter 11), and where the 100 percent penalty is unsecured but is provided for in the Chapter 13 plan and the taxing entity fails to file a timely proof of claim, the 100 Percent Penalty may be discharged without payment or nominal payment. 11 USC §§1328(a), 1322 and also see In the Matter of Workman, 108 BR 826 (Bkrtcy.M.D. Ga 1989) wherein the Court held that 100 Percent Penalty was a “prepetition claim” barred by IRS's failure to timely file a proof of claim notwithstanding the fact that the 100 Percent Penalty was not assessed. In addition, see In the Matter of Gregory, 705 F.2d 1118 (1983) for a definition of what constitutes “provided for” in the Chapter 13 plan.

4. CALIFORNIA SALES TAX DEBT in TAX BANKRUPTCY CASE

   The dischargeability of sales taxes turns on the issue of whether, under the law of the state, the sales tax is actually an excise tax, which may be discharged in bankruptcy if “stale,” that is, the claim is over three years old under 11 USC §507(a)(8)(E), as distinct from a true sales tax which is a nondischargeable trust fund tax. The courts appear to be split on this issue with the majority finding that such taxes are in fact true sales taxes, and hence, not dischargeable. Some states, view the issue to be whether the debtor can be made personally liable under the respective state law for the sales tax claim.

   1. Majority Rule - Sales tax is imposed on the customer or buyer, to be collected by the retailer and forwarded to the taxing agency and therefore is a nondischargeable trust fund tax (i.e., Washington, Texas, Alabama, Illinois, Tennessee and New York) .
   2. Minority Rule - States, such as California and Hawaii reason that a sales tax is one that is imposed on the retailer for the privilege of doing business and as such is a mere excise tax capable of being discharged under 11 USC 507(a)(8)(E) if arising from a transaction which occurred more than three years prior to the filing of bankruptcy and also having met various other factors for tax bankruptcy discharge. Tax and bankruptcy law for discharging California sales tax “CDTFA” has been changing so it is important to review the current rulings on this matter.
5. EXCISE TAXES IN BANKRUPTCY CASE

Excise taxes are taxes which may be discharged if “stale,” that is, if imposed on a transaction occurring more than three years prior to the bankruptcy filing. 11 USC §507(a)(8)(E). As discussed above, Sales Tax and Excise tax treatment in bankruptcy cases differ substantially based on each state’s interpretation of the tax transaction. However, pure Excise tax is seen as an indirect tax, one which is not indirectly imposed upon any person or property but rather, is one that is imposed on the performance of an act, for example, the engaging in any occupation or the enjoyment of a privilege. Some examples of excise taxes include Federal alcohol and tobacco taxes, gas guzzler tax, tax on ozone-depleting chemicals, tax on undistributed income, speculative investment of private foundations, and tax on “golden parachute” payments.

6. EMPLOYMENT TAXES IN BANKRUPTCY CASE

An employment tax (i.e., employer's share of the payroll tax liability) on a wage, salary or commission accrued for wages paid within three years of the bankruptcy is not dischargeable. Thus, employment taxes accruing before three years prior to the filing of bankruptcy are dischargeable under 11 USC §507(a)(8)(D). However, see In re Pierce, 115 B.R. 523(N.D. Tex. 1990) which was overturned on appeal, In re Pierce, 935 F.2d 709 (5th Cir. 1991). Employment taxes are deemed to accrue on the April 15 date following the close of the taxable year in which the quarter falls.

7. TAX LIEN: CDTFA, FTB OR IRS TAX LIEN IN BANKRUPTCY CASE

Notwithstanding the discharge of a nonpriority tax claim in bankruptcy, a tax lien filed by the IRS, FTB, CDTFA or EDD will be enforceable to the extent there exist assets to which the tax lien attached as of the date of the filing of the bankruptcy petition under Chapter 7, 11 or 13. Thus, it is now well settled that the IRS tax lien is intended to survive the bankruptcy proceeding. Accordingly, after the bankruptcy proceeding, if the tax debt is no longer enforceable against the individual taxpayer, in order to collect from exempt assets, a foreclosure proceeding should be brought in the United States District Court (IRC §7403) by the IRS. An administrative seizure by IRS or taxing agencies or attempted sale by IRS personnel is therefore capable of being a set aside.

8. PROPERTY TAXES IN BANKRUPTCY CASE

Property taxes which are assessed against real property held by a taxpayer within one year of the commencement of the tax bankruptcy case are not dischargeable under 11 USC §507 (a)(8)(B)

under any tax bankruptcy case. In practice, however, property tax claims in California are typically secured against the property to which they pertain and are therefore difficult to discharge without payment.

9. ERRONEOUS TAX REFUNDS ISSUED BY IRS IN BANKRUPTCY CASE

11 U.S.C §507(c) provides that a claim of a governmental unit including IRS, FTB, EDD or CDTFA arising from an erroneous tax refund or tax credit has the same authority as a tax bankruptcy claim for the tax to which such tax or refund or credit relates back to. Thus tax discharge analysis should be focused on the 11 USC §507(a)(8) priority standing.

10. IRS TAX COLLECTION & TAX BANKRUPTCY TOLLING EVENTS
    1. Three-year Period - Is tolled during various periods, including any period of time that (a) an extension of time to file was in effect (11 USC §507(a)(8)(A)(i)) or, (b) according to the majority of case law, the time that any bankruptcy proceeding was pending plus six months, or (c) probably, during any period, a Taxpayer's Assistance Order was in effect (IRC §7811).
    2. Late Filed Tax Return - As is the case with the three-year rule above, the running of the two-year period under 11 USC §523(a)(1)(B)(ii) for a late filed tax return is tolled during the time the debtor is in bankruptcy. In the Matter of Stoll, 132 B.R. 782(ND. Ga. 1990).
    3. The 240-day Period - Is also tolled by any period during which the debtor was in bankruptcy plus six months.
    4. Three-year statute of Limitations on Tax Assessment - The three-year period under IRC §6501 is tolled during any period during which the taxpayer is in tax bankruptcy plus 60 days.
    5. The Ten-year statute of Limitations For Collection - The ten-year period under IRC §6502(a) is suspended during anytime that the taxpayer is in tax bankruptcy plus an additional six months. A summary of the foregoing tolling events as well as others are summarized in our tax discharge chart which you can request from our firm.