Discharging Taxes in Bankruptcy

PART IV

Tax Discharge in Chapter 11

By

 Morgan D. King, Esq.
Of the California Bar

Originally appearing in the San Francisco Recorder in three parts 

a. In general

Now let's take a look at discharge of tax claims in Chapter 11.

A Chapter 11 is, in principal, very similar to a Chapter 13. That is, like Chapter 13 a Chapter 11 is a court-approved consolidation of debt, with a repayment schedule. And, like Chapter 13, it often includes the additional benefit of a partial or total wipe-out of unsecured debt. However, Chapter 11 is a more ritualized and complex program and involves considerably more attorney work, and hence considerably larger fees and costs. Accordingly, it is not suitable for most individual or small business cases.

b. The criteria for discharge

The criteria for discharge of a tax claim in Chapter 11 is the same as for Chapter 7. So, for example, a debtor who has failed to file tax returns for the tax years in question at least more than two years before filing the bankruptcy is not eligible for a discharge (wipe out) of the claim. Accordingly, the ability to wipe out a tax claim in Chapter 11 is not as great as a Chapter 13, which does not require a filed tax return.

c. Benefits

Are there any advantages to handling tax claims in Chapter 11, as compared with Chapter 13? In many situations the answer is, yes. Let's look at some of them.

1. Unlike Chapter 13 which ordinarily requires that payments under the plan begin immediately, there is usually a "grace" period in Chapter 11 of anywhere from six months to several years before the debtor must begin making his payments under a confirmed plan. Many debtors desperately need this grace period in order to overcome a debt or cash-flow crisis.

2. While in Chapter 11 unsecured tax claims must be paid within six years of assessment, section 1129(a)(9)(C) places no such time limit on payment of secured taxes. Hence, unlike Chapter 13 which requires that such claims be paid in no more than 60 months, the debtor may be able to confirm a Chapter 11 plan providing for a considerably longer payment period.

3. Unlike Chapter 13 which places debt limitations for eligibility in Chapter 13, there are no such debt limitations in Chapter 11. Therefore a debtor may be ineligible for Chapter 13 because his secured debts exceed $871,550, or his unsecured debts exceed $290,525 (see 11 U.S.C. § 109(e)), yet be eligible for a Chapter 11 reorganization.

d. Disadvantages

Now, a glance at some of the most common disadvantages.

1. Unlike Chapter 13, a priority tax claim paid through Chapter 11 ordinarily continues to accrue interest, substantially adding to the cost of handling the claim. 11 U.S.C. § 1129(a)(9)(C).

2. Priority tax claims paid in Chapter 11 must be paid within six years of date of assessment (not from date of filing the chapter 11). 11 U.S.C. § 1129(a)(9)(C). In comparison, the Chapter 13 plan may provide up to five years from date of filing the bankruptcy for payment regardless of date of assessment. 11 U.S.C. § 1322(a). Hence, a priority claim that was assessed several years ago may require payment in full upon or soon after confirmation of the Chapter 11 plan, something many debtors are not financially capable of doing.

3. Unlike Chapter 13 where the creditor has little say over confirmation of the plan, in Chapter 11 tax claims for unsecured, dischargeable taxes probably give the taxing entity a vote along with other general unsecured creditors. This is because the only tax claims that do not get a vote on the plan in Chapter 11 are those that are not classified, and 11 U.S.C. § 1123(a)(1) provides that only priority taxes are not to be classified. See 11 U.S.C. § 1129(a)(8), Voting.

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