Under the old act there was a cool, little loophole for unfiled tax returns in a Chapter 13. Pretty close to the top of the IRS’ wish list for BAPCPA was closing that loophole. They got it — and a brand new headache.
How taxes are handled in a Chapter 13 Reorganization is governed by two different concepts. First, you have the familiar issue of dischargeability. Section 523 (as limited by Section 1328) sets out the debts that may not be discharged in a bankruptcy, and it provides the familiar 3-year rule, 2-year rule and 240-day rule for dischargeability. So, speaking in the most general terms, income taxes incurred within three years are not dischargeable. This hasn’t changed.
The new oops (one of many in the new Code) is in the Section that establishes priority for taxes. In most Chapter 13’s priority, unsecured debt gets paid (and in most cases must get paid); and general, unsecured debt doesn’t. It gets discharged.
There has long been a third class of unsecured debt — student loans. Since they are not entitled to statutory priority, they generally don’t get paid (there are two exceptions); but they also are not discharged. What is worse is that they continue to accrue interest during the course of the Bankruptcy, so if someone files for bankruptcy and is behind on their student loans; they are going to be in worse shape when they are done. (If they are current and the payment plan extends more than five years, in most districts the debt can be treated as current, long-term debt and provided for outside the plan. Also, they get paid the same percentage other general, unsecured debt does; so, they do get paid in full in 100% plans.)
Now, we have a class of taxes that gets the same treatment as student loans. Why? I’m so glad you asked, because Congress tinkered with Section 507 without having a clue what they were doing.
Now, Section 507 requires that for taxes to receive priority treatment, they must have been assessed before the Petition date.
I just got an e-mail from a client who is about to file a Chapter 13 and is going to owe taxes for 2006 — that she can’t pay. Not a problem, include them in the 13 plan. WAIT JUST A MINUTE. First of all, she hasn’t filed her returns yet. Ok, GET THEM FILED; but that isn’t enough. Next, those taxes have to be assessed before the petition date in order to receive priority treatment. If they aren’t assessed before the petition date, they will be general, unsecured debts and if the plan doesn’t pay 100% — they won’t be discharged and penalties and interest may continue to accrue over the life of the plan.
Ok, take a deep breath and call Special Procedures or the IRS General Counsel’s office. Request an expedited assessment. We can do this — but wait! The Oklahoma Tax Commission doesn’t formally assess taxes. So, now what? They aren’t sure yet. The tax geeks say that when the taxes become final, meaning they can no longer be challenged or appealed, then they have been assessed for purposes of this Statute. Are they right? Who knows? So, what do you do if the client has a Motion to Confirm his Sheriff’s Sale in January, can’t file his taxes until he gets his W-2’s and is sure that he is going to owe for the preceding year? Pick your poison.
You gotta love this act.