Content area
Full Text
Bankruptcy & Insolvency
Common tax issues are encountered in Chapter 7 and Chapter 11 bankruptcy cases. Failure to fully understand the application of tax laws in the context of a Chapter 7 or Chapter 11 bankruptcy case can undermine the success of the bankruptcy proceedings, result in unanticipated adverse tax consequences, and even expose a party to personal liability.
A Chapter 7 bankruptcy is a liquidation proceeding in which the debtors nonexempt assets, if any, are sold by the Chapter 7 trustee, and the proceeds are distributed to creditors according to the priorities established in the Bankruptcy Code. A Chapter 11 bankruptcy is a reorganization proceeding in which the debtor repays creditors through a court-approved plan of reorganization. Chapter 11 is ordinarily used by business debtors; however, individual consumers may be eligible to file for Chapter 11 bankruptcy under certain circumstances (see Toibb v. Radiof, 501 U.S. 157 (1991)). A Chapter 11 case is typically pursued by individuals who continue to have substantial personal earning power but whose debts exceed the Chapter 7 and Chapter 13 limits.
Role of Tax Considerations in Bankruptcy: In General
A fundamental goal of the federal bankruptcy laws is to give debtors a financial "fresh start" from burdensome debts (e.g., Local Loan Co. v. Hunt, 292 U.S. 234 (1934)). The U.S. Bankruptcy Code operates in conjunction with the Internal Revenue Code (IRC) and defers to the IRC for purposes of determining tax consequences of the bankruptcy process (11 U.S.C. §346(k)).
However, unlike the Bankruptcy Code, the IRC is not primarily concerned with fairness, equity, or a fresh start for the debtor (e.g., In re Olson, 121 B.R. 346 (Bankr. N.D. Iowa 1990); In re McGowen, 95 B.R. 104 (N.D. Iowa 1988); In reNevin, 135 B.R. 652 (Bankr. D. Hawaii 1991)). In addition, Congress itself acknowledged this tension between the IRC and bankruptcy laws in connection with the enactment of the Bankruptcy Act of 1978 (see S. Rep't No. 95-989,95th Cong., 2d Sess., at 13-14 (1978): "A three-way tension thus exists among (1) general creditors, who should not have the funds available for payment of debts exhausted by an excessive accumulation of taxes for past years; (2) the debtor, whose 'fresh start' should likewise not be burdened with such...