Dischargeability

In addition to the stay on collection and the ability to force seized property to be returned, both a chapter 11 and a chapter 13 allow the payment of taxes over time, sometimes without interest. Moreover, under certain circumstances, tax liabilities can be discharged in bankruptcy without full payment. As with other dischargeable debts, if a tax liability is discharged, the Service is forever barred from trying to collect the liability. Therefore, in order to adequately represent a client with serious tax liabilities, it is imperative to understand what is dischargeable in a bankruptcy.

The bankruptcy code sets forth an order in which certain types of creditors will be paid. The type of creditors consist of secured creditors, administrative creditors, priority creditors and unsecured creditors. Secured creditors are creditors possessing a pre-petition lien on an asset or assets of the debtor. The Service will be secured if a notice of federal tax lien was filed prior to the bankruptcy and the debtor had property to which the lien attached. As discussed previously, the tax lien attaches to all property and rights to property belonging to the debtor. Generally secured claims must be paid the full value of the asset securing their claim or must be given the asset.

Administrative creditors are creditors whose claims came into existence after the bankruptcy filing. These would include the attorney's fees, trustees fees, and taxes arising during the pendency of the bankruptcy but prior to plan confirmation. The code provides for these claims to be paid as a first priority. The code also provides for certain pre-petition claims to be paid as a seventh priority. As a "priority claim" these taxes will be paid ahead of other unsecured creditors. Obviously understanding what type of taxes fall under the "priority” category is crucial in terms of knowing what order they will be paid in the bankruptcy. Perhaps more importantly, it is crucial to know what taxes are priority, since the code provides that these liabilities are not dischargeable in a chapter 7 or individual 11 and full payment of priority taxes must be provided for in order for a chapter 11 or 13 plan to be confirmed, whether a tax liability qualifies as a priority claim is a critical question.

If an income tax liability is involved it will be a priority tax and thus non-dischargeable, if any of the following apply:

As can be seen, time elements are critical in determining dischargeability and therefore a misunderstanding of these provisions can and often does result in a mistimed bankruptcy. This may results in not discharging a liability that could have been discharged, an oversight that is tantamount to malpractice.

Bluestein & Muhlbauer, P.C.
333 International Drive
Williamsville, NY 14221
716.633.3200

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