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Bankruptcy Taxation

Bankruptcy Code Does Not Preempt State Law for Allowance of Claims

By: Dylan Lackowitz

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Like other states, New Jersey allows third parties to purchase tax liens at auction.[1] These liens against real property are a result of property owners failing to pay local property taxes.[2] Successfully bidding on the lien at auction gives the purchaser the right to foreclose on the property and to seek a judgment on the debt note.[3] In New Jersey, the bidding begins at 18% interest, and each bid lowers the interest rate that would have been assessed on the tax debt.[4] Once the bidding reaches 0%, the bidding parties will then bid on a premium payable to the municipality holding the lien.[5] The party that wins at auction pays the municipality the tax debt owed by the delinquent property owner and any premium incurred during the bidding process in exchange for the tax lien, as evidenced by a tax sale certificate and its accompanying rights.[6] New Jersey law, however, also provides that any holder of a tax sale certificate, who knowingly charges or exacts an excess fee in connection with the redemption of any tax sale certificate, shall forfeit such tax sale certificate to the person who was charged such excessive fee.[7] In In re Princeton Office Park, L.P., the United States Court of Appeals for the Third Circuit held that the United States Bankruptcy Code (the “Code”) does not preempt state law regarding the allowance of claims.[8] Therefore, the Third Circuit held that Plymouth Park Tax Services LLC’s (“Plymouth”) claim in bankruptcy against Princeton Office Park L.P. (“Princeton”) was disallowed because Plymouth charged Princeton an excessive fee in connection with the redemption of a tax sale certificate.[9]

The Government Will Get Theirs (Most of the time)

By: Clayton J. Lewis

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In the case of In re Brown, the Bankruptcy Court for the Middle District of Florida held that a tax debt owed to the IRS was excepted from a hardship discharge, and accordingly was not excused from payment. The debtors in In re Brown filed for Chapter 13 bankruptcy relief and initially implemented a payment plan for 100% of their debts, including a total of $303,229 payable to the IRS. The debtors, however, were unable to meet their payment obligations and had to amend their payment plan twice. With over $155,000 still due to the IRS, the debtors offered to settle theirs debt with the IRS. The debtors and the IRS were unable to reach a settlement. The IRS nonetheless suggested that the debtors file for a hardship discharge under section 1328(b) of the Bankruptcy Code. The debtors followed this suggestion and received a hardship discharge, and their bankruptcy case was closed. The discharge order expressly noted that the debt to the IRS, however, was not discharged and was still due in full. When the IRS attempted to collect the debt, the debtors filed a complaint against the IRS in the bankruptcy court, alleging that the IRS had violated the Discharge Order.

Seventh Circuit Reaffirms that a State Entity May Not Assert Sovereign Immunity Defense in a Bankruptcy Case

By: Melanie Lee

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

At the Constitutional Convention, the States agreed not to assert any sovereign immunity defense “in proceedings pursuant to ‘Laws on the subject of Bankruptcies.’”[1] The agreement was made to “prevent competing sovereigns’ interference with discharge[ing]…” debts. [2] The Seventh Circuit, in In re Bulk Petroleum , held that Kentucky could not assert sovereign immunity as a defense to a debtor’s request to an excise tax refund.[3] There, Bulk Petroleum Corp., prior to filing its chapter 11 petition, had lost its license as a “gasoline and special fuels dealer” in the state of Kentucky.[4] As a gasoline and special fuels supplier, the debtor, pre-petition, was entitled to a refund for the excess fuel taxes it paid.[5] The loss of the license did not require the debtor to cease business in Kentucky or permit the debtor to ignore its tax obligations.[6] However, according to the Kentucky Department of Revenue (“KDOR”), only a “taxpayer” within the meaning of the statute was entitled to a refund.[7] The KDOR refused to refund the fuel taxes to the debtor because the debtor “was unlicensed” and therefore, not a ’taxpayer.’[8] The Seventh Circuit disagreed and found that while the debtor was unlicensed, the debtor was still required to pay the fuel taxes to its upstream suppliers.[9] The suppliers were authorized to add the fuel tax to the debtor’s invoices because of their capacity as “trust officer[s] of the state” under Kentucky Revised Statute 138.280.[10] Because this statute required suppliers to collect, hold, and turn over the tax collected to Kentucky, the court held that the debtor had paid the fuel tax, via its suppliers, despite being unlicensed.[11] Consequently, the debtor was entitled to any excess tax paid on the gasoline, which ended up being sold outside of Kentucky.[12] Despite having not been raised by either party, the Seventh Circuit considered the possibility of Kentucky asserting sovereign immunity, under the Eleventh Amendment, as a defense to the state having to issue the refund.[13] According to the Seventh Circuit, that defense would have failed because the States “agreed in the plan of the [Constitutional] Convention not to assert any sovereign immunity defense they might have had in proceedings brought pursuant to ‘Laws on the subject of Bankruptcies.’”[14]

The IRS Can Offset Post-petition Tax Overpayments Against Pre-petition Tax Liabilities

By: Kyle J. TumSuden

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Recently, in In re Pugh, the Bankruptcy Court for the Eastern District of Wisconsin modified the automatic stay to allow the IRS to offset the debtor’s post-petition claim for tax overpayment against the debtor’s pre-petition tax liability due to the IRS. In Pugh, the chapter 13 debtor confirmed her plan, which provided that she would be able to keep any federal or state tax refunds received during the term of the plan. Sometime after the debtor had filed, the IRS audited her pre-petition tax returns and discovered a tax liability for 2011. The debtor then filed a proof of claim on behalf of the IRS for the tax liability for 2011, and the IRS subsequently filed an amended proof of claim. In early 2014, the debtor filed her 2013 federal income tax return, claiming a refund based on an overpayment. The IRS did not remit the refund to the debtor and instead moved for an order modifying the automatic stay to allow the IRS to offset the debtor’s post-petition claim to a tax overpayment against pre-petition tax liabilities. The debtor responded that, pursuant to section 541(a)(7) of the Bankruptcy Code, the right to the refund was property of the estate because the 2013 tax refund did not exist at the time of the bankruptcy filing. In addition, the debtor argued that the 2011 tax obligation arose post-petition because, at the time of filing, she did not owe any taxes for 2011. The IRS, however, maintained that the overpayment for 2013 was not property of the debtor or the estate because under section 6402 of the Internal Revenue Code, the IRS was entitled to offset such funds against the tax liability for 2011. Therefore, the IRS argued that the debtor was entitled to a refund only if there was a net amount remaining after offset. Ultimately, the court granted the IRS’ order modifying the automatic stay, thereby allowing the IRS to offset the debtor’s post-petition tax overpayment for 2013 against the debtor’s pre-petition 2011 tax liability.

The Nature of a Parent-Subsidiary Relationship Determines How to Allocate a Refund in a Tax Sharing Agreement

By: Samuel Cushner

St. John’s Law Student

American Bankruptcy Institute Law Review Staff


Recently, in FDIC v. AmFin Financial Corp.,[i] the Sixth Circuit held that a tax sharing agreement between a bank holding company and its subsidiary was ambiguous as to the ownership of an income tax refund and that the district court erred in refusing to consider extrinsic evidence concerning the parties’ intent as to the ownership of the funds.[ii] In 2009, the bank holding company filed for chapter 11 bankruptcy protection.[iii] As a result, the Office of Thrift Supervision closed the bank holding company’s bank subsidiary and placed it into FDIC receivership.[iv] Later on, the bank holding company filed a consolidated 2008 federal tax return on behalf of itself and its affiliates showing a total net operating loss of $805 million, with the bank subsidiary’s losses accounting for $767 million of that total.[v] After the IRS issued a refund of approximately $195 million to the parent company, the FDIC claimed[vi] that over $170 million of that refund belonged to the bank subsidiary. Finding that the tax sharing agreement was unambiguous, the United States District Court for the Northern District of Ohio concluded that the tax sharing agreement created a debtor-creditor relationship with respect to tax refunds between the parent and its affiliates, including the subsidiary, and thus, the parent owned the refund.[vii] The Sixth Circuit reversed and remanded to the district court to determine whether the tax sharing agreement created either a debtor creditor relationship or a trust or agency relationship under Ohio law with respect to the tax refunds.