Bankruptcy Taxation

Recently, in In re Debenedetto[1] the Bankruptcy Court for the Northern District of New York held that a debtor could not modify the interest rate on tax liens on his property that had been purchased by a creditor from the City of Schenectady, NY (the “City”) because the creditor was the holder of a “tax claim” that cannot be modified under section 511(a) of the Bankruptcy Code.[2] In Debenedetto, the creditor, American Tax Funding, LLC (“ATF”), purchased a tax lien from the City and claimed that the debtor owed a rate of 21 percent per annum on the lien, which was the interest rate imposed by statute for delinquent real property tax payments owed to the City.[3] The debtor objected to ATF’s claims, arguing that ATF was not the holder of a “tax claim” under section 511(a) and was therefore not entitled to receive the anti-modification protection afforded by that section. Thus, the debtor argued that the interest rate on AFT’s secured claim was subject to modification pursuant to the methodology set forth by the Supreme Court in Till v. SCS Credit Corp.,[4] which would likely result in the creditor receiving a significantly lower interest rate on the liens. To determine whether ATF had a “tax claim,” the court looked to two factors: (1) whether the payment by the private purchaser to the government entity extinguished the underlying debt[5] and (2) whether there was a “continuity of rights between the original holder . . . and the private purchaser.”[6] When applying the first factor, the court found that “the underlying tax debt was not extinguished upon payment . . . to the City . . .” because ATF was not required to pay the full face amount of the tax lien.[7] Furthermore, the court also reasoned that the underlying debt was not extinguished by the sale because the City was entitled to repurchase the tax liens from ATF.[8] With respect to the second factor, the court concluded that there was a continuity of rights between the City and ATF because by the terms of the Purchase and Sale Agreement, the City assigned its right of claim on the delinquent tax debt to ATF. Thus, the court concluded that ATF, as a secured creditor, held a valid “tax claim” and was entitled to the applicable interest rate as determined by state law.

S-Corp and QSub Tax Status Do Not Constitute Property of the Bankruptcy Estate

By: Ryan Jennings

St John’s Law Student

American Bankruptcy Institute Law Review Staff

In In re Majestic Star Casino, LLC, the Court of Appeals for the Third Circuit held as a matter of first impression that a Chapter 11 debtor’s status as a pass-through entity for taxation purposes did not constitute “property” of the bankruptcy estate.[1] The debtors, Majestic Star Casino II (“MSC II”) and other subsidiaries and affiliates, were wholly owned by a non-debtor corporation called Barden Development, Inc. (“BDI”).[2] Don H. Barden (“Barden”) was the sole shareholder, CEO, and president of BDI.[3] In November of 2009, the debtors filed for bankruptcy under chapter 11 of the Bankruptcy Code.[4] Later that year, Barden chose to revoke BDI’s status as an “S” corporation (“S-Corp”) for tax purposes, thus forfeiting the company’s pass-through tax status.[5] As a result of that election, MSC II’s status as a qualified subchapter S subsidiary (“QSub”) was also automatically revoked.[6] Thus, MSC II was now subject to federal and state taxes that it used to pass on to Barden.[7] MSC II asserted that the revocation of BDI’s S-Corp status constituted an unlawful postpetition transfer of property of MSC II’s bankruptcy estate.[8] The Third Circuit reversed the decision of the bankruptcy court, holding that MSC II’s status as a QSub for tax purposes was not property, and even if it was, it would belong to the shareholders of its non-debtor parent corporation and not to MSC II.[9]