Copyright 1999
Federal News Service, Inc.
Federal News Service
MARCH 18, 1999, THURSDAY
SECTION: CAPITOL HILL HEARING
LENGTH: 2685 words
HEADLINE: PREPARED STATMENT OF
DONALD F. HARRIS
PRESIDENT
STATES'S ASSOCIATION OF
BANKRUPTCY ATTORNEYS
ATTORNEY, NEW MEXICO TAXATION AND REVENUE DEPARTMENT
BEFORE THE
HOUSE JUDICIARY COMMITTEE
SUBCOMMITTEE ON COMMERCIAL AND ADMINISTRATIVE LAW
SUBJECT - HEARING ON H.R. 833,
THE
"BANKRUPTCY REFORM ACT OF 1999"
BODY:
Summary of Comments on the Tax Provisions of The
Bankruptcy Reform Act of
1. The system often constitutes a game of
"gotcha" with governmental creditors, particularly tax creditors. The
bankruptcy laws were not intended to enable debtors to effectively ambush the government
through the use of gamesmanship and discharging hidden liabilities.
2. Non-bankruptcy tax law is based on voluntary compliance, and these principles should be
carried over to a greater degree with regard to tax debts in
bankruptcy. The burden under the current law is often placed on the government to ferret
out unknown problems whereas the debtors have all of the information concerning
their financial affairs.
3. Congress must not forget about the 260 million non-bankruptcy- filing members of the public who are affected by the
bankruptcy laws and who struggle to pay their debts.
4. The effective notice to government
provision will help address the disadvantaged position the government is in
with regard to information regarding the debtor.
5. The interest rate provision is fair and would make for certainty where the
law is now uncertain and unpredictable.
6. The tolling provision is a necessary clarification in the law. The purpose
of the priority periods can be rendered meaningless if, as some courts have
reasoned, the priority is lost during a
bankruptcy case. The current law can lead to manipulation and promote sequential filings.
7. Chapter 13 should not discharge non-filed returns, fraudulent tax claims, or
priority tax claims that are not actually paid.
The current law is frequently abused, and rewards those taxpayers who do not
comply.
8. The course of business provision will help address a recurring, and serious,
problem where debtors use the
bankruptcy process to finance their operations through non-payment of taxes. The
provision will help the governments by making the obligation to file and pay
clearer, and by making the remedies easier, in these problem cases.
9. The requirement to file tax returns as a condition of confirming a Chapter
13 plan is fair, and will help address the recurring problem where plans are
confirmed without the tax claims being appropriately provided for.
All of the tax provisions not specifically discussed are supported by the
states. Most are non-controversial and were recommended by the National
Bankruptcy Review Commission.
*********************
1. Introduction
Thank you for inviting me to come to speak today. The
States' Association of
Bankruptcy Attorneys is a non-profit association of attorneys who work in or with states'
Attorneys' General offices in order to protect states' interests in
bankruptcy court. Our primary concern is in developing a shared expertise among state and
local government lawyers in the area of
bankruptcy/tax law as it affects state and local governments. Our organization is in a
truly unique position to observe and comment upon how the
Bankruptcy Code's provisions operate with regard to tax debts, and the improvements that
may occur if this bill becomes law. A. Too Much
"Gotcha" Going On
Bankruptcy is an important social safety net; but the net is currently being used by
hundreds of thousands of businesses and consumers to obtain an unfair advantage
over their creditors with regard to debts that could be paid. This is
particularly
true with tax debts. While governmental agencies are facing increased pressure
to limit their resources, the
bankruptcy system provides a way to stymie collection, and, all too often, eliminate
debts that the government is completely unaware.
On the tax side of the ledger, on both the state and federal level, our
governments rely on voluntary compliance. The government does not learn about
most tax debts until and unless they have been reported to the taxing
authority.
Bankruptcy is generally based upon much the opposite principle: If a creditor wants to be
paid, it must generally go into the
bankruptcy court, tell the trustee or debtor what the creditor believes is owing, and ask
for payment. The creditor must generally object to provisions in proposed plans
that do not treat the creditor fairly.
There are currently loopholes in the law which allow debtors to take advantage
of the tension between the voluntary
compliance nature of taxation and the debtor-oriented
bankruptcy system. This creates the
"gotcha" trap, which unfairly eliminates tax debts every day in
bankruptcy courts throughout the country--particularly in Chapter 11, and Chapter 13
cases. The governmental entity is often either unaware of the debt altogether
(because the debt was either unreported or misrepresented) or is not made aware
of the debt in a timely manner. Alternatively, the debtor's lawyer may acquire
a court order with respect to a tax debt, which order would not be anticipated
and is contrary to the
bankruptcy code. In any combination of the above scenarios, the debtors can, and often
do, score a
"gotcha." It is grossly unfair to the honest taxpayers. It is currently the law, but it
is not what Congress intended.
B. Who is Representing the Public in the Process?
This panel, and other committees considering
bankruptcy
legislation, will hear from a relatively tiny segment of those who are affected
by the
bankruptcy laws. The professionals will state that very little is wrong with the system.
Of course, any real
bankruptcy reform will threaten their livelihood as well as offend their sincere beliefs that
bankruptcy should be a readily available mechanism for anybody with any financial
difficulty.
The creditors' groups will predictably state that they are being treated
poorly, that the system is being abused, and that the laws need to be tightened
up. It might be valid to view the governmental groups as having this bias, but
it should be remembered that the governmental representatives do not have a
personal stake in the cases. I submit that we are a bit more objective. But
before I move on to the substantive provisions of the bill, there are millions
of people and businesses in this country whose voices may not be heard at all
in these proceedings.
Who is looking out for the millions of working people in this country who
honestly pay their taxes every year, even though it is a struggle and even
though they, like everyone, hate paying taxes? With the business community,
especially small businesses, organizing one's affairs so that the taxes get
paid is often not easy. Most business people dutifully pay their debts. Who is
looking out for them? This is what Congress must do.
There is a moral component to paying one's debts. Congress must find the right
balance that permits the honest but unfortunate debtor to acquire a
"fresh start," while protecting obligations owed to the public from being eliminated by
ambush and removing the incentives for those debtors seeking an unfair
advantage. The system is currently out of balance.
2. The Tax Provisions of H.R. 833
The
States' Association of
Bankruptcy Attorneys (SABA) wholeheartedly supports the tax provisions in the bill.
Although we would like to see more substantive changes, these proposed changes
go a long way toward reducing a significant problem with the current system:
The intended
"substance" of the current law is too easy to obfuscate. The bill's tax provisions
primarily clarify and even simplify areas of the
bankruptcy code dealing with tax debts, while not significantly changing the result that
Congress intended in most cases. The provisions would help insure that the
public is treated fairly, while providing clearer guidelines that help make the
results more certain. Any legal system is improved when the results are made
more certain.
I will now go through some of the items in the bill which are important to
emphasize. Desiring to keep these comments brief, every provision will
not be discussed. However, failure to address a section does not imply a lack
of support for the tax provisions of the bill. SABA supports all of the tax
provisions.
Section 801. Treatment of Certain Liens
This section will stop the practice of invading the public's tax lien, and
therefore the public treasury, to pay for the administration of a failed
Chapter 11 proceeding. Usually, the administration of a Chapter 11 will entail
expenses of professionals who choose to perform services for Chapter 11
debtors. There is no economic or policy justification for shifting the burden
of their unpaid fees to the public.
The bill would allow a Chapter 7 trustee to invade a tax lien, and would allow
wages to be paid from a tax lien. The taxing authorities do not like this
portion of the section, but this is a compromise, and is a significant
improvement over the current
law.
Section 802. Effective Notice to Government
For reasons stated above in the introduction, SABA believes that the greater
notice to the government, the better. Debtors are already required to keep
accurate records under both the
bankruptcy laws and the state and federal tax laws. This provision is consistent with,
and compliments, other areas of the tax codes and the
bankruptcy code. It would not affect honest debtors who have complied with their legal
record-keeping requirements, but could significantly cut down on the incidents
of discharging hidden liabilities.
Section 804. Rate of Interest of Tax Claims
With regard to secured, administrative, and real property tax claims, the bill
would require that the non-bankruptcy interest rate apply. This would generally be the result in most cases under
the current law, and the bill primarily adds certainty in those areas. It would
also eliminate the ability to try to
"low
ball" out-of-state governmental entities who may not have resources to travel to
different states to challenge interest rates which might be proposed in motions
or in
bankruptcy plans.
With regard to other tax claims, the bill would fix interest rates at the
federal deficiency rate plus three points. Some of the members of SABA did not
like this provision, because some aggressive and efficient attorneys general
offices can negotiate even higher rates than the bill provides. The current law
provides for the nebulous present value concept in many cases. However, most
members of SABA like the bill because they find that objecting to interest
rates is not a good allocation of resources, especially in out-of-state cases.
The present value analysis in reported cases is confusing, inconsistent, and of
questionable value to a tax claim for which there is
no
"market" to which to compare a
"market rate." The law sets a definite floor, which might often become the standard rate. It
is helpful to both governments and debtors because it creates certainty.
Section 805. Tolling of Priority of Tax Claim Time Periods
Many courts reach a similar result as the language in the bill explicitly
provides. However, there is a split of authority on this issue, and the current
bankruptcy code does not provide the clear answer.
One rationale for the priority time periods is to give the government an
opportunity to collect the tax before it becomes
"stale" and potentially dischargeable. Thwarting the collection activities through the
use of a
bankruptcy petition should suspend the time during which the taxes would otherwise become
"stale." Otherwise, the tax priority means little if it can be circumvented through the
manipulation of sequential
bankruptcy
cases.
Section 807. Chapter 13 Discharge of Fraudulent and Other Taxes
This provision would address a significant problem. Often tax obligations are
eliminated in Chapter 13, even though the government never knew of the debt.
Chapter 13's often get confirmed very quickly, in some jurisdictions within
30-60 days of the case being initially filed. Governmental entities are
inherently ill-equipped for Chapter 13's as they frequently occur in practice.
An honest debtor who is represented by a conservative debtor's lawyer will have
filed all of the tax returns. The debtor can benefit by paying the more recent
"priority" portion in full, but without interest, and perhaps discharge some old or
"stale" tax debt with a small dividend. This is what Congress intended. Way too
often, this is not what happens. The debtors skirt the system. There are
several reasons why.
First, although there is a provision in the
bankruptcy code which requires that priority taxes be paid in full, that provision does
not have any teeth. Clever plan drafting might result in paying priority taxes
less than the full amount. Because there is no exception to the discharge for
these taxes, often they are not paid yet discharged. This is not what was
intended.
Second, often the debt is not discovered until well after the
"bar date" for filing claims. This will occur because of non-filed returns or fraudulent
returns. These debts will be discharged in a Chapter 13 with virtually no
payment.
Third, state taxing authorities have been sued in Pennsylvania, Oregon and
perhaps other states for filing estimated tax claims for non-filed periods in
Chapter 13 cases. The basis of the lawsuits were that the estimated claims were
Rule 11 violations. Most judges do not discourage taxing authorities from
filing estimated or
"protective" proofs of claim, and there have not been that many disputes. However, the
existence of a reported opinion in Oregon, which sanctioned the state, and a
publicized settlement in Pennsylvania puts taxing authorities in a difficult
position in Chapter 13.
In summary, Section 807 does not remove the intended benefit of being able to
stretch-out some taxes interest free and discharge others outright. However, it
will put the burden on the proper party in the tax context. The debtor has the
records and knowledge of his affairs, and he should be required to properly
provide for the payment of his priority taxes through the plan. This is a
burden no greater than filing the tax returns in the first place. Currently,
the
system often rewards those who either do not comply at all or who file false or
fraudulent returns. Section 812. Course of Business Payment of Taxes
Post-bankruptcy tax accruals, or pyramiding of tax debt, by debtors is very common. The
government often involuntarily finances
bankruptcy debtors. Reported opinions have ruled that taxing authorities must go into
court and notify all creditors in the case that the government wants to be
paid, and to get a court order authorizing the payment. Some trustees feel
nervous paying some post-bankruptcy tax debts without a court order, because the
bankruptcy code does not provide a clear directive that the post-bankruptcy taxes can be paid as a matter of course. This slows down the process, and can
result in the
bankruptcy estate incurring unnecessary interest.
The bill would give the
taxing authorities more tools to combat the recurring, and serious, problem of
pyramiding of taxes in
bankruptcy.
Section 816. Requirement to File Tax Returns to confirm Chapter 13 Plans
As stated in the comment above, the hidden tax liability issue is a problem in
Chapter 13 cases. This section would help with that problem. It would help
limit the relief to those who otherwise comply with the law. This provision
gives clear guidance to trustees on this issue where there is none now some
trustees require tax returns, some trustees merely ask if they have been filed,
and some trustees do not inquire at all. In addition, the provision provides
clear and fair consequences for not filing the returns. Finally, there is a
provision temporarily excusing non-compliance, but the debtor must show that
there is good cause.
3. Conclusion
The tax provisions of
H.R. 833 represent a significant improvement in the law, while not changing the
original intent of statute in most cases. These provisions should help reduce
the manipulation of the system at the public's expense. The provisions will
help governments which are at a significant disadvantage with regard to
information and without resources to investigate every debtor. The tax
provisions should be adopted without modification.
END
LOAD-DATE: March 23, 1999
