As of this writing, bankruptcy reform legislation had passed the Senate and was expected to move quickly through the House and be signed by President Bush. The Bankruptcy Abuse and Prevention and Consumer Protection Act of 2005 may already be law as you read this column.

Most of the popular press coverage of the legislation has focused on provisions that would make it more difficult to do a Chapter 7 bankruptcy and walk away from debts, pushing more people into Chapter 13 debt repayment arrangements.

Among the more than 200 sections of this major piece of legislation, however, are 20 provisions focused on tax. These provisions do not directly alter the Internal Revenue Code, but address the interrelationship of taxes and bankruptcy and the treatment of tax debts in bankruptcy. Beyond the tax title, other provisions of the legislation also have some impact on taxes, such as bankruptcy protection for tax-favored retirement and education savings.

Priority of tax claims

The bankruptcy legislation specifies the priority of pre-petition tax claims and focuses on a period of 240 days before the date of the filing of the bankruptcy petition. The changes clarify the priority of tax claims in light of tolling periods during the time that an offer in compromise is pending. The legislation also amends the section of the Bankruptcy Code addressing tardily filed priority tax claims to make the timing dependent, in addition to the date on which final distribution commences, on a date that is 10 days after the mailing of the summary of the trustee's final report to creditors.

A wording change, from "assessed" to "incurred," is also made in the section addressing priority property taxes.

Tax filings

The legislation would require that, for plan confirmation, the debtor has filed all applicable federal, state and local tax returns as required under Section 1308 of the Bankruptcy Code. Section 1308 is also amended to provide guidance as to what constitutes a timely filed return. Failure to timely file tax returns may result in dismissal of the case or conversion to a Chapter 7 case.

The new bankruptcy legislation also makes some definitional changes and wording changes to the provisions discussing income tax returns prepared by tax authorities.

Periodic payment of taxes

The legislation includes changes in the requirements for periodic payment of taxes in Chapter 11 cases. Regular installment payments are to be made over a period ending not later than five years after the date of the order for relief and must be made in a manner not less favorable than the most favored nonpriority unsecured claim provided for by the plan.

The legislation also addresses the requirements for payment of taxes arising during the operation of a business under supervision of the bankruptcy court. Generally, such taxes are to be paid by the due date provided under the Internal Revenue Code, unless one of a specific list of exceptions applies.

Tax liens

The bankruptcy legislation strengthens the treatment of a properly perfected unavoidable tax lien arising in connection with an ad valorem tax on real or personal property, providing greater protection than previously was the case. The legislation also adds a reference to Internal Revenue Code Sec. 6323, discussing the validity and priority of certain claims, and similar provisions of state and local law, in listing exceptions to when the avoidance of statutory tax liens is prohibited.

Fraudulent taxes

Included in the legislation are provisions prohibiting the discharge of fraudulent taxes in both Chapter 11 and Chapter 13 cases.

State and local taxes

One of the lengthier tax provisions addresses the treatment of state and local taxes in bankruptcy, giving state and local taxes treatment similar to that of federal taxes.

Other tax provisions

Also included in the legislation are provisions simplifying the calculation of interest on tax claims, providing standards for tax disclosure, addressing the set-off of tax refunds, simplifying fuel tax claims, improving the notice of a request for a determination of taxes, clarifying that stays of tax proceedings are limited to pre-petition taxes, and addressing the discharge of the bankruptcy estate's liability for unpaid taxes.

Retirement and education funds

The bankruptcy legislation, in a separate title focused on consumer protection, also adds additional protections for retirement funds and savings for post-secondary education. The legislation provides broad protection for retirement funds, including those exempt from taxation under Internal Revenue Code Sections 401, 403, 408, 408A, 414, 457 and 501(a). There are exceptions to discharge for certain plan loans.

For IRA accounts, there is a $1 million limitation on the protection, but this limitation excludes IRA accounts rolled over from qualified plans, which are protected without dollar limitation.

The Supreme Court also ruled recently that IRA assets are protected from bankruptcy creditors under existing law prior to this bankruptcy legislation, since the early withdrawal penalty puts a significant limit on the ready access of the debtor to these assets, at least until age 59. It was not immediately clear what affect the Supreme Court ruling might have on very large IRA accounts or Roth IRAs, and whether it might, in effect, erase the $1 million limit on protection created by the bankruptcy legislation. Some protection had already been afforded to these accounts under various state laws.

The new legislation should at least make practitioners more comfortable in recommending that their clients roll money from old 401(k) plans into rollover IRAs, where they may have more investment control, without fear of greater exposure to creditors.

The education provisions of the law specifically focus on protection of education IRA accounts and 529 plans, in either the tuition credit or account forms. The education account protections do not extend to funds placed in the accounts within the year prior to the bankruptcy petition filing.

Summary

The overlaps between the bankruptcy laws and the tax laws can often be very complex and confusing. Tax practitioners will want to become at least familiar enough with these changes in the tax provisions of the Bankruptcy Code to know when to consult with a bankruptcy expert.

Practitioners may also want to review the retirement holdings of their clients in light of this legislation to see if it makes sense now to do rollovers to IRAs that had been held up in the past due to creditor protection concerns. Most provisions in the new law will generally be effective 180 days after enactment, but rollovers to traditional IRAs may begin immediately without further concern, since the Supreme Court has settled that issue in advance of the legislative remedy.

George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a WoltersKluwer company.

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