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Association of Insolvency & Restructuring Advisors
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Alan Barton Mr. Barton is a Partner in the Mergers & Acquisitions Tax Practice of KPMG LLP. He specializes in corporate bankruptcy tax advi-sory, consolidated return group tax planning and net operating loss preservation and utili-zation planning for corporations. He earned a BBA in accounting from Baylor University. Being a Certifi ed Public Accountant and a Certifi ed Insolvency and Restructuring Advi-sor, Mr. Barton is frequently called upon to speak at seminars on a variety of tax topics. Are fees of professionals hired by the various committees and paid for by the debtor deductible by the debtor? Hillsborough Holdings Corporation and its thirty-two subsidiaries (the “Debt-ors”) fi led voluntary Petitions for Relief under Chapter 11 of the Bankruptcy Code on December 27, 1989. The Debtors emerged from bankruptcy on March 17, 1995. On its consolidated federal income tax returns for the tax years ending May 31, 1992 through May 31, 1994, the Debt-ors claimed deductions for professional fees and expenses, which included the fees and expenses of the professionals hired by the various committees which had been been the subject of litigation and dispute paid by the Debtors. The IRS disputed the deductibility of these professional fees on the grounds that the Debtors had not es-tablished that these professional fees and expenses were “ordinary and necessary” expenses paid or incurred in carrying on the Debtors’ business. The Debtors di-vided the committee professional fees and expenses into fourteen categories. The bankruptcy court reviewed cer-tain of the relevant precedents under IRC section 162 allowing current deductibility and under IRC section 263 requiring capi-talization. In referencing Missouri-Kan-sas Pipe Line Co. v. Commissioner, 148 F.2d 460 (3d Cir. 1945) and Placid Oil Co. v. Internal Revenue Service, 988 F.2d 554 (5th Cir. 1993), the bankruptcy court noted that in the context of a business reorgani-zation, whether in a bankruptcy context or outside of the bankruptcy context, it has been generally held that such expenses are not ordinary deductible business expenses within the meaning of IRC section 162. In the instant case, the bankruptcy court noted that six of the fourteen catego-ries of committee professional fees dealt solely with issues that were related to the bankruptcy case, i.e., “bankruptcy admin-istration,” “Debtors’ plan of reorganiza-tion,” “Creditors’ plan,” “miscellaneous plans,” “consensual plan,” and “trade post-petition agreement.” The bankruptcy court held “The case law is clear that these expenses are related to the restructuring of a corporation, which is an ‘extraordinary’ event outside the scope of a corporation’s usual trade or business activities.” Mill Estate, Inc. v. Commissioner, 206 F.2d 244, 246 (2d Cir. 1953). For the balance of the categories of committee professional
fees, the Debtors sought to have the court apply the Lohrke test, in
which two prongs are used to determine the deductibility regarding the
payment of another person’s expenses, found in Lohrke v. Commissioner,
48 TC 679 (1967). The first part of the test ex-amines the purpose and
motive behind the payment of another’s obligations, and the second
part of the test evaluates whether the expense meets the definition
of “ordi-nary and necessary.” The Debtors main-tained that
certain of the categories of the professional fees and expenses paid
to the committee advisors (e.g., “veil piercing litigation,”
“claims disputes,” “sales of assets,” and “ordinary
course business”) were necessary to the continuation of the Debtors’
business operations. As a result, the bankruptcy court held that none of
the professional fees and ex-penses paid by the Debtors for committee
advisors were deductible under IRC sec-tion 162. In re Hillsborough
Holdings Corp., No. 89-9715-8P1 through 89-9746-8P1 and No. 90-11997-9P1
(Bankr. M.D. Fla. 2003). Hillsborough Holdings Corporation and its thirty-two subsidiaries (the “Debt-ors”) filed voluntary Petitions for Relief under Chapter 11 of the Bankruptcy Code on December 27, 1989. The Debtors emerged from bankruptcy on March 17, 1995. On its consolidated federal income tax returns for the tax years ending May 31, 1992 through May 31, 1994, the Debt-ors claimed deductions for professional fees and expenses, which included fees and expenses of the professionals hired by the Debtors related to projects abandoned by the Debtors during the pendency of the bankruptcy case. The IRS disputed the deductibility of these professional fees on the grounds that the Debtors had not es-tablished that these professional fees and expenses were “ordinary and necessary” expenses paid or incurred in carrying on the Debtors’ business. The Debtors di-vided the professional fees and expenses into various categories. The Debtors argued that certain categories of professional fees that re-lated solely to the bankruptcy cases which would generally be required to be capital-ized, i.e., “value sharing plan,” “Debtors’ plan of reorganization,” “miscellaneous plans,” “trade post-petition agreement,” and “bank settlement agreement” were all abandoned projects, and therefore, should be deductible currently in accordance with A.E. Staley Manufacturing Co. v. Commis-sioner, 119 F.3d 482 (7th Cir. 1997). The IRS argued that the costs of ad-ministering the
bankruptcy cases cannot be subdivided into deductible and capital expenses
since the bankruptcy filing was a “radical and global event,”
which pro-duced long-term benefits, thus all of the costs must be capitalized.
The bankruptcy court did allow the Debtors to deduct
the professional fees and expenses in two categories related to abandoned
projects, i.e., “sale of assets” and “Wedlo transaction,”
noting that both of these types of expenses could have oc-curred outside
of the Debtors’ reorganiza-tions. In re Hillsborough Holdings
Corp., No. 89-9715-8P1 through 89-9746-8P1 and No. 90-11997-9P1 (Bankr.
M.D. Fla. 2003). Can tax returns filed by the debtor in response to the IRS amnesty program after substitute returns had been previ-ously prepared by the IRS be considered to be returns under 11 U.S.C. section 523(a)(1)(B)? Tax returns filed by the debtor in response to the IRS amnesty program were considered to be “returns” under 11 U.S.C. section 523(a)(1)(B)(ii) even though substitute returns had previously been filed by the IRS and taxes for such years had been assessed. The debtor did not timely file tax returns for 1990 and 1991. The IRS pre-pared substitute returns for the debtor for such years. On October 11, 1993, the IRS assessed the debtor $11,066 in taxes for 1990. On April 25, 1994, the IRS assessed the debtor $12,749 in taxes for 1991. The debtor became aware of an IRS amnesty program and in response thereto, the debtor had a CPA prepare his tax returns for 1989, 1990, 1991, 1992 and 1993. These returns were filed by the debtor on March 10, 1995. The 1990 and 1991 tax returns listed taxes due that were identical to the amounts previously assessed by the IRS. The debtor timely filed his tax returns for 1994 and subsequent years. On April 21, 1998, (the “Petition Date”), the debtor filed a Chapter 7 bank-ruptcy petition. The debtor received his discharge on August 6, 1998. The debtor re-opened his bankruptcy on December 21, 2001, so that the bank-ruptcy court could determine the dischargeability of his 1990 and 1991 federal income tax obligations. The debtor argued that his tax liabilities were dischargeable pursuant to 11 U.S.C. section 523(a)(1)(B)(ii), since he filed tax returns for 1990 and 1991 more than two years prior to the Petition Date. The Government, relying on In re Hin-delang, 164 F.3d 1029 (6th Cir. 1999), argued that the debtors 1990 and 1991 tax returns do not qualify as “returns” for purposes of 11 U.S.C. section 523(a)(1)(B) because they merely restated the tax liabilities previously assessed for such years and had no effect on the debtor’s tax liabilities for such years. Since the Form 1040s filed by the debtor served no purpose under the Internal Revenue Code, the Government argued that they should not be treated as returns and the taxes for such years should be excepted from discharge. Pursuant to 11 U.S.C. section 523(a)(1)(B)(i), a tax liability is not dischargeable if a return for such tax has not been filed by the debtor. The bankruptcy court rejected the Government’s argument of the per se rule of Hindelang and concluded that Form 1040s filed after assessment can still con-stitute “returns” under 11 U.S.C. section 523(a)(1)(B)(ii). The bankruptcy court, following the decisions in In re Nunez, 232 B.R. 778 (9th Cir. BAP 1999) and In re Ralph, 258 B.R. 504 (Bankr. M.D. Fla. 2000) rev’d, United States v. Ralph, 266 B.R. 217 (M.D. Fla. 2001), held that Form 1040s filed after assessment can still constitute “returns” un-der 11 U.S.C. section 523(a)(1)(B)(ii) if the debtor acted in good faith with the focus be-ing on the debtor’s intent at the time he filed the delinquent Form 1040s. The bankruptcy court held that the debtor’s
returns, even though filed after sub-stitute returns had been filed
and taxes had been assessed for such years, constituted an honest and
reasonable attempt by the debtor to satisfy the tax law, i.e., complying
with the IRS Amnesty Program, and therefore the Forms 1040 filed for
1990 and 1991 by the debtor constituted returns for purposes of 11 U.S.C.
523(a)(1)(B)(ii). Since the returns were filed more than two years prior
to the Petition Date, the taxes for 1990 and 1991 are dischargeable.
In re Klein, No. 98-13391-BKC-RAM (Bankr. S.D. Fla. 2003). Are restitution payments made by a debtor convicted of tax evasion voluntary or involuntary? After being convicted of tax evasion for the tax years 1990, 1991, and 1992, the debtors (a husband and wife) made restitu-tion payments of $75,402 as required in the criminal judgments. The judgments entered against the debtors did not specify how the IRS should allocate the restitution payments to the debtors’ income tax liabilities for the three tax years. The IRS allocated $70,608 of the restitution payments to the debtors’ 1990 income tax liability. Voluntary payments of tax debt will typically be applied in the manner the tax-payer has designated. Involuntary payments of a tax debt will be allocated in a manner serving the best interest of the IRS. Rev. Proc. 2002-26, 2002-15 I.R.B. 746. An involuntary payment includes “any payment received by agents of the United States as a result of distraint or levy from a legal pro-ceeding in which the Government is seeking to collect its delinquent taxes or file a claim therefor,” as set forth by the Tax Court in Amos v. Comm’r, 47 T.C. 65, 69 (1966). Pursuant to Rev. Proc. 2002-26, the IRS applied the payments to the 1990 liability instead of allocating the payments over the period of 1990-1992. The application of the restitution payments to the 1990 tax liability maximized the total amount collectible by the IRS since penalties beyond three years old are entitled to discharge. In re Burns, 887 F.2d 1541 (11th Cir. 1989). The debtors argued that the restitution payments could not be completely catego-rized as voluntary or involuntary. In addi-tion, the debtors argued that based on a Su-preme Court decision, the bankruptcy court has the authority to designate involuntary payments of a Chapter 11 debtor to specific tax liabilities, as long as the designation is necessary for the success of the reorganiza-tion. United States v. Energy Resources Co., 495 U.S. 545, 551, 109 L. Ed. 2d 580, 110 S. Ct. 2139 (1990). The IRS argued that the current case was distinguishable from Energy Resources because in the Energy Resources case, the IRS had the ability to collect the full amount of the unpaid tax through the corporate debt-or’s plan of reorganization. In the instant case, if the debtors’ were allowed to reallocate the payment from the 1990 tax year to 1991 and 1992, it would reduce the total amount that the IRS was entitled to collect, since penalties more than three years old are subject to discharge. In addition, the IRS ar-gued that the debtors had not demonstrated that the success of their reorganization was dependent on the reallocation. The bankruptcy court held that the restitution payments
were in the nature of involuntary and undesignated payments. The bankruptcy
court also held that the debtors had failed to link the success of their
reorganization with the reallocation of the payments. As a result, the
bankruptcy court held that the restitution payments were prop-erly applied
by the IRS to the debtors’ 1990 tax liability. In re Tecson, No.
01-09728-3P1 (Bankr. M.D. Fla. 2003). |
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