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October/November
2004 |
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Requesting
Prompt Tax
Determination under 505(b)
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This article discusses the benefits
and difficulties of requesting prompt determination of taxes under
Bankruptcy Code Section 505(b), sometimes referred to as a “505(b)
letter”. If properly filed, the statutory notice can bring
a certain amount of clarity and closure to the tax risks in a
bankruptcy case, as it can shorten what is usually a three year
statute of limitations (or longer) to six months. While income
taxes are usually a minor problem in bankruptcy, many hours are
spent and sometimes substantial amounts paid in sales and use
taxes and payroll taxes and penalties, etc. This procedure can
eliminate some of those types of problems.
1. The statutory provision:
“505. Determination of Tax Liability.(a)(1)--Except as provided
in paragraph (2) of this subsection, the court may determine the
amount or legality of any tax, any fine or penalty relating to
a tax, or any addition to tax, whether or not previously assessed,
whether or not paid, and whether or not contested before and adjudicated
by a judicial or administrative tribunal of competent jurisdiction.
(2)--The court may not so
determine
(A)--The amount or legality
of a tax, fine, penalty, or addition to tax if such amount
or legality was contested before and adjudicated by a judicial
or administrative tribunal of competent jurisdiction before
the commencement of the case under this title; or
(B)--any right of the estate to a tax refund, before the earlier
of—
(i)--120 days after the
trustee properly requests such refund from the governmental
unit from which such refund is claimed; or
(ii)--a determination by such governmental unit of such
request.
(b)--A trustee may request
a determination of any unpaid liability of the estate
for any tax incurred during the administration of the
case by submitting a tax return for such tax and a request
for such a determination to the governmental unit charged
with responsibility for collection or determination of
such tax. Unless such return is fraudulent, or contains
a material misrepresentation, the trustee, the debtor,
and any successor to the debtor are discharged from any
liability for such tax—
(1)--upon payment of the tax
shown on such return, if—
(A)--such governmental unit
does not notify the trustee, within 60 days after such request,
that such return has been selected for examination; or
(B)--such governmental unit does not complete such an examination
and notify the trustee of any tax due, within 180 days after
such request or within such additional time as the court,
for cause, permits;
(2)--upon payment of the
tax determined by the court, after notice and a hearing,
after completion by such governmental unit of such examination;
or
(3)--upon payment of the tax determined by such governmental
unit to be due.”
Thus, if a request for prompt
determination is properly made, the governmental unit has only
60 days to notify the trustee of the commencement of an audit
of the return and only 180 days to assess any additional tax,
or additional assessment is prohibited. While taxpayers are naturally
reluctant to bring undue attention to themselves, experience shows
it is very difficult for most governmental units to respond within
the tight timelines of 505(b), because governmental taxing units
are usually structured to spread out their workflow over a multi-year
statute of limitations.
2. Entities which may
avail themselves of protection
The statute, which was enacted in 1978, specifically lists the
“trustee,” “debtor” and “any successor
to the debtor” as entities which may benefit from the shortened
statute of limitations. While the application to a trustee or
the debtor was obvious, the meaning of “successor to the
debtor” has been the subject of some controversy. In individual
bankruptcies, an estate which is a separate taxable entity is
created. At least one case (In re Fondiller,Bankr. N.D. Cal. 1990)
has held that such an estate is a “successor to the debtor,”
however the bankruptcy court’s decision was later overturned
by the district court (125 B.R. 805) and other cases have held
that it is not a successor for purposes of the protection of a
505(b) letter. (In re West Texas Marketing, 1993 U.S. Dist. Lexis
19798, 94-1 USTC CCH, In re Rode, 119 B.R. 697). In Chapter 11
Reorganizations, a liquidating trust has been interpreted to be
a successor to the debtor, so 505(b) letters should be used with
all tax returns filed by the trust.
3. Mechanics of the request
At the federal level, the Internal Revenue Service (IRS) issued
guidance in 1981. Revenue Procedure 81-17 clarifies that the request
is to be made by the Trustee or Debtor-in-Possession by filing
a tax return for the tax, presumably with payment, and a request
(letter) for determination of the tax. Because the IRS has extensively
reorganized since 1981, but has not updated the Revenue Procedure,
some of the instructions contained in it have to be translated
into today’s IRS procedures. Rev. Proc. 81-17 contemplates
the taxpayer will file the original of the return as usual, now
with the appropriate IRS Service Center, and file a copy of the
return plus the request letter with the ‘Special Procedures
Function’ of the District Director. While there still is
a special IRS unit generally assigned to each bankruptcy court,
it is not necessarily called by that same name and there is no
District Director level within the current IRS. Practitioners
are forced to locate the appropriate IRS mailing address for the
copy and request. As always, it is wise to file all tax returns
and requests by certified mail with return receipt requested.
What is the effect of not completely
complying with the prescribed Rev. Proc. 81-17 procedure? In one
case, where the tax return and the request for prompt assessment
were sent only to the Ogden IRS Service Center, the court still
held that assessment after the 60/180 day period was barred (In
re Carie Corporation, 128 B.R. 266). In other cases with similar
facts, the IRS was allowed to make subsequent assessments as the
request was defective. (In re Flaherty 169 B.R. 267 (NH 1994)).
Rev. Proc. 81-17 says that within
60 days of receipt, the Examination Function will notify the taxpayer
whether the return will be examined or is being accepted as filed.
Experience shows that while an occasional ‘acceptance letter’
is issued by the IRS pursuant to a 505(b) letter, the practitioner
will rarely receive any response from the IRS.
4. Types of taxes covered
Section 505(b) says it applies to “any unpaid liability…for
any tax,” whereas 505(a) refers to “any tax, penalty
or fine relating to a tax.” The section has been interpreted
by the courts more consistently with the broader wording of 505(a).
Presumably, the request for prompt determination can apply to
any federal tax or tax return—income, excise, payroll, information
returns, employee benefit returns, etc. It also can apply to penalties
and interest related to a tax. (State and local taxes will be
discussed below).
However, the appropriate federal
return must have been filed to receive closure. For example, In
re Farm Loan Services (153 B.R. 234) involved a trustee who filed
corporate income tax returns, Form 1120, with a request for “a
prompt determination of any unpaid tax liability of the bankruptcy
estate pursuant to 11 U.S.C. §505(b) and Revenue Procedure
81-18.” When it was discovered more than six months later
that W-2 payroll tax forms of the debtor were filed late, the
IRS assessed the usual late filing penalty. The trustee argued
that the request for prompt assessment with the corporate income
tax forms should have discharged him of any liability, but the
court held he did not file the W-2 forms with a request for prompt
assessment more than six months before the penalty was assessed.
5. Periods covered
Section 505(b) says it applies to “any tax incurred during
the administration of the case.” This presumably restricts
it to postpetition taxes incurred. There is a clear cut off in
the pre and post-petition tax periods for most types of taxes,
such as income and payroll; however, there is a bewildering variation
between the taxable periods and assessment dates for state and
local property taxes. When in doubt, assuming the tax is incurred
during the administration of the case and filing the prompt request
for determination is probably wise. The shortened period of limitations
for the administrative expense taxes adds to the complexity of
bankruptcy taxes, since it can result in the anomalous situation
where the statute of limitations for assessment are still open
for pre-petition years after they are closed for administration
expense taxes.
While the original intent of
the provision may have been that one request for prompt determination
be filed after all administrative period tax returns were filed,
in practice, a request for prompt assessment often is filed as
each tax return is submitted to the government, including quarterly
payroll tax returns as well as year end returns, such as 1099,
1120, 1041 and 5500.
6. State and local taxes
Even less certainty exists about how to use 505(b) letters with
state and local taxes. First, most state and local units do not
even have the minimal guidance which exists at the federal level
with Rev. Proc. 81-17. Practitioners often submit state and local
taxes following the federal procedure and using a similar letter
form. Practice varies as to whether one or two copies of each
return is filed. A major problem in state and local taxes is the
lack of recognition of liability for sales and use tax, personal
property taxes, gross receipts taxes, income taxes, etc. What
can be done to run the statute of limitations for an operating
business that did not have reporting systems in place to identify
all material tax liabilities? Sometimes a blanket 505(b) letter
is filed with a state listing all types of state taxes. But does
that afford any protection, if tax returns of each type are not
filed? Another difficulty is identifying the correct address at
which to file the return. Obviously, using the wrong address gives
the governmental unit an opportunity to argue lack of notice.
Conclusion
The request for prompt determination procedure within the Bankruptcy
Code is a significant benefit in eliminating one more source of
continuing problems--the slow, grinding machinery of federal and
state taxes. The 505(b) letters have to be used carefully, but
can give you a position of advantage vis a vis the governmental
taxing units.
Forrest Lewis, CPA, is a member of the firm of Plante & Moran,
PLLC.
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