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Chapter 11 |
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Chapter 11 |
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Part 25. Special
Topics
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Chapter 17. Bankruptcy
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Section 11. Bankruptcy
Processing of Chapter 11 Cases
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25.17.11 Bankruptcy Processing of
Chapter 11 Cases
- 25.17.11.1
Introduction
- 25.17.11.2
The
Chapter 11 Debtor
- 25.17.11.3
Initial
Processing
- 25.17.11.4
Internal
Revenue Code § 1398 Issues
- 25.17.11.5
Disclosure
Statements and Plans of Reorganization
- 25.17.11.6
The
Chapter 11 Discharge and the Effects of
Confirmation
- 25.17.11.7
Post-Confirmation
Actions
- 25.17.11.8
Closing
Chapter 11 Bankruptcies
25.17.11.1 (09-01-2004)
Introduction
1.
Reorganization. Chapter
11 is a rehabilitative proceeding that gives the
debtor a "breathing period," from the
petition filing to plan confirmation, during which
time business affairs can be reorganized and a plan
devised for the orderly payment of creditors.
Chapter 11 is frequently referred to as the "reorganization
bankruptcy. " Chapter 11, like
Chapter 7, cases begin with the filing of a
bankruptcy petition.
·
a Chapter
11 bankruptcy petition may be filed voluntarily
by the debtor or involuntarily
by creditors
·
an
involuntary case may not be filed against a farmer
or a noncommercial corporation
2.
Debtor-in-Possession/Trustee. In
a Chapter 11 proceeding, the debtor usually operates
as a debtor-in-possession (DIP). However, a trustee
or an examiner may be appointed for cause, including
fraud, dishonesty, incompetence, or gross
mismanagement of the affairs of the debtor by
current management, either before or after the
commencement of the case. See 11 U.S.C. § 1104. The
duties of the trustee or DIP include administering
the estate and operating the debtor’s business.
See 11 U.S.C. §§ 1106,1108. In a timely fashion,
the DIP or trustee must either:
A.
file a plan or a report explaining why a plan
will not be filed; or
B.
recommend the case be converted to another
chapter or be dismissed.
3.
Complex/Long Duration. Chapter
11 cases are ordinarily more labor–intensive to
monitor and evaluate than other bankruptcies because
of the complexities of restructuring efforts that
comprise part of the process. After a plan is
confirmed, the creditors must monitor their receipt
of payments under the terms of the plan. A Chapter
11 bankruptcy case can last for several years.
25.17.11.2 (09-01-2004)
The Chapter 11 Debtor
1.
Eligibility.
Any entity eligible to file a Chapter 7 petition (individual, sole
proprietor, partnership, or corporation) can file
Chapter 11, except
a stockbroker or a commodity broker. A railroad,
which cannot file a Chapter 7 petition, may
file a Chapter 11 petition.
2.
Main Chapter for Business Debtors. Chapter
11 is the primary reorganization chapter of the
Bankruptcy Code for business debtors. Ideally, a
reorganizing Chapter 11 plan is acceptable to most
of the debtor's creditors because the plan is more
likely (over time) to pay a greater amount of the
debtor's pre-bankruptcy debts than if the business
were liquidated. A Chapter 11 bankruptcy allows the
debtor to continue business operations through a
plan of reorganization, which meets statutory
criteria. 11 U.S.C. § 1129. (Cooperation among the
various interests is crucial to a successful
reorganization.) Generally, reorganization, by
preserving jobs and assets, is preferable to
liquidation.
3.
Individuals and Chapter 11. An individual is eligible to file Chapter 11
even if the individual is not engaged in a business.
However, when individuals file for bankruptcy, but
want to retain the use of their non-exempt property,
they may opt for a Chapter 13 proceeding.
Note:
While an individual Chapter 7 debtor
must wait at least six years between Chapter 7 cases
to obtain a second Chapter 7 discharge of debt,
pursuant to 11 U.S.C. § 727(a)(8), no
similar limitation prevents a Chapter 11 debtor
obtaining successive discharges.
25.17.11.3 (09-01-2004)
Initial Processing
1.
Notice.
The bankruptcy courts provide the
2.
Opening Actions .
A case should be opened in accordance with
Reminder:
Bankruptcy
Freeze Code. To prevent violations of the
automatic stay, Transaction Code 520 must be input
by the Service within five
workdays of
the Service's receipt of notification of the
bankruptcy filing.
3.
Preventing Violations of Automatic Stay. If
research reveals no liabilities or pending
assessments, the case should be kept under TC 520
control until the potential for a violation of the
Bankruptcy Code expires. The freeze also allows for
monitoring of postpetition tax compliance.
4.
Proof of Claim. If
the debtor owes taxes above the tolerance specified
in Law Enforcement Manual (LEM) 5.5.3, a claim
should be prepared and timely filed in accordance
with
A.
11 U.S.C.
§ 1111(a) provides a claim is deemed to be filed
for any debt listed on the debtor’s schedules, except
a debt listed as disputed, contingent, or
unliquidated.
B.
If all
prepetition returns are not filed by the time the
claim is filed, the liabilities for any unfiled
returns should be shown as "unassessed"
(formerly listed as estimated). The unassessed
amount on the claim must have a factual basis.
Note:
The
5.
Trust Fund Taxes. If
a Trust Fund Recovery Penalty (TFRP) investigation
is in order, it should be addressed early in the
bankruptcy proceedings. If the TFRP is applicable,
and the case meets LEM criteria for field
assignment, but is unassigned, Insolvency should
issue ICS 01 or Form 2209 to field Compliance, or
assign the investigation to an Insolvency Advisor,
per local procedures, for a determination of the
TFRP liability.
25.17.11.3.1 (09-01-2004)
Contact Points
1.
Contact Points . Contact points have been established between
local Insolvency units and other
2.
Insolvency Assistance. When
Insolvency is contacted by other Service employees
on matters relating to bankruptcy, Insolvency will
perform the necessary research to assist in a
resolution. If appropriate, Insolvency will elevate
complex or unusual matters to Counsel.
3.
Postpetition Debts. Compliance
personnel should be familiar with
25.17.11.3.2 (09-01-2004)
Adequate Protection and Turnover
1.
Protection for Secured Creditors. Adequate protection safeguards a secured
creditor against a decrease in the value of a
creditor’s collateral during
the period prior to confirmation of the plan. During
this time, a creditor is stayed from taking
collection action and is not receiving plan
payments. Adequate protection may be requested to
protect the value of the creditor's interest in the
property being used by the DIP. See 11 U.S.C. §
361.
2.
Turnover/Adequate Protection. A voluntary Chapter 11 filing is sometimes
preceded by the
3.
Most Common Types. Adequate
protection usually includes periodic cash
payments (the most common form) on the
secured claim and/or replacement
liens on postpetition assets. Minimum
dollar criteria should be established for adequate
protection to be pursued. Local Insolvency
guidelines, with Counsel involvement, if
appropriate, should be followed.
4.
Examples of Adequate Protection:
·
retaining a
portion of any funds received
·
receiving
monthly payments (with postpetition interest) before
a plan is confirmed
·
obtaining
replacement liens on after-acquired assets (for
example, accounts receivable and inventory)
·
providing
for postpetition tax compliance
·
any other
appropriate relief
5.
Depreciating Equity and Financing Concerns. The
6.
Time Constraints. If
adequate protection is applicable, it must be
addressed quickly before the assets are dissipated.
Adequate protection for turnover of property to the
debtor varies depending on the unique circumstances
of the case, including the type of property
involved.
Note:
The court can deny a request for
adequate protection deeming the proposed arrangement
to be unsatisfactory or inadequate. The proposal may
be renegotiated, with court approval.
25.17.11.3.2.1 (09-01-2004)
Prepetition Levies
1.
Intangible Property. Under
11 U.S.C. § 542, unless the automatic stay is
lifted, the
2.
Avoidance.
If the
Note:
Voluntary payments of the trust
fund portion of employment taxes, and
other trust fund taxes, are not
subject to avoidance. These payments are
not transfers of property of the debtor.
3.
Tangible Property. Absent
extenuating circumstances, which may allow for the
automatic stay to be lifted, the
4.
Right to Adequate Protection. Although the property is generally required to
be turned over, the
5.
Release vs. Referral. Negotiations
involving adequate protection often involve both
field Compliance and Insolvency employees, and they
are generally conducted with the debtor's attorney.
Counsel should be consulted for local procedures.
A.
Release.
If the value of the property does not exceed
the minimum dollar criteria for relief from the stay
or adequate protection, the levy or seizure should
be released immediately.
B.
Referral.
If the value exceeds the minimum
amount, Insolvency should refer the case
expeditiously to Counsel to consider a motion for
relief from the stay, or to seek adequate protection
while the agreement is being negotiated with the
debtor.
6.
Urgency.
Issues surrounding the continuation of business operations may intensify the
need to resolve collection actions quickly; for
example, funds earmarked to meet payroll have been
levied, or equipment needed to conduct business has
been seized. Delays in settling the collection
activity could result in a violation of the
automatic stay and awards for damages against the
Service.
7.
Adequate Protection Agreement. The
Adequate Protection Agreement should provide for
protection to replace the property being released.
This can include:
A.
the
B.
periodic
payments, including payment of postpetition
interest;
C.
a
replacement lien on after-acquired assets, such as
inventory or accounts receivable;
D.
timely tax
deposits and filing of returns; and, most
importantly,
E.
default
provisions.
8.
Default provisions. Adequate protection agreements should include
language outlining actions to be taken in the event
of default. Those provisions can include:
A.
notice of
default to the debtor and debtor's attorney with a
short "cure" timeframe;
B.
a
"drop dead" clause providing for unopposed
conversion to Chapter 7 if the default is not cured;
C.
an
automatic lifting of the stay against collection if
the default is not cured; or
D.
any other
appropriate remedy.
25.17.11.3.3 (09-01-2004)
Cash Collateral/Property Depreciation of the Estate
1.
"
Ordinary
Course of Business.
" In a Chapter 11 case, the
debtor-in-possession typically wants to continue
running the business until it can be reorganized or
sold. The debtor may automatically continue its
routine ( "ordinary
course" ) use, sale, or lease of
most of its prepetition property pursuant to 11
U.S.C. §§ 363(c)(1) and 1107(a).
2.
Cash Collateral .
The Bankruptcy Code can significantly limit a
debtor's ability to use its cash
collateral without the consent of
creditors with secured interests in such property.
Cash collateral includes cash and cash equivalents,
such as negotiable instruments and funds in
depository accounts. Also, see
Note:
The limitations in the Bankruptcy Code
on the debtor's use of cash collateral and
restrictions are significant in Chapter 11 cases.
This is because operating businesses in bankruptcy
are found most typically in Chapter 11 cases and
have the greatest need for immediate cash to
continue running.
3.
Property Devaluation. The
time required to reorganize the business and
construct a payment plan may take a year or longer.
During this time, a secured creditor can experience
a devaluation of the property through depreciation,
or the cash collateral may disappear or be consumed
through normal business operations. The creditor can
do nothing because of the automatic stay.
4.
Adequate Protection Negotiations. To
protect the creditor against this scenario and guard
against the risk of losing the security for the
debt, the creditor is entitled to adequate
protection. As soon as possible after a Chapter 11
is filed, Insolvency should identify any secured
claims it has against the debtor, make prompt
contact with the debtor's counsel, and begin
negotiations for adequate protection as a condition
for the debtor's continued use of cash collateral.
5.
Lien Rights.
The
6.
Superpriority Liens in a Chapter 11 Proceeding. 11 U.S.C. § 364 provides debtors may, with court approval, obtain
postpetition financing. To induce lenders to grant
this financing, superpriority liens can be offered. Such
liens become senior to all other liens.
Note:
In accordance with 11 U.S.C. § 364(d),
superpriority liens can be provided only if the
holder of the previous lien, including the
7.
Real Property and Adequate Protection. Adequate
protection is seldom sought by the
8.
Insolvency Actions. If
the
a.
send AIS
Letter 2173, or an equivalent local letter, to the
debtor with a copy to the debtor’s attorney,
advising the
b.
based on
response(s) received, attempt to reach an agreement;
negotiations for adequate protection of the
government's lien interests will follow guidelines
similar to those used when the
c.
make a
prompt referral to Counsel, asking for a motion to
provide adequate protection to the
25.17.11.3.4 (09-01-2004)
Collection Statute of Limitations and Chapter 11
Plans
1.
Tax Collection Waivers. Pursuant
to I.R.C. § 6502(a), as amended by the
2.
Chapter 11 Plans Are Not Installment Agreements. Although
Chapter 11 plans make a series of periodic
(installment) payments to the Service, typically
toward the taxpayer's priority and secured tax
debts, with interest, the Chapter 11 plan differs in
many respects from an installment agreement under
I.R.C. § 6159, and is, therefore, not considered as
such.
3.
Collection Statute Expiration Date (CSED) and Confirmed Plans. The
limitation period for collecting a tax provided
for by a confirmed Chapter 11 plan is
generally suspended automatically via I.R.C. §
6503(h)(2) while the
taxpayer is current on Chapter 11 plan payments up
to the time the taxpayer is in substantial default
on the plan payments, plus six months.
4.
Waiver Expiration Date. Collection limitation waivers (Form 900)
obtained from taxpayers before December 31,1999,
outside of the context of an installment agreement,
expired automatically on or before
Note:
The automatic suspension of the
collection limitation period pursuant to I.R.C. §
6503(h)(2), while the automatic stay is in effect
and while a confirmed Chapter 11 plan providing
fully for the tax is in effect, is not shortened by
a collection limitation waiver between the debtor
and the Service that expires at an earlier date.
5.
CSED and Corporate Cases in Chapter 11. In
corporate cases, and other cases where the debtor is
not an individual, the Service may generally rely on
the suspension of the limitation period provided for
in I.R.C. § 6503(h)(2) to collect tax payments
after confirmation of Chapter 11 plans. The Service
should, nevertheless, insist Chapter 11 plans be
paid in full within the timeframes required by the
Bankruptcy Code.
6.
CSED and Individuals in Chapter 11. In
cases where the debtor is an individual, and the
plan provides for the full payment of a particular
tax, the Service may also generally rely on I.R.C.
§ 6503(h)(2) for the suspension of the collection
period.
Caution:
However,
the Service cannot rely on the I.R.C. § 6503(h)(2)
suspension in cases where the debtor is an
individual with respect to taxes that are both (1) non-dischargeable, and (2) for which
full payment is not provided in the plan.
7.
CSED — Individuals and Secured Claims. Similarly, in cases where the debtor is an individual, the Service cannot
rely on the suspension of the collection statute
regarding secured claims if
the plan does not provide for full payment of the
secured claim. The following situations
apply these principles:
A.
The tax is
non-dischargeable, and the Service did not file a
proof of claim (for example, the Service was not
aware of the claim before the bar date).
B.
The tax or
tax penalty is non-dischargeable but is not entitled
to priority claim treatment (for example,
non-priority taxes and tax penalties described in 11
U.S.C. §§ 523(a)(1)(B), 523(a)(1)(C), or
523(a)(7)), and the Service filed a general
unsecured claim for these taxes or penalties; the
plan provided for less than full payment of these
claims).
C.
The tax,
though otherwise dischargeable, was secured by
property that was excluded, exempted, or abandoned
from the bankruptcy estate.
8.
CSED Protection for the
25.17.11.3.5 (09-01-2004)
Trust Fund Considerations in Chapter 11
1.
Policy Statement P-5–60. Absent statute of limitations considerations,
the general policy of the Service is to
refrain from asserting the TFRP against non-debtor
responsible persons in cases where the corporate
debtor's Chapter 11 plan provides for full payment
of trust fund taxes, as long as the plan is not in
default.
2.
RO Assigned Accounts. When
the trust fund balance due accounts (e.g., corporate
Forms 941) are assigned to field Compliance at the
time of the bankruptcy petition, the revenue officer
(RO) manager is responsible for issuing an ICS Other
Investigation to an RO to conduct the
investigation as soon as possible. The RO should
periodically update Insolvency on the progress of
the investigation.
3.
Non-RO Assigned Balance Due Accounts. Insolvency
is responsible for initiating the TFRP investigation
in bankruptcies, not involving balance due accounts
already assigned to field Compliance as of the
bankruptcy petition filing date. Insolvency may
either issue an ICS Other
Investigation or Form 2209 to the field
or assign the TFRP investigation to an Insolvency
Advisor. Also, see
4.
LEM-TFRP Criteria. Generally,
Insolvency should initiate a TFRP investigation
based on the TFRP criteria in the Law Enforcement
Manual (LEM), considering tolerance and
collectibility factors.
5.
Withholding of TFRP Investigation. If
a TFRP investigation is withheld based on LEM
criteria, expiration of the assessment statute may
be allowed without Insolvency intervention. In that
circumstance, established procedures must be
followed and clearly documented on AIS explaining
the reason the TFRP investigation was withheld.
Caution:
If
less than six months remain before the ASED, the
case should not be forwarded for a TFRP
investigation.
6.
In Chapter 11 – Withholding Assessment Against Responsible Persons.
A.
If the
debtor is a corporation responsible for unpaid trust
fund taxes, assertion of the TFRP against
responsible persons will normally be withheld while
the proceeding is pending prior to confirmation of a
plan of reorganization. However, note (7), Indicators
to Consider — Doubtful Collection,
below.
B.
If the
corporate debtor has a confirmed reorganization plan
providing for full payment
of the trust fund taxes, assertion and
collection of the TFRP is normally deferred as long
as the corporate debtor is current with plan
payments.
7.
Indicators to Consider – Doubtful Collection. For
any case meeting the LEM criteria, the trust fund
investigation should be conducted as soon as
possible to identify potential responsible officers
and to secure waivers when possible. Forbearance
from asserting and collecting the TFRP will remain,
unless factors indicate ultimate collection is
doubtful from the corporate debtor. Indicators of
doubtful ultimate collection follow.
A.
Potentially
responsible individuals will not sign Form 2750, Waiver
Extending Statutory Period for Assessment of Trust
Fund Recovery Penalty.
B.
Additional
unpaid liabilities pyramid after the petition date.
C.
The
corporation continues to operate at a loss.
D.
Assets are
liquidated.
E.
Excessive
compensation is paid to officers during the
bankruptcy proceeding.
F.
Unreasonable
delay occurs in proposing a plan.
G.
The debtor
is unable to effectuate a plan.
H.
The debtor
defaults on plan payments or is only paying on plan
sporadically.
8.
Designation of Payments in Chapter 11 Plans.
A.
In Chapter
11 cases, when a corporate debtor owes the
B.
A corporate
debtor's designation of plan payments first to trust
fund taxes can be an attempt to shift the risk of a
failed Chapter 11 plan from the corporation's
"responsible parties " onto the
C.
In U.S.
v. Energy Resources,
495 U.S. 545 (1990), the Supreme Court ruled
bankruptcy courts have the authority to approve
Chapter 11 plans which order the
D.
Even after
Energy
Resources, the Service may challenge
whether proposed designations of payments to trust
fund taxes are necessary to the success of
reorganizing Chapter 11 plans. Courts are still
split on if a bankruptcy court may designate the
application of payments made under a Chapter 11 plan
to trust fund taxes when the plan provides for the
debtor's liquidation, rather than the debtor's
continuation as a reorganized business.
E.
Application of the bankruptcy plan paymentswill be made according to the Designated Payment Code (DPC) shown on the
transaction as outlined in Document 6209,
Reminder:
A TFRP assessment is classified as priority
(unless secured by a lien) on the Service's proof of
claim. A TFRP is never to be paid as a general
unsecured claim. Despite being named as a penalty,
the TFRP is treated as a tax.
25.17.11.3.6 (09-01-2004)
Compliance Monitoring
1.
LAMS.
The Litigation Account Management System (LAMS) is a sub-system to AIS used
to monitor compliance for all debtors in Chapters
11, 12, and 13. LAMS generates a report to match
closed cases on AIS with unreversed TC 520s on IDRS.
This report should be worked timely to identify
violations of the automatic stay. Through LAMS,
timely reviews can be made when working on large
dollar and chronic repeater cases. The AIS
User's Guide provides additional
information on LAMS. See
2.
Postpetition Monitoring Report. Insolvency
receives a quarterly delinquency list, the
Postpetition Monitoring Report, on all open
bankruptcy cases. Local Insolvency units should
establish dollar criteria for frequent monitoring,
based on the normal current employment tax
liability, to detect large dollar non-compliance.
3.
In-Business Compliance Monitoring. Compliance
monitoring must be conducted for all in-business
debtors, including those cases where no proof of
claim will be filed or no money is owed.
4.
TC-136 — BMF Monitoring. The use of TC 136 assists Insolvency when
monitoring for Business Master File (BMF)
compliance. For compliance monitoring, the
Insolvency Interface Program (IIP) now inputs a
systemic TC 136 reflecting the Last Return Amount
Code of "1."
A.
The input
of TC 136 suppresses both litigation transcripts for
TC 650 and FTD alerts.
B.
An
FTD-FIDUC transcript is generated when a systemic
check discloses substantial underdepositing.
C.
When
systemic monitoring is no longer necessary, TC 137
should be input.
5.
Large Dollar/Chronic Delinquency Cases. In
lieu of systemic monitoring, Insolvency should
consider one or all of the following when monitoring
large dollar or chronic repeater cases:
A.
periodic manual monitoring on IDRS (as
established by local management guidelines);
B.
verification of timely tax deposits on
Form 6123 (sent to Insolvency); and, if necessary,
C.
issuance of Letter 986,
requiring the DIP to file monthly returns.
6.
Non-Compliance Actions by Insolvency. Any
case of significant postpetition/pre-confirmation
non-compliance must be addressed promptly. Depending
on the case circumstances and local procedures,
Insolvency should take the actions listed below.
A.
Input the
appropriate transaction code to suspend the account.
B.
Make
contact with the debtor or debtor’s attorney.
Request all delinquent deposits be made and/or
delinquent returns filed immediately.
C.
Set a target date for the debtor to come into compliance.
D.
If the
debtor's tax delinquencies continue, list the
liabilities on Form 6338–A, Request
for Payment of Internal Revenue Taxes,
and file with the court.
E.
Send a copy
to the debtor and debtor's attorney, including a
letter advising them the
F.
Annotate on
the Request for Payment form an estimate of the
current tax period liability and an estimate of the
amount due on any unfiled returns.
G.
Consider a
referral for court intervention.
Exception:
Postpetition individual liabilities of
an individual
debtor. See
7.
Referral.
If the delinquency is not resolved, and the arrearage justifies a referral,
Insolvency should immediately refer the case to
Counsel for court intervention. The referral should
include the debtor's TINs.
8.
Dismissal.
The Chapter 11 case, although not eligible to convert to a Chapter 7, can be
dismissed if the debtor is:
A.
a farmer;
B.
a
corporation which is not moneyed, business or
commercial; or
C.
any entity
not eligible to file Chapter 7.
25.17.11.3.6.1 (09-01-2004)
Postpetition Debts — Chapter 11 Individuals
1.
Postpetition Debts/Individuals. In
an individual
Chapter 11 case, the individual debtor and the
bankruptcy estate represent two separate taxable
entities. Any postpetition liability incurred by the
individual debtor may not be claimed in the
bankruptcy proceeding.
2.
No Stay on Individual's Postpetition Debts. No
stay of collection is placed on the individual's
postpetition debts. Such debts can be collected from
non-estate assets, such as exempt assets and the
individual debtor’s postpetition wages. Collection
of these accounts is not to be suspended.
3.
Income From Business. When
the individual debtor operates a business as a sole
proprietorship, or if the business is solely owned
by the debtor, it may not be clear whether income
from the business is property of the estate or the
debtor’s separate postpetition income. In such
cases, Insolvency may need to consult with local
Counsel.
25.17.11.3.7 (09-01-2004)
Chapter 11 No Liability Cases
1.
Significant Bankruptcy Cases. Cases meeting the
Significant Bankruptcy Case Processing Procedures
criteria in
2.
No Liability Closures — Caution. If
a "no liability"
determination is made in a Chapter 11 case, caution
must be exercised in early closure of the case.
Closure, in all instances, must conform with the
provisions of the Bankruptcy Code to protect the
debtor's rights.
3.
Required Research. At
a minimum, current research must be done which
shows:
·
no balance
due periods
·
no pending
assessments
·
no unfiled
returns
·
no pending
examinations
·
plan review
does not show any potential liability to the
·
debtor is
current for at least a minimum
of two consecutive postpetition quarters (BMF taxes)
·
no other
issues requiring Insolvency's attention
4.
Plan or Disclosure Statement Received After Case Closure. If
the Service receives a disclosure statement or a
plan after closing a no liability Chapter 11 case,
Insolvency should reopen the case to conduct another
liability review.
25.17.11.3.8 (09-01-2004)
Tolerance Cases
1.
Abatement of Tolerance Cases. If a debt has not been scheduled for payment
by the trustee, and a claim has not been submitted
by the debtor on behalf of the
Caution:
Exceptions to the abatement of below
tolerance cases exist when pending litigation or
criminal investigation are involved. See
Note:
Although the provisions of LEM allow for
a tolerance amount to avoid the filing of a proof of
claim, Insolvency is not precluded from filing a
claim on any case, if that is the practice of the
local Insolvency unit.
25.17.11.4 (09-01-2004)
Internal Revenue Code § 1398 Issues
1.
I.R.C. § 1398. Internal Revenue Code
§ 1398 contains special tax provisions for an
individual filing Chapter 11.
2.
Forms 1040 and 1041 Filings. When an individual files bankruptcy under
Chapter 11 provisions, two taxpayers exist
postpetition:
a.
the trustee
or debtor-in-possession files a return (Form 1041)
for all income which belongs to the estate; and
b.
the
individual debtor files a return (Form 1040) for all
income of the debtor which is not part of the
estate. I.R.C. § 1398.
Note:
These same provisions are applicable to
individual Chapter 7 cases. See
3.
Individuals Can Terminate Tax Year. Although
this practice is not common, individuals may elect
to terminate their tax year when the bankruptcy
petition is filed.
A.
If this election is made, the tax year is
terminated as of the day before the bankruptcy
filing, which will result in the debtor filing two
"short-year" returns. This election is
made by filing the first short year return on or
before the due date, which is the 15th day of the
fourth month following the close of the first short
year.
B.
The debtor must write at the top of the firstshort
year return: SECTION
1398
ELECTION.
At the top of the second
short year return, the debtor must write: SECOND
SHORT YEAR RETURN AFTER SECTION 1398 ELECTION.
Note:
The election can also be made by filing
an extension to file on or before the due date of
this return.
C.
The spouse can join in this election. If the
spouse does join, a joint return must be filed for
the first short year. If the spouse does not join, a
joint return cannot be filed for that year.
D.
If an individual files Chapter 11 and makes the
I.R.C. § 1398 election, the spouse may join in this
election. If the spouse subsequently files Chapter
11, the second filing creates a second I.R.C. §
1398 election opportunity. If the election should be
made again, three short year returns are required.
E.
Once this election is made, it may not be
changed unless the case is dismissed. See (4) below.
4.
Bankruptcy Estate in Individual Chapter 11 Case. The
bankruptcy estate in an individual Chapter 11 case
is a separate taxable entity. A separate Employer's
Identification Number must be obtained for the
estate.
.
An income
tax return must be filed on Form 1041 if the estate
has sufficient income to meet the filing
requirements. The 1041 filing requirements are the
total of the amount of one exemption plus the
standard deduction for a married person filing
separately.
A.
The estate may initially choose its own taxable
period (i.e., when its first tax year ends) as long
as the initial period does not exceed one year.
B.
The debtor-in-possession or the trustee must
determine what portion of income, deductions, and/or
credits belongs to the individual debtor and what
portion belongs to the estate. Earnings from
personal services performed by the debtor after the
petition date are not
part of the estate and should be included
on the individual's Form 1040. Income derived from
assets of the estate should be reported on the
estate's Form 1041.
Example:
A loss derived from rental property
would not be available to reduce the 1040 income as
the rental property is part of the estate, and the
loss should be reported on the 1041.
C.
Also, any prepetition net operating loss (NOL)
available to the individual will become part of the
estate when the petition is filed and will not be
available to the individual so long as the estate
exists. When the estate terminates, any remaining
net operating loss will revert to the individual,
but first it must be reduced by the amount of any
discharged debt.
D.
A joint bankruptcy petition actually creates two
bankruptcy estates – unless the court has
substantively consolidated the estates. If the
estates have not been consolidated, two 1041
obligations exist.
E.
Local Insolvency offices should consider sending
a standard letter to individual Chapter 11 debtors
and trustees advising them of these opportunities
and their resultant tax responsibilities.
F.
If the Chapter 11 case is subsequently
dismissed, the effect is as if a bankruptcy petition
was never filed. Therefore, the debtor must file
amended returns to replace any short year returns
filed or 1041s filed.
Note:
Publication 908, Tax
Information on Bankruptcy,
details information on this subject.
25.17.11.5 (09-01-2004)
Disclosure Statements and Plans of Reorganization
1.
Requirement.
Chapter 11 is the only chapter of the Bankruptcy Code requiring a Disclosure
Statement to accompany a proposed plan of
reorganization.
2.
Clarifies Plan. The
Disclosure Statement may be brief or lengthy, but it
should generally explain what the proposed plan
means to particular creditors and to other
interested parties. The contents of this Statement
are not binding on the
3.
Notice of Hearing. The
debtor must eventually submit a Disclosure Statement
and Plan of Reorganization. The court then schedules
a hearing on the Disclosure Statement, sending a
notice of the hearing to all creditors. Immediately
upon receipt of this notice, Insolvency should
request a copy of both documents, usually from the
debtor's attorney.
4.
Insolvency Review. Insolvency
should review the claim and the case file to
determine if new tax liabilities have accrued and if
all prepetition liabilities have been included on
the claim. The claim should be amended as
appropriate. This review will also identify if
administrative tax liabilities have been incurred.
If so, an administrative claim should be filed.
5.
Lien and Equity Issues. If the
6.
Objections.
The Disclosure Statement must provide sufficient information for the
reviewer to make a judgment about the plan.
25.17.11.5.1 (09-01-2004)
The Small Business Election
1.
" Fast Track" Bankruptcies. A
" fast track"
Chapter 11 bankruptcy accelerates the plan
confirmation process by an eligible debtor's
electing to be treated as a small business. In
"fast track" cases, the debtor may file a
plan within 100 days after the date of the order for
relief. All plans must be filed within
160 days after
the date of the order for relief. Under certain
conditions, these timeframes may be reduced or
increased by the bankruptcy court. See 11 U.S.C. §
1121(e).
2.
Court-Conditional Approval. If the debtor has made this election, the
court can conditionally approve the Disclosure
Statement without notice to creditors, subject to
final approval after notice and hearing, in
accordance with 11 U.S.C. § 1125(f). Acceptances of
the plan may be solicited by the debtor based on the
conditionally–approved Disclosure Statement. A
hearing on the Disclosure Statement may be combined
with a hearing on confirmation.
3.
Provisions.
11 U.S.C. § 101(51C) provides the small business election is:
A.
available
to debtors whose aggregate prepetition debts do not
exceed $2 million; but
B.
not
available to debtors engaged in real estate
businesses.
25.17.11.5.2 (09-01-2004)
The Plan of Reorganization
1.
Negotiations. The Bankruptcy Code prescribes minimal
requirements for the structure and the confirmation
of a Chapter 11 plan. However, the plan provisions
result from negotiations among the debtor and its
creditors. The
2.
Quality Plan Reviews/Timely Objections. Chapter
11 plans may fail to provide properly for the
Service's claims, so the Service must review these
plans carefully and in a timely manner. The Service
should consider objecting to plans when they are
deficient.
3.
Plan Provisions. The
plan must provide, as follows:
A.
Administrative Expenses. Administrative
( "admin" ) expenses must be paid in full
on the effective date of the plan, unless the claim
holder agrees to different treatment, as required by
11 U.S.C. § 1129(a)(9)(A). The
Caution:
Failure
to file a timely request for payment presents
substantial risk the court will hold such
administrative taxes to have been discharged
notwithstanding 11 U.S.C. §§ 1129(a)(9)(a) and
503.
B.
Secured Claims and Protection of the Government's Interests. Secured
claims should be paid in full within a reasonable
amount of time with interest accruing from the
effective date of the plan.
C.
Full Payment Provision. The Service should generally insist the plan
at a minimum provide for
full payment of secured claims before the collection
period is due to expire, absent the I.R.C. §
6503(h) suspension.
D.
Collection Suspension Language. If
a provision for payment within this time cannot be
obtained, the plan should be modified to include
language clarifying the collection period will be
suspended pursuant to I.R.C. § 6503(h)(2). See
E.
Lien Retention Provision. The plan must contain a provision the
Service's lien, relating to any secured claim, will
be retained until the plan is completed. This is
because 11 U.S.C. § 1141(c) provides, with limited
exceptions, the property dealt with by the plan is
free and clear of all claims of creditors once the
plan is confirmed, unless the plan provides
otherwise.
F.
Oversecured Claim. If
the value of the collateral exceeds the amount of
the claim, (the Service's secured claim is
oversecured), the plan should provide for interest
on the claim from the petition date. The Service
contends the interest rate for oversecured claims
should be the I.R.C. statutory rate, but local
practices may vary.
G.
Unsecured Priority Claims. 11 U.S.C. § 1129(a)(9)(C) provides, unless
the creditor agrees to a different treatment,
unsecured priority claims must be paid in full, in
cash, within six years of assessment, including
interest on the claim from the effective date of the
plan to the date of payment.
H.
Unsecured General Claims. Unsecured
general claims are not required to be paid in full,
nor do they receive interest. However, general
creditors must be paid an amount at least equal to
that which the creditors would have received under
Chapter 7, in accordance with 11 U.S.C. §
1129(a)(7). An unsecured claim should be filed by
the Service if unsecured amounts are due the
Note:
Plans may divide general claims into
categories by amount and provide for more prompt
disposition of smaller claims. In such cases, the
reviewer may consider, with
managerial concurrence, reducing the
general claim for more prompt "up front"
payments and disposition, depending on the terms and
amounts. See (8), Deficient
Plans – Exceptions, below.
I.
Default Provisions. During
plan negotiations, a default
provision should be obtained, specifying
non-dischargeability of federal tax liabilities
until paid and permitting administrative collection
action upon default. This forms a significant aspect
of the plan in light of the high default rate of
Chapter 11 plans. Without a provision in the plan
outlining remedies upon default, the Service is left
with an uncertain legal position which could lead to
litigation.
J.
Default Language. The following model language can be modified
to fit local practice or the circumstances of a
particular case: If the
reorganized debtor substantially defaults on the
payments of a tax due to the
4.
Full Plan Review Critical. In addition to reviewing the plan to ensure it
adequately provides for the Service's claims, the entire
plan must be evaluated to determine if it includes
provisions detrimental to the government.
5.
Plan Review "Red Flags." No list can be all inclusive, but Insolvency must exercise caution when plan
provisions are reviewed, and any of these factors
are noted:
·
balloon
payments — while irregular or fluctuating payments
may be acceptable for a seasonal business,
·
designating
payments to trust fund taxes first
·
discharge-like
releases and/or injunctions in favor of non-debtor
third parties, such as officers of the debtor
corporation
·
distribution
of property to the government in lieu of cash
·
excessive
time periods between confirmation and the effective
date
·
excessive
time to cure any default in the plan
·
giving any
third party, such as the creditor’s committee, the
right to delay payment to any creditor
·
language
which purports to change or conclusively determine
tax consequences under the I.R.C.
·
payment of
interest for only a portion of the claim
·
payment of
secured claims for periods longer than the required
six year period for priority claims
·
providing
for payment over several years but not providing for
equal monthly payments
·
providing
for large immediate cash payments to general
creditors but payments over time to priority
creditors
·
provisions
giving general unsecured creditors more favorable
treatment than priority creditors
·
provisions
dealing with any post-confirmation taxes or bringing
post-confirmation matters under court jurisdiction
·
the
creation of a post-confirmation trust, funded by
assets of the bankruptcy estate
·
unrealistically
short administrative claim bar dates
·
any other
provision which jeopardizes the government’s
interests
6.
Tax Consequences. Plans
providing for liquidation or the sale of property
should be reviewed for the tax impact. See
7.
Deficient Plans — General. If the plan does not meet minimum requirements
for payment under the Bankruptcy Code, or other
serious concerns arise, Insolvency should advise the
debtor’s attorney of the deficiencies and
negotiate an acceptable plan. The changes will then
be included in an amended plan or in the order
confirming the plan. In any event, the agreed-upon
changes must be in
writing.
8.
Deficient Plans — Exceptions. If a proposed plan of reorganization does not
provide for the payment of the
Note:
This recommendation may be made only if
no other creditor benefits to the detriment of the
Service. Under no circumstances will the
9.
Evaluating Deficient Plans.
10.
Acceptance of Deficient Plans. If
a debtor demonstrates agreeing to treatment
different than is statutorily required under the
Bankruptcy Code is in the government's best
interest, the specific payment terms must be
incorporated into the debtor's plan of
reorganization and are subject to the approval of
the bankruptcy court. Provisions protecting the
government's rights to collect upon a default in
plan payments should be included in the terms of the
plan.
Note:
The AIS history must reflect the factors
considered in the decision to accept treatment of
the
11.
Prompt Objections. If
the debtor's counsel is unresponsive to Insolvency
contacts, unable to demonstrate acceptance of a
deficient plan is in the government's best
interests, or if the interests of the government are
at risk, a referral to Counsel should be made to
file an objection to the plan.
12.
Contents of Objection Referral.
13.
Written Notice to Debtor. After an acceptable plan has been filed,
Insolvency should advise the debtor in
writing of the amount of the required
payments if the amounts are not specified with
clarity in the plan.
14.
Individual Debtor and Non-Dischargeable Taxes. If
the bankruptcy is an individual case, the debtor and
the debtor's attorney should be advised in writing
of any non-dischargeable
liabilities which will survive the proceeding and be
collectible after the stay is lifted.
25.17.11.6 (09-01-2004)
The Chapter 11 Discharge and the Effects of
Confirmation
1.
Bankruptcy Estate Upon Confirmation. Upon
confirmation:
A.
all
property of the bankruptcy vests in the debtor
unless the plan or the confirmation order provides
otherwise in accordance with 11 U.S.C. § 1141(b);
B.
the
automatic stay is terminated. 11 U.S.C. § 362(c).
2.
Effective Date of Plan. The effective date of the plan will usually be
defined in the plan itself. If not, the effective
date is the date the confirmation order becomes
final.
3.
Plan Confirmation Binding. A Chapter 11 plan is confirmed when the court
enters an order confirming the plan. Confirmation
binds the debtor and creditors to the terms of the
plan.
Caution:
Insolvency
should scrutinize the order confirming the plan to
ensure the debtor received a discharge and property
did vest in the debtor at the time of confirmation.
4.
Discharge.
11 U.S.C. § 1141(d) provides confirmation of the plan discharges the debtor
from any debt arising before the date of
confirmation, unless the plan or confirmation order
provides otherwise.
5.
Automatic Stay Terminated. The
automatic stay is usually terminated at
confirmation, and TC 520 closing codes input to
comply with the automatic stay are released.
Generally, TC 520 CC 81 is input on these accounts
when the stay is lifted.
6.
Non-Discharge. Confirmation does not
discharge a debtor if:
A.
the plan
provides for liquidation of all or substantially all
property of the estate;
B.
the debtor
does not engage in business after the confirmation
of the plan; and
C.
the debtor
would be denied a discharge in Chapter 7. In
practice, this usually applies to corporations and
partnerships which are not eligible for discharge in
Chapter 7. However, it may also include other
debtors who 1) have committed fraud; 2) have not
been open and truthful during the proceeding; or 3)
have been previously granted discharges within
six years of filing the present petition.
Note:
A discharge hearing is normally required
to determine if a discharge should be denied for
these reasons.
7.
Individuals/Certain Taxes Not Discharged. Confirmation
in a Chapter 11 case does not discharge anindividual
debtor from certain
taxes, in accordance with 11 U.S.C. § 523(a). If
the non-dischargeable taxes are paid in the
proceeding, the accruals not paid will survive the
proceeding and be collectible after confirmation.
See
8.
Non-Collection Outside of Plan. Although
confirmation does not discharge an individualdebtor
from taxes excepted from discharge under 11 U.S.C.
§ 523(a), the
A.
a
substantial default has occurred;
B.
circumstances
allowing collection through setoff arise, or;
C.
the plan
does not provide for full payment of the
non-dischargeable taxes.
25.17.11.7 (09-01-2004)
Post-Confirmation Actions
1.
Transaction
code 520 CC 81 is generally input on all modules
covered by the plan.
2.
After
verifying TC 520 CC 81 has posted, any TC 520s with
other closing codes must be reversed and TC 137
input on all accounts having a TC 136.
3.
Any
unassessed deficiencies or unpostable returns should
be assessed as appropriate.
25.17.11.7.1 (09-01-2004)
Disposition of Acquired Property
1.
Disposing of Acquired Property. If
property is received in accordance with the plan,
the plan should be reviewed for restrictions or
considerations that inhibit disposing of the
property. If none is identified, the property should
be treated similarly to property acquired by
redemption, including recording any deeds,
certificates of title or similar documents, and then
selling the acquired property. See
25.17.11.7.2 (09-01-2004)
Monitoring the Plan
1.
AIS Follow-up. Insolvency must monitor the plan after
confirmation to ensure the debtor is making required
payments to the
2.
Monitoring Timeframe. AIS
follow-up should be set appropriately. In most
cases, this should be done at
least quarterly
.
Caution:
To
ensure protection of the government's interests in
large dollar cases, and in cases of unusual
complexities and/or sensitivity, monitoring should
be conducted more frequently.
3.
Plan Payments Review. To monitor the debtor's payments under the
plan effectively, Insolvency must review and
identify the terms governing the
A.
amount of
payments;
B.
date of
payments;
C.
default
provisions;
D.
claim
classifications;
E.
frequency
and regularity of payments;
F.
amount of
any arrearage;
G.
interest
rate;
H.
payments to
general unsecured creditors;
I.
length of
time to pay the claim; and
J.
special
conditions.
4.
Application of Payments. Payments
should be applied to the claim for which the payment
was received, whether secured, priority, or general.
In addition, the
payment must be applied in accordance with the plan,
if so specified. Otherwise, the
payments will be applied in the best interests of
the government. See
25.17.11.7.3 (09-01-2004)
Plan Default
1.
Default Notice. If
plan payments have not been received as required,
the following steps should be taken, as appropriate:
A.
A pending
default notice ( "last-chance " letter)
should be sent in accordance with the plan's default
provisions as soon as a
potential default has been identified.
B.
A date must
be specifiedin
the letter for the debtor to come into compliance
with the plan provisions (for example, 30 days from
the date of the "pending default " letter)
including full payment of plan payments to date and
staying current on plan obligations.
C.
A default notification letter must be sent to the debtor and attorney if a
debtor does not come into full compliance after the
date given in the "last-chance" letter.
Note:
Even if the plan contains no default
provisions, it is recommended a
"last-chance" letter be sent to the debtor
and the debtor's attorney when a potential default
of the plan exists.
2.
Available Options. If
the default is not cured by the time required in the
plan or the default letter, available options
include:
A.
administrative
collection;
B.
a motion to
convert or dismiss; or
C.
a referral
to Counsel to determine the proper legal action for
the Service to take.
3.
Administrative Collection. Pursuant
to
A.
Plan Language. If the plan provides specific default
language, the Service and the debtor will be bound
by that provision.
B.
Consult Counsel. If the plan has no provision specifying the
Service's remedies upon default, the Service's
options are less clear. Insolvency should consult
Counsel for guidance with local practice and case
law.
4.
Substantial Default. The Service can administratively collect the
full amount of the liabilities provided for in a
Chapter 11 plan when the
debtor is in substantial default, such as
where:
a.
the debtor has defaulted on a series of plan
payments and has ceased making regular payments
under the plan;
b.
the Service has sent a notice of default; and
c.
it is clear the debtor will not cure the default
in a reasonable time nor remain current on plan
obligations.
Note:
In
such cases, the debtor is no longer operating under
the terms of the plan and has opted out of
participation in the bankruptcy process.
5.
Payments Current/Arrearage Exists. When
the debtor is behind on plan payments, but continues
to make regular payments under the plan,
administrative collection of only the past due
payments, and not the entire amount due under the
plan, may be appropriate.
Example:
If the debtor missed three $1,000
payments, but is making regular payments, the amount
of arrearage, $3,000, can be administratively
collected.
6.
Administrative Collection. If
administrative collection is appropriate, and
identifiable levy sources are found, consideration
may be given to Insolvency's sending a modified
notice of intention to levy. Otherwise, Form 2209
should be sent to field Compliance for collection of
the defaulted amount, or the entire amount, as
appropriate. Insolvency should consult with Counsel
if this situation arises.
7.
Discharged Taxes. No attempts can be made to collect discharged taxes.
·
corporate
— unless the plan provides otherwise, any pre-confirmation
tax liabilities not provided for in a Chapter 11
plan are discharged pursuant to 11 U.S.C. § 1141(d)
in corporate Chapter 11 cases
·
individual
— in Chapter 11 cases of individuals,
pre-confirmation liabilities
not provided for in the plan are also discharged
with the exception
of liabilities that are non-dischargeable
pursuant to 11 U.S.C. § 523(a) and postpetition
liabilities of the individual debtor (as opposed to
the liabilities of the bankruptcy estate)
8.
Motions to Convert or Dismiss. When
deciding to refer a case for a motion to convert or
dismiss, Insolvency must consider each case
separately. In some cases, administrative collection
may not be feasible because of lack of assets, or
the court may retain jurisdiction over the assets.
In these instances, the case will probably be
considered for a conversion to a Chapter 7
proceeding. See
25.17.11.7.4 (09-01-2004)
Accrual of Post-Confirmation Tax Liabilities
1.
Tax Debts Arising After Confirmation. Liabilities
incurred after the effective date of confirmation
are not
subject to the bankruptcy court’s jurisdiction.
They cannot be claimed in the proceeding, and Insolvency
should not input any codes to suspend collection of
these liabilities.
Exception:
Potential
Referral.
If the plan or the order confirming the plan provides the property of the
estate does not vest in the debtor (for example, if
the property vests in a liquidating trust),
Insolvency should suspend these accounts from
collection and refer the case to Counsel.
2.
Insolvency/Counsel Assistance. Customer
service units or field Compliance personnel should
proceed with appropriate collection activities on
these accounts. However, if issues and questions
arise at the field level, and/or if uncertainty
exists on how to proceed, they must contact
Insolvency for assistance. If the matter is complex,
Insolvency should suspend these accounts from
collection while it requests advice from Counsel.
25.17.11.8 (09-01-2004)
Closing Chapter 11 Bankruptcies
1.
Reasons for Closure. Events
that may close a Chapter 11 case are:
·
dismissal
(including voluntary)
·
conversion
to a Chapter 7 liquidation proceeding
·
default of
the payment plan
·
plan
completion
2.
Closing Actions.
·
·