Collection

Overview
Bankruptcy Terms
Bankruptcy Legislation
Bankruptcy Section 6658
Bankruptcy Fraud
Statute of Limitations
Golden Parachute
Definition of "pending"
Chapter 9 Cases
Collection
Delinquent Accounts
Common Issues
IRS Case Processing
Proof of Claim
Chapter 7 Cases
Payments
Chapter 11
Chapter 12
Chapter 13
Closing

25.17.2  The Bankruptcy Code (11 U.S.C.) and Its Effect on Collection

• 25.17.2.1   Introduction
• 25.17.2.2   Introduction to the Bankruptcy Code – 11 U.S.C.
• 25.17.2.3   Bankruptcy Code Chapter Organization
• 25.17.2.4   Chapters in Bankruptcy
• 25.17.2.5   Important Sections of the Bankruptcy Code
• 25.17.2.6   Bankruptcy Rules
• 25.17.2.7   Local Rules and Standing Orders
• 25.17.2.8   Trustee
• 25.17.2.9   The Effect of Bankruptcy on Collection

25.17.2.1  (09-01-2004)
Introduction

1.       Federal bankruptcy law embraces the entire field of debtor-creditor relationships to provide a uniform and equitable method of distribution of the debtor's assets to the debtor's creditors. At the same time it gives the debtor an opportunity to start over with a clean (or at least improved) financial slate. This section introduces the reader to the Bankruptcy Code and its impact on tax collection.

Note:

Subsection IRM 25.17.2.9.1, at the end of this section provides a summary of how the various bankruptcy discharges affect the overall collection process.

25.17.2.2  (09-01-2004)
Introduction to the Bankruptcy Code – 11 U.S.C.

1.       The Bankruptcy Code. Initially individual states, not the federal government, enacted insolvency laws. Bankruptcy law is now contained in a federal statute called the Bankruptcy Code (11 U.S.C. for citations), comprising Title 11 of the United States Code (11 U.S.C.). The Bankruptcy Code establishes the law under which bankruptcy proceedings are commenced, administered, and closed. These procedures apply to all bankruptcies filed on or after October 1, 1979 .

2.       Chapters of the Bankruptcy Code. The Bankruptcy Code is divided into chapters:

·         Chapters 1, 3, and 5 contain general provisions applicable to all types of bankruptcies

·         Chapter 7 deals with liquidating bankruptcies

·         Chapter 9 concerns debts of a municipality

·         Chapter 11 provides information on reorganizations of individuals and corporations

·         Chapter 12 concerns family farmer reorganizations

·         Chapter 13 deals with reorganizations of individuals with regular income

3.       Automatic Adjustments of Dollar Amounts in Bankruptcy Code. At 3–year intervals, automatic adjustments of dollar amounts in effect under certain sections of the Bankruptcy Code are made to reflect changes in the Consumer Price Index. 11 U.S.C. § 104(b)(2). The latest scheduled automatic adjustments were on April 1, 2004 , and future adjustments will continue at each 3–year period ending on April 1 thereafter. The various sections of the Bankruptcy Code affected include:

·         109(e) (allowable debt limits for filing under Chapter 13)

·         507(a) (priority claims)

·         522(d) (exemptions allowed to the debtor)

These amounts will be published in the Federal Register on their respective effective dates. These adjustments shall not apply with respect to cases filed before the date of such adjustments. 11 U.S.C. § 104.

25.17.2.3  (09-01-2004)
Bankruptcy Code Chapter Organization

1.       Organization. Chapters 1, 3, and 5 of the Bankruptcy Code apply to all proceedings unless modified by a specific provision under a proceeding type. The Bankruptcy Code sections listed under each chapter are not all inclusive but have been added as a general reference. Some of the chapters in the 11 U.S.C. are further subdivided into subchapters.

2.       Chapter 1, General Provisions

·         Section 101, Definitions

·         Section 105, Power of Court

·         Section 106, Waiver of Sovereign Immunity

·         Section 109, Who May be a Debtor

3.       Chapter 3, Case Administration

·         Section 302, Joint Cases

·         Section 361, Adequate Protection

·         Section 362, Automatic Stay

4.       Chapter 5, Creditors, Debtor, and the Estate

·         Section 522, Exemptions

·         Section 523, Exceptions to Discharge

·         Section 524, Effect of Discharge

·         Section 541, Property of the Estate

·         Section 542, Turnover of Property of the Estate

·         Section 553, Setoff

25.17.2.4  (09-01-2004)
Chapters in Bankruptcy

1.       Bankruptcy Options. A debtor who files bankruptcy has two options:

a.       Liquidation — Chapter 7 and liquidating Chapter 11 — liquidation of assets to pay off debts; or

b.       Reorganization — Chapters 11, 12, 13 — reorganizing to pay creditors over a period of time through a plan.

2.       Chapters of Bankruptcy. The chapters under which entities can file for bankruptcy protection are as follows:

A.      Chapter 7 — Liquidation. A proceeding filed by an individual, business, or other entity, including corporations and partnerships, to pay creditors through liquidation and distribution of the debtor's assets.

B.      Chapter 9 — Adjustment of a Municipal Debt. A bankruptcy filed by a municipality, generally authorized to be a debtor by state law, which is insolvent or unable to meet its debts as they mature, and desires to effect a plan to adjust those debts.

C.      Chapter 11 —Reorganization. A proceeding filed by an individual, business, or other entity (primarily a corporation) where creditors are paid under a plan, often long term.

D.      Chapter 12 —Family Farmers. A reorganization proceeding for family farming operation, with characteristics of both Chapters 11 and 13. (Unlike Chapter 13, the debtor does not receive a superdischarge. The farmer is allowed to remain in business while formulating a plan to pay creditors.)

E.      Chapter 13 — Individuals. A voluntary reorganization of debts for individual debtors (including wage earners and sole proprietors) under the direction of a trustee who disburses payments to creditors. (Repayment is through a plan, which the court can approve for up to 60 months. The debtor receives a superdischarge after successful completion of the plan.)

25.17.2.5  (09-01-2004)
Important Sections of the Bankruptcy Code

1.       Introduction. Particular sections of the Bankruptcy Code impact the Service's position during the pendency of a bankruptcy. Familiarity with the Bankruptcy Code increases the Service's awareness of debtor's rights so those rights are not violated while the debtor is under court protection. Should violations occur, the Service may be liable for damages.

2.       Sovereign Immunity. Section 106 of the Bankruptcy Code waives the sovereign immunity of the IRS and other governmental units. The doctrine of sovereign immunity asserts the United States cannot be sued unless it specifically waives its exemption from suit, such as by passing a statute permitting a damages suit against the United states.

3.       Section 362, Automatic Stay. This provision of the Bankruptcy Code imposes an automatic stay (prohibition) on certain actions of creditors, including the United States, as of the petition date.

A.      Prohibits Acts to Collect. The filing of a bankruptcy petition operates as an automatic stay prohibiting acts to collect debts incurred before the filing of the bankruptcy petition and acts to take possession of, or exercise control over, property of the estate and the debtor.

B.      Exceptions. Exceptions to the automatic stay are found in 11 U.S.C. § 362(b). The Bankruptcy Reform Act of 1994 (BRA 94) expanded the list of exceptions to include: assessment of tax, issuance of notices of deficiencies, audits to determine tax liability, solicitation of tax returns, and the issuance of a notice and demand for payment of an assessment.

4.       Section 522, Exemptions. Provided in this section of the code are the property exemptions a debtor may select. The federal exemptions apply unless the state in which the debtor is domiciled has enacted specific legislation authorizing or mandating the use of state exempted property.

A.      Under 11 U.S.C. §§ 362 and 522, collection may not be pursued against exempt property while the automatic stay is in effect.

B.      Upon discharge, however, exempt property is subject to collection of dischargeable taxes and non-dischargeable taxes for which a Notice of Federal Tax Lien (NFTL) was filed prior to the petition date.

Note:

Exempted property is not subject to liquidation by the court.

5.       Section 523, Exceptions to Discharge. Exceptions to tax discharge for individual debtors are listed in Subsection 523 (a)(1). Not discharged are those tax liabilities given priority status by 11 U.S.C. § 507, except administrative expenses. In addition, non-dischargeable taxes include taxes for which a return was not filed, a late return filed within two years of the bankruptcy petition, a fraudulent return, trust fund taxes, and taxes the debtor willfully attempted to evade or defeat.

Note:

In a Chapter 13 bankruptcy, an individual may qualify for a superdischarge of all prepetition tax debts without regard to § 523 exceptions.

6.       Section 524, Discharge Injunction. The collection of discharged tax liabilities is prohibited by this code section. Tax determinations made by bankruptcy courts are binding on the IRS . The Service can be sued for damages, including attorney fees, for violating the automatic stay or the discharge injunction under 11 U.S.C. § 524. However, punitive damages cannot be awarded.

7.       Section 541, Property of the Estate. The filing of a bankruptcy petition creates an estate comprised of all property of the debtor as of the commencement of the case. The estate comes under the court's jurisdiction as of the date a bankruptcy petition is filed.

8.       Section 542, Turnover of Property to the Estate. The conditions under which property must be turned over to the estate for the trustee's use, sale, or lease are defined. This "turnover" may include a refund due an individual debtor for prepetition taxes unless the refund may be offset.

9.       Section 547, Preferences. The trustee is authorized to avoid certain transfers of the debtor's property made on or within 90 days before the date of the bankruptcy filing or between 90 days and one year before the petition date to an insider. An "insider" may include a relative, stockholder, or an officer or director of a corporate debtor, among others. 11 U.S.C. § 101(5). This section on preferences encompasses property seized by the government, as the term transfer also relates to involuntary payments. However, it does not include payments of tax liabilities made in the ordinary course of business.

10.   Section 553, Setoff — A creditor's right to set off a mutual debt owed by the creditor to the debtor that arose before the bankruptcy proceeding began is preserved. This authority allows the IRS to credit a refund that arose before the petition date against a prepetition tax liability of the debtor, provided the automatic stay has been lifted.

25.17.2.6  (09-01-2004)
Bankruptcy Rules

1.       Bankruptcy Rules. The Bankruptcy Rules and Forms govern procedures in cases under Title 11 of the United States Code. The rules shall be cited as the Federal Rules of Bankruptcy Procedure and the forms as the Official Bankruptcy Forms (e.g., Form B10, Proof of Claim). The Bankruptcy Rules were adopted to secure the just, speedy, and inexpensive determination of every case and proceeding. Bankruptcy Rule 1001. These Rules provide a structure to the bankruptcy process by standardizing the formats, timeframes, and methods to follow in the implementation of the Bankruptcy Code.

2.       Important Bankruptcy Rules. Some Bankruptcy Rules are more pertinent than others to the Service, and Insolvency employees should familiarize themselves with them. Examples of the relevant Bankruptcy Rules include:

·         Rule 1007 — when a debtor files a petition (order for relief), certain schedules or statements must also be filed

·         Rule 2002(a)(7) — creditors must receive notice of the bar date

·         Rule 2002(j) — notice of a Chapter 11 case must be mailed to the IRS where the case is pending, whether or not the IRS is a creditor; notice of Chapter 7, 12, and 13 cases must be given to the IRS when it is listed as a creditor in the debtor's schedules

·         Rule 2004 — on motion of any party in interest, the court may order the examination of any entity

·         Rule 7001 — Adversary Proceedings are subject to the formal procedural rules of Part VII of the Bankruptcy Rules; the rules in Part VII govern the procedural aspects of litigation involving the matters referred to in this rule

Example:

A proceeding to object to or revoke a discharge, and to determine the dischargeability of a debt, is known as an Adversary Proceeding.

·         Rule 9014 — contested matters are less formal than adversary proceedings; most proceedings under the Bankruptcy Code fall under the scope of this rule

Example:

Contested matters can include objections to confirmation, relief from the automatic stay, request for use of cash collateral, and avoidance of liens.

25.17.2.7  (09-01-2004)
Local Rules and Standing Orders

1.       Local Court Practices. Each bankruptcy court may make and amend its own local rules governing its practices and procedures. Insolvency should have access to any local rules/agreements or standing orders that provide specific guidelines for each bankruptcy court in which Insolvency has control. Employees need to become familiar with them as they impact the judicial actions in a local area. Actions forbidden in one judicial district may be allowed in another. Similarly, actions requiring a court hearing and ruling in one jurisdiction may be resolved administratively in another district.

2.       Counsel Assistance. Insolvency must confer with Counsel when interpretations are required covering local court practices. Judges in different districts may render divergent court decisions, and even trustees in the same district can each handle matters differently.

25.17.2.8  (09-01-2004)
Trustee

1.       Bankruptcy Trustees. The fiduciary responsibility to administer the bankruptcy estate rests with the bankruptcy trustee. The trustee ensures creditors are paid according to the provisions of the Bankruptcy Code as reflected in the debtor's plan. Trustees are appointed to serve in specific Chapter 7 or 11 cases as panel or case trustees. For Chapters 12 and 13, standing trustees are appointed to serve in all cases in the district.

2.       The United States Trustee. The role of the United States Trustee (employed by the Justice Department) is a supervisory entity charged with monitoring:

·         the performance of all Chapter 7 trustees

·         the performance of each Chapter 12 and 13 standing trustee

·         certain matters in Chapter 11 cases

Note:

IRM 25.17.1.6 Glossary — Bankruptcy Terms and other specific sections of this IRM pertain to the role of trustees in the different chapters of bankruptcy.

25.17.2.9  (09-01-2004)
The Effect of Bankruptcy on Collection

1.       How Bankruptcy Affects Collection of Taxes. The filing of a bankruptcy petition immediately affects the collection of taxes. The actions the IRS may take depend on various factors, including, but not limited to:

A.      whether the debtor is an individual, corporation, or partnership;

B.      what chapter of bankruptcy is filed;

C.      existence of complex or unusual issues, such as community property, trust fund, adequate protection, pyramiding of taxes;

D.      whether the tax is owed for pre- or post- petition periods; and

E.      where the case currently stands in the bankruptcy process.

2.       Table – Showing How Bankruptcy Can Affect Collection. The following table demonstrates the impact bankruptcy has on collection actions. Because of the variance of permissible actions among the courts, guidance on all possible actions cannot be provided in this IRM .

Note:

Service employees should contact Insolvency, which, in turn, may need to consult with Counsel when assistance is required on complex bankruptcy-related issues.

25.17.2.9.1  (09-01-2004)
Bankruptcy Discharges – Impact on the Overall Collection Process

1.       Introduction. A debtor's ultimate goal in bankruptcy is to gain relief from indebtedness by obtaining a discharge from debt. The discharge bars creditors from collecting discharged debts. Specific sections of IRM 25.17 deal in depth with discharge issues for the various bankruptcy chapters. Listed below is a summary of the overall impact of bankruptcy discharges on the Service's collection process.

2.       Discharge – Individual Debtors.

A.      Chapter 7. In a Chapter 7 case, the court grants a discharge, subject to the exceptions in 11 U.S.C. § 523 for individual debtors. 11 U.S.C. § 727(a). A court may deny a discharge if one of the criteria in 11 U.S.C. § 727 is met.

B.      Chapter 11. In a Chapter 11 case, the confirmation of a plan discharges all pre-confirmation debts, except for those listed in 11 U.S.C. § 523 for individual debtors, whether or not a proof of claim has been filed. 11 U.S.C. § 1141(d)(1).

Note:

A Chapter 11 confirmation does not act as a discharge (1) if the plan provides for the liquidation of all or substantially all of the property of the estate; (2) if the debtor does not engage in business after the plan is confirmed; or (3) if one of the criteria of 11 U.S.C. § 727 is met. 11 U.S.C. § 1141(d)(3).

C.      Chapter 12. In a Chapter 12 case, once the debtor has completed payments under the plan, the court will issue a discharge of all debts provided for in the plan, except for those listed in 11 U.S.C. § 523. See 11 U.S.C. § 1228(a). In certain circumstances, a judge can also issue a hardship discharge before the plan is completed. 11 U.S.C. § 1228(b).

D.      Chapter 13. In a Chapter 13 case, once a debtor has completed plan payments, the court grants a superdischarge. 11 U.S.C. § 1328(a). All tax debts provided for in the plan and disallowed claims are discharged. After a plan is confirmed, but before it is completed, the court may grant a hardship discharge, subject to the exceptions in 11 U.S.C. § 523.

Note:

In a hardship discharge, the Chapter 13 debtor must show: (1) the failure to complete the plan is due to circumstances beyond the debtor's control; (2) the value of the property actually distributed is at least what would have been distributed in a Chapter 7 proceeding; and (3) modification of the plan is not practical.

3.       Discharge — Corporate Debtors.

A.      Chapter 7. A Chapter 7 discharge is not available for corporate debtors. 11 U.S.C. § 727(a)(1).

B.      Chapter 11. A corporate discharge in Chapter 11 cases is a superdischarge without exception. 11 U.S.C. § 1141(d)(1).

C.      Liquidating Chapter 11. A corporation is not entitled to a discharge in a liquidating Chapter 11 proceeding. 11 U.S.C. § 1141(d)(3).

D.      Chapter 12 (Family Farmer). Refer to IRM 25.17.12.3, Chapter 12 Eligibility. Note in particular paragraph (3), 50 and 80 Percent Rules — Partnerships/Corporations for Chapter 12 bankruptcies.

4.       Exceptions from Discharge — Individuals. Under 11 U.S.C. § 523(a), the following taxes are not discharged in an individual Chapter 7, 11, or 12 bankruptcy:

A.      Priority tax claims. See IRM 25.17.6.5.2, Unsecured Priority Claims.

B.      Taxes for which a return was not filed. 11 U.S.C. § 523(a)(1)(B) denies a debtor a discharge of taxes when a return was not filed. IRM 25.17.2.9.1.2 deals with what does and does not constitute a valid tax return.

C.      Taxes for which a late return was filed within two years of the bankruptcy filing.

D.      Taxes for which the debtor filed a fraudulent return or willfully attempted to evade or defeat the tax. It is not always clear what constitutes a willful attempt to evade or defeat taxes under 11 U.S.C. § 523(a)(1)(C).

5.       Fraud Restrictions. To judge actions as fraudulent, the Service must consider the following strictures:

A.      A preponderance of the evidence must be able to prove willful evasion.

B.      Failure to file and pay taxes is usually not enough to demonstrate fraud. But the Service holds a debtor's voluntary, conscious, and intentional failure to file returns for an extended period of time, and a failure to pay taxes when the debtor had the ability to do so, qualifies as willful evasion under B. C. § 523(a)(1)(C).

C.      Some courts require the Service to prove some affirmative misconduct, such as the debtor concealed or fraudulently transferred assets.

Caution:

Insolvency must obtain written approval from Counsel before beginning collection actions for taxes non-discharged on the grounds of fraud.

25.17.2.9.1.1  (09-01-2004)
Collection from Exempt Property after Discharge

1.       Exemptions. Pursuant to 11 U.S.C. § 522(b), an individual debtor may choose to exempt certain property from the bankruptcy estate. The debtor may elect to follow state exemptions or the federal exemptions listed in 11 U.S.C. § 522(d).

2.       Property of the Estate. Some of the debtor's property may be excluded from the estate under 11 U.S.C. § 541.

3.       Pension Plans. Pension plans with enforceable anti-alienationprovisions are not property of the estate. 11 U.S.C. § 541(c)(2). An anti-alienation provision is a clause put into the pension plan that restricts the ability of the employee to transfer ownership of the funds in the plan. If a pension plan is excluded from the bankruptcy estate under § 541(c)(2) because it contains an enforceable anti-alienation provision, the Service will not include the value of the debtor's interest in such a plan in its secured claim. The Service's lien continues to exist outside of bankruptcy and can be considered in collecting discharged taxes if a valid Notice of Federal Tax Lien was filed prepetition.

Caution:

If questions arise as to whether a particular pension plan should be included or excluded from property of the estate, Counsel's guidance should be sought.

4.       Valid Federal Tax Lien — Survives Bankruptcy Discharge. If the Service has properly filed a prepetition Notice of Federal Tax Lien – and the lien is still valid (e.g., refiled correctly, if applicable) – the lien survives the bankruptcy discharge. 11 U.S.C. § 522(C)(2)(B). Thus, the Service may collect discharged taxes from property that is either exempt from the estate, excluded from the estate, or abandoned by the trustee.

Caution:

The Service must follow normal collection procedures while ensuring the provisions of the Bankruptcy Code are not violated.

25.17.2.9.1.2  (09-01-2004)
A Valid Tax Return

1.       A Valid Tax Return for Discharge Purposes. The Bankruptcy Code does not define a "valid" tax return. Courts generally hold for a document to qualify as a return, it must:

A.      purport to be a return;

B.      be executed under penalty of perjury;

C.      contain sufficient data to allow calculation of tax; and

D.      represent an honest and reasonable attempt to satisfy the requirements of the tax law.

2.       Invalid Returns. Following the above criteria, under 11 U.S.C. § 523, a blank return is not a valid return, nor is a Substitute for Return (SFR) prepared by the Service without the taxpayer's signature.

Note:

However, an SFR prepared by the Service with the taxpayer's signature is generally considered to be a valid return for discharge purposes.