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11050-11053 Collection After Discharge

11050. CONCEPT OVERVIEW
Taxes that meet the requirements of Bankruptcy Code section 523(a)(1) are non-dischargeable in bankruptcy and include:

1) Taxes determined to have priority status as defined in Bankruptcy Code section 507(a)(8); i.e., pre-petition unsecured taxes;

2) Taxes determined to be post-petition administrative taxes within the meaning of Bankruptcy Code section 507(a)(2) and section 503(b)(1)(B);

3) Taxes assessed in the absence of a legally required tax return; and

4) Taxes assessed because of a fraudulent return or because the debtor acted willfully to evade the tax. 

When an individual debtor receives a discharge in bankruptcy, the automatic stay against enforced collection action against the debtor is terminated for any non-dischargeable debts, if there are no assets in the estate to pay the taxes.

In these cases, the tax collector should rely on the bankruptcy estate to pay the priority taxes if there are sufficient funds. If there are no assets in the bankruptcy estate, collection enforcement procedures may be pursued against the individual. Payment cannot be obtained from both sources. Under the new bankruptcy code, discharged debtors have been able to exempt considerable assets. However, such debtors may be employed and subject to wage garnishment or may have a bank account subject to seizure. Collections should not be written off just because an individual has filed bankruptcy. 

NOTE: Before using enforced collection procedures after a discharge in bankruptcy, the tax collector should ensure that the tax became delinquent within one year before the filing of the petition in bankruptcy, so it qualifies as a non-dischargeable debt. It is apparent that an aggressive collection effort is required for the first year after delinquency in order to reduce the amount of unrecoverable taxes due to a subsequent bankruptcy.

11051. STATUS OF UNSECURED TAX LIENS
Collections on unsecured tax liens filed before the filing of the bankruptcy petition are not precluded by a discharge in bankruptcy, even though the taxes were more than one year delinquent when the petition was filed (Verran v. U.S. Treasury Department (1980) 623 F. 2d 477). In other words, a discharge in bankruptcy does not release or affect a tax lien, and the lien should not be released just because the taxes were discharged in bankruptcy. See Sales Free and Clear of Liens, M-11052.

11052. SALES FREE AND CLEAR OF LIENS
Since several 1987 cases, trustees in Chapter 7 proceedings and debtors in Chapter 11 proceedings are no longer abandoning real property just because the liens exceed the value of the property (see In re Sherrell (1987) 78 B.R. 804 and In re K.C. Machine and Tool Co. (1987) 816 F. 2d 238).

Trustees often hold onto the real property and sell the property free and clear of liens under Bankruptcy Code section 363 (f). Usually, trustees pay the secured (non-tax) liens, then pay their own and their attorney's administrative expenses plus other administrative expenses, and then the eight priorities under Bankruptcy Code section 507. They consider this process "stepping into the shoes of the tax collector."

As to unsecured taxes, the law is clear that the trustees may do this, unless there is a valid objection to the motion to sell free and clear of liens. However, there is some opposition to the trustee loading down the estate with attorney's fees where few creditors benefit from such sales. See the dissent in K.C. Machine and Tool Co., supra. 

Regarding secured taxes, there is still a legal question as to whether Pearlstein v. Small Business Administration, 719 F. 2d 1169, mandates payment of secured taxes ahead of secured creditors' claims and the trustee's administrative expenses in sales free and clear of liens, or whether the secured tax liens are to be paid after the trustee's administrative expenses and the eight priorities under Bankruptcy Code section 507.

Upon the sale free and clear of the liens, the lien is transferred to the proceeds of the sale. Most title companies require the secured taxes to be paid upon sale, although some are now recognizing the bankruptcy court order to sell free and clear of liens. Therefore, the failure to object to a sale free and clear of liens could result in non-payment of pre-petition secured taxes in special cases, depending on the trustee's and the court's view as to the priority of the secured taxes and the amount of administrative expenses.

11053. OBJECTIONS TO SALES FREE AND CLEAR OF LIENS
To sell property free and clear of liens, the debtor or trustee must have an interest in the property, or there must be unsecured administrative expense creditors. In addition, one of the five requirements of Bankruptcy Code section 363(f) must be met. Bankruptcy Code section 363(f)(4) requires the dispute to involve the validity of the lien, not the priority or amount (Matter of Strand Wholesale, Inc. (1985) 47 B.R. 999). Bankruptcy Code section 363(f)(5) requires a creditor to receive the full amount of his/her lien, unless there are special equitable circumstances (In re Wing (1986) 63 B.R.).