TAX DISCHARGEABILITY RULES
General Discharge Rules for Income taxes:
- The tax return was due, including extensions, more than three years before the bankruptcy filing, §§ 507(a)(8)(A)(I) and 523(a)(1)(A). Also, consider tolling events;
- A tax return was filed more than two years before the bankruptcy filing, § 523(a)(l)(B);
- The tax was assessed more than 240 days before the petition date, §§ 507(a)(8)(A)(ii) and 523(a)(1)(A). Also consider any tolling events; and,
- The return was not fraudulent, § 523(a)(1));
- The taxpayer did not willfully attempt to evade the tax, § 523(a)(1)).
Sales Taxes: (Excise tax vs. Trust Fund Sales Tax vs. Tax on Gross Sales)
Need to determine if the tax is excise tax or pure sales tax. If the sales tax is a pure sales tax, most courts hold that it is a nondischargeable trust fund tax. But, an excise tax which is a tax charged to the seller for the privilege of doing business would be dischargeable if the tax event or the tax return related to the event arose more than three years prior to the filing of the bankruptcy. § 507(a)(8)(E)
California courts were not clear on whether the tax is excise tax, Trust Fund pure sales tax or Tax on Gross Sales until Ilko v. California State Board of Equalization, 2011 651 F.3d 1049 (9th Cir, 2011).
Daniel Ilko established a corporation named EAS, Inc. to operate a used car business. EAS operated from May 1, 1993, through March 31, 2003. EAS was audited for tax periods 10/1/1993 through 9/30/1996, taxes were assessed on June 20, 1997.
Daniel Ilko filed personal bankruptcy on July 3, 2001, and discharge was granted on October 3, 2001.
November 10, 2005, BOE issued a dual determination under Section 6829 for all the taxes that the corporation owed. Taxpayer argued that taxes were discharged because more than 3 years had passed since the audit period. Court rules that under Section 6829 Dual Determination Rule liability cannot rise until the corporation terminates, dissolves or abandons business. BOE has under Section 6487 either 3 years or 8 years (if no returns were filed) to assess against the individual. (Government may choose not to assess even if return was filed). In Ilko taxes were not discharged because of the following reasons: 1) BOE did not assess taxes prior to bankruptcy filing; 2) No returns were filed therefore 2 year rule never triggered; 3) Possible 3 year rule violation because 6829 return would be due upon termination of the corporation.
Bankruptcy Court also clarified and defined sales
tax in California. Sales tax in California per Ilko court can be classified as both tax on gross receipts and as excise tax. Further, excise taxes can be classified as either customer-trust fund (ie tax is incurred by customer to be held in trust for the BOE by the retailer) or excise tax on a retailer (ie tax is incurred by retailer and collected by retailer). Bankruptcy court chose the latter definition for California sales tax but alluded that traditionally excise tax only applies to commodities like motor fuel, tobacco and alcohol and not income based. Taxpayer after Ilko ruling has to differentiate the type of excise tax that were incurred then determine whether the tax was income based or not.
Discharging Dual Determination Sales Tax requires the following bankruptcy strategy:
- Establish a clear date of termination, dissolution or abandonment of business;
BOE requires a responsible person to file a separate return in his or her own name for the section 6829 liability. After filing applicable 6829 return, the limitation period for issuing a determination under section 6829 is three years from the last day of the month following the quarter of termination or three years from the filing of the return, whichever is later. If 6829 return is not filed, the limitation period for issuing a determination under section 6829 is eight years from the last day of the month following the quarter of termination.
Taxpayer can litigate any issues pertaining to the tax liability in the bankruptcy court including any arguments raised through the appeals process.
Employment Tax (IRS and EDD)
Payroll withholding taxes are not dischargeable. However, certain employer portions of the trust fund taxes may be dischargeable if the dischargeability rules stated above are met.
Designation of responsible officer and thus personally liable for the 100% penalty for trust fund taxes can be determined by the bankruptcy court.