Income Tax Claims in the Year of Bankruptcy: A Congressionally Created Quagmire


How is the government's claim for income taxes incurred by a debtor in the year of bankruptcy treated? Is the government's tax claim entitled to priority as a first priority expense of administration, even though part of the year's taxes was incurred prepetition? If not, is the claim entitled to eighth priority under its special rule for tax claims? The courts did not reach consistent results on these questions prior to the 2005 Act. The courts agreed that the government's claim for pre-petition taxes should not be entitled to administrative expense priority, but differed on whether the claim was entitled to eighth priority (and hence excepted from discharge under a special rule) or whether the claim was simply a personal obligation of the debtor that passed through bankruptcy unimpaired rather than a bankruptcy "claim." This paper exposes the inconsistent legal theories and faulty analysis used by the courts in attempting to achieve rational results from a seriously flawed statutory procedure.

The 2005 Bankruptcy Act, which goes into effect for most purposes on October 17, 2005, has eliminated the eighth priority safe habor that many courts relied upon to achieve a rational result. Now, the courts will be forced to decide whether to use faulty reasoning to grant administrative expense priority, whether to use faulty reasoning to avoid treating the debtor's tax obligation as a bankruptcy "claim," or whether to recognize that the new rule should properly result in subordinating the government's claim to general unsecured status, which would render the claim dischargeable.

With nearly two million bankruptcy cases filed each year, nearly all of which involve some year-of-bankruptcy tax liabilities, these are important questions involving large numbers of people and large sums of money. This article should serve as a guide through the complex maze of bankruptcy tax jurisprudence to judges and practitioners attempting to answer these questions. I hope it also serves as a manifest to Congress on the need to revise the statutory rules.


Bankruptcy Law | Commercial Law | Tax Law

Date of this Version

September 2005