One of the benefits of bankruptcy is that it provides some certainty as to what is owed. If successful, the bankruptcy process can provide debtors with a fresh start. But things get complicated when taxes are involved. The recent Breland v. Commissioner, 152 T.C. 9 (2019), case provides an example whereby the IRS was allowed to assess additional taxes for tax years that were subject to a prior bankruptcy.
Facts & Procedural History
The taxpayer is a business that filed Chapter 11 bankruptcy in 2009. The IRS filed claims for the 2004-2008 tax years. The IRS agreed to the plan of reorganization, which would result in some of the unpaid taxes that it was aware of being treated as unsecured claims.
The taxpayer challenged the assessment of tax penalties, which resulted in the IRS conducting additional discovery. During the discovery process, the IRS learned of information that led it to believe that additional tax was due.
While the bankruptcy case was pending, the IRS issued notices of deficiency for the 2004-2008 tax years. The taxpayer filed a petition with the U.S. Tax Court in response to the notice of deficiencies.
The question for the court was whether the IRS could pursue the 2004-2008 taxes given that the bankruptcy plan of reorganization disposed of the taxes.
Chapter 11 Bankruptcy
Chapter 11 bankruptcy is for businesses. It can allow the business to remain in operations and to restructure. While it is often used by the largest Fortune 500 companies, it is also used by smaller taxpayers.
Chapter 11 allows the business to avoid some of its debts while restructuring others. It does this by obtaining a plan of reorganization. If accepted by the court, then the bankruptcy can proceed and may lead to the discharge of debts–including unsecured tax debts.
Collateral estoppel is a phrase that describes a defense that prevents a party from re-litigating an issue. This provides finality to court proceedings.
Collateral estoppel applies if:
- the issue in the second suit is identical in all respects with the one decided in the first suit,
- there is a final judgment rendered by a court of competent jurisdiction,
- the party against whom collateral estoppel is invoked was a party (or privy to a party) to the prior judgment,
- the relevant issue was actually litigated and the resolution of the issue must have been essential to the prior decision, and
- controlling facts and applicable legal rules must remain unchanged from those in the prior litigation.
If these elements are met, the debtor is precluded from re-litigating the issue again.
Taxes & the Bankruptcy Plan of Reorganization
This brings us to the present case. The question was whether the IRS was collaterally estopped from bringing suit for the 2004-2008 tax liabilities when the bankruptcy court had already approved a plan of reorganization for the taxes.
The court considered McQuade v. Commissioner, 84 T.C. 137, 146 (1985). McQuade is the leading case on collateral estoppel for taxes in the bankruptcy context.
In McQuade, the bankruptcy court held a trial on the tax liabilities for the years at issue and entered findings of fact and conclusions of law determining that the taxpayer had no tax liabilities. The case stands for the proposition that the bankruptcy court decision was final as the creditor is collaterally estopped from re-litigating the dischargability of their debt.
In the present case, the court distinguished the facts from those in McQuade. Specifically, the court noted that the bankruptcy court did not have a trial or enter findings of fact. Rather, the court merely approved the reorganization plan that the parties had agreed to.
Given that the bankruptcy court did not finally determine the taxes, the court concludes that the IRS is not precluded from re-litigating 2004-2008 tax liabilities. This holding should concern those who have or are pursuing Chapter 11 bankruptcy. Chapter 11 bankruptcy may not provide finality for debts–such as unpaid taxes–that one would think bankruptcy would provide.