Bankruptcy

Bankruptcy

June 01, 2004

Bankruptcy did not discharge taxes owed to the United States.

The US government has the right in certain circumstances to go after anyone who is transferred assets by a company for income taxes that are owed by the company. This is called “transferee liability.” It exists when a company liquidates and distributes all of its assets to its owners. It also exists when a company that is insolvent at the time distributes just some of its assets to its owners while the company remains in business. In such cases, the US government can pursue the owners for income taxes that the company should have paid.

The owners cannot escape this tax liability by filing for bankruptcy, a US appeals court said in May.

The US bankruptcy laws generally allow someone going through bankruptcy a fresh start; he gets to shed his debts and start over. However, this does not apply to income taxes. Such taxes are not discharged in a bankruptcy proceeding.

The case in May involved an individual who was the sole owner of a corporation. The corporation liquidated in 1987 and distributed all of its assets to its owner. The owner filed for bankruptcy in 1995 and was discharged from all of his debts. However, it later came out that the corporation had failed to file an income tax return for 1987, and it owed $481,180 in taxes that year. The IRS pursued the owner for the taxes. A bankruptcy court said the IRS was out of luck, since its claim against the owner was not a “tax” but rather a general unsecured debt. The only “tax” was owed by the corporation; its claim against someone else for the amount was just a general debt.

However, a US appeals court said in May that while the bankruptcy court may have been right technically, its decision made no sense as a policy matter.

The court said transferee liability for taxes should be treated as a “tax” for purposes of what gets discharged in bankruptcy. The case is McKowen v. IRS.

Keith Martin