Teaching tax procedure often involves explaining that someone with a dispute has three choices – Tax Court, District Court or the Court of Federal Claims. Often forgotten in the discussion of forum choices lies the role of bankruptcy courts in determining federal tax disputes. A recent bankruptcy court decision gives the opportunity to talk about when a bankruptcy court should and should not decide a federal tax dispute.
Mr. Perry filed a chapter 7 no asset case. The vast majority of chapter 7 cases are no asset cases. A no-asset case does not mean that the debtor has no assets at all. Rather, it means that the debtor has no assets for the trustee to distribute. A typical debtor filing a chapter 7 no asset case might have a house or a car which have liens against them equal to or greater than the value of the assets. Such a debtor would generally have clothes, furniture, appliances, etc. but these assets, even if unencumbered would come with the exempt property provisions of BC 522. The debtor might also have a pension plan with value that was excluded from the estate. No matter how the liens, exemptions, or exclusions lined up, the bottom line for a no-asset case is that the trustee represents the unsecured creditors and can locate no assets of the debtor available to the bankruptcy estate to satisfy the debts of the unsecured creditors.
Mr. Perry owed federal taxes. He filed a discharge hearing with respect to the taxes and lost. He decided that if he could not discharge them he would like to use the opportunity available to those in bankruptcy to contest the underlying liability for those taxes in bankruptcy court rather than in Tax Court, District Court or the Court of Federal Claims. BC 505(a)(1) generally allows this to happen but does not provide a completely open door to contest the taxes even for those in bankruptcy. The critical part of the language of that section is the word “may.” That would give the bankruptcy judges the option to hear or not to hear a tax merits contest. The issue then becomes when should the bankruptcy judge hear such a contest and when should the judge walk away.
While taxpayers have the three non-bankruptcy forums for contesting tax liabilities mentioned above, the apparent choices in where to litigate a tax matter can turn out more illusory than real. If a taxpayer has allowed the tax to get assessed, the door to the Tax Court generally closes. It may be cracked open to a limited extent through the collection due process procedures but generally a taxpayer with an assessed liability has the limited option of District Court or the Court of Federal Claims. That option gets limited further by the Flora rule which requires full payment of the tax before bringing an action in those courts. So, a taxpayer with an assessed liability that they cannot pay may have no options for litigation of the underlying tax liability unless the bankruptcy option opens up. This confluence of factors can make contesting the merits of a liability in bankruptcy court quite attractive for the person otherwise locked out of a forum in which to litigate.
I suspect that Mr. Perry may have found himself in that position although the opinion does not make that clear. If he were, he would not be the first. Perhaps the first case in which a bankruptcy court was asked to allow the contest on the merits of the liability in a chapter 7 no asset case was Diez. In that case, Mrs. Diez had a very large liability and she had missed the opportunity to go to Tax Court. She filed bankruptcy for the purpose of contesting the tax liability and the bankruptcy court abstained. The judge in Diez and in most subsequent cases involving chapter 7 no asset cases have abstained because the tax litigation has no bearing on the bankruptcy case.
BC 505(a) sits in the bankruptcy code for the purpose of allowing the quick resolution of bankruptcy cases and not for the purpose of creating a fourth forum for tax merits litigation. The writers of the bankruptcy code knew that tax cases sometimes took a long time to resolve but that bankruptcy cases needed resolution so that a decision on reorganization or distribution could occur. In cases necessitating a quick decision, BC 505 allows the bankruptcy court to step in and decide the tax issue. No-asset chapter 7 cases do not necessitate a quick decision for reorganization or distribution of assets or for any reason. This is because the bankruptcy court does nothing (this is an exaggeration but may not be far from the truth in some cases) other than granting the debtor a discharge.
In a no-asset chapter 7 case neither the creditors nor the trustee care about how much taxes the debtor owes. The tax liabilities are a non-event for bankruptcy purposes. Certainly, the debtor cares but does the post discharge concern of the debtor extend to cause the bankruptcy court to assert its jurisdiction over the merits (not the dischargability) of the debtor’s tax liability.
In Perry, the bankruptcy court examined the circumstances of his case as well as the prevailing case law before determining that it should not reach the merits of his tax liability. I think the court correctly decides to abstain. The case offers a good, yet succinct, discussion of the case law on both sides of this issue. Persons with tax disputes should take note of the opportunity to litigate the dispute in bankruptcy court if that opportunity exists. Some good reasons might make the bankruptcy court the forum of choice in those situations in which it is available. Generally, it will not be available in no asset cases and Perry follows an almost unbroken line of cases making that determination.