Squeezing Blood From Turnips: Tax Issues in Bankruptcy Matters

12/11/2001

Introduction

Dealing with taxes in a bankruptcy case requires both the court and the debtor’s attorney to consider the prevailing, yet conflicting, public policy objectives.  First, because the collection of taxes is essential for the orderly operation of the government and the preservation of governmental services, Congress has provided taxing authorities with broad collection powers (i.e., liens, priorities, and civil and criminal penalties).  Bankruptcy, on the other hand, seeks to provide a debtor with a fresh start and an opportunity for financial rehabilitation.  This bankruptcy policy cannot be completely accomplished if the debtor is not provided some degree of relief from tax liability.  Furthermore, many times relief from tax liabilities can lead to the successful rehabilitation of a debtor, which ultimately results in the realization of greater tax revenue than would have been generated if the debtor was forced to face insurmountable past tax liabilities.
 
Given the tension that exists between these two policies, the statutory and case law addressing the interrelationship of taxes and bankruptcy is extremely confusing.  Consequently, in many bankruptcy cases, the tax aspects of a debtor’s financial situation are often addressed improperly and sometimes even ignored by bankruptcy counsel.  However, bankruptcy and tax practitioners should always be aware that bankruptcy often allows a debtor to “level the playing field” with taxing authorities, inasmuch as the extraordinary remedies available to taxing authorities are somewhat diminished when they are forced to collect tax debts within the confines of the Bankruptcy Code.

In order to comply with certain U.S. Treasury regulations, we are informing you that any U.S. federal tax advice that may be contained in this document is not intended or written to be used, and cannot be used, by any person for the purpose of (i) avoiding any tax penalties that may be imposed by the Internal Revenue Service or any other U.S. federal taxing authority or agency or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

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