Tax Litigation in Bankruptcy

In this post, we are going to divert our attention to another forum for tax litigation that is available to both individuals and companies in bankruptcy.

The U.S. bankruptcy court system

U.S. bankruptcy courts are separate units of district courts, and bankruptcy court judges serve limited terms. Per 28 U.S. Code 1334, bankruptcy courts have exclusive jurisdiction over cases falling under the Bankruptcy Code. All cases in bankruptcy court are heard by one judge. There is ample opportunity for formal and informal discovery, and for presenting witnesses. There are no jury trials.

Disputing tax liability in bankruptcy court

Under 11 U.S. Code 505, bankruptcy courts have jurisdiction (with limited restrictions) to determine the amount or legality of any tax, any fine or penalty relating to a tax, or any addition to a tax whether or not it has already been assessed or paid, and whether or not it has been previously contested and adjudicated. Bankruptcy courts decide tax disputes for Chapter 7, Chapter 11, or Chapter 13 filers with regard to both federal and state taxes, including, but not limited to:

  •  The validity or amount of IRS deficiency claims
  • The validity of IRS tax liens
  • The right to discharge federal tax debt

A bankruptcy court may order the IRS to issue a refund — as in Tax Court, taxpayers need not prepay a proposed tax liability. 11 U.S. Code 505(a)(1). This is a major factor in the increasing number of tax cases being heard in this venue. Note that some pre- or partial-payment actions are heard by bankruptcy courts and bankruptcy courts also handle refund litigation.

Restrictions to Bankruptcy Court jurisdiction

Bankruptcy Court only has jurisdiction to determine the amount and legality of a tax claim if: (1) the bankruptcy trustee has properly requested a government refund, and (2) the government has either made its determination or 120 days have elapsed (11 U.S. Code 505(a)(2) and 26 U.S. Code 6532(a)(5)).

Legal Representation

Taxpayers should keep in mind that in addition to their bankruptcy attorney, they should retain a tax attorney to assist them in litigating their tax dispute, regardless of the venue.

The final blog in this series will cover appeals of trial court decisions.

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