Part 4. Examining Process
Chapter 27. Bankruptcy
Section 1. Bankruptcy Petitions
This section provides an introduction to bankruptcy and how petitions are handled.
Individuals, partnerships, corporations, and limited liability companies may file for debt relief by filing a bankruptcy petition with the Bankruptcy Court. Bankruptcy laws, enacted by Congress, began with the Bankruptcy Act of 1800. Currently, the bankruptcy code, with amendments, can be found at Title 11 of the U.S. Code. The Bankruptcy Reform Act of 1994 (BRA 94) brought about major changes to the code affecting debtor treatment. Most recently, the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) was signed into law on April 20, 2005. For additional information about federal bankruptcy laws, refer to IRM 220.127.116.11, Federal Bankruptcy Law. Bankruptcy law has three primary objectives:
To relieve debtors from pre-bankruptcy financial burdens (where there are insufficient assets to satisfy debts owed to creditors);
To rehabilitate debtors and give them a "fresh start" by allowing them to retain assets necessary for subsistence which are exempt from creditors reach; and
To protect creditors by establishing an orderly and equitable system of satisfying their claims out of existing assets and/or future income and earnings.
The Bankruptcy Act of 1800 will not be covered in this section because there are very few, if any, of these cases still active.
The Bankruptcy Code combined with BRA 94 and BAPCPA provides the laws under which bankruptcy proceedings are commenced, administered, and closed. There are six types of bankruptcies which can be filed, Chapters 7, 9, 11, 12, 13 and 15. Refer to IRM 18.104.22.168, Chapters in Bankruptcy, for definitions of each bankruptcy chapter.
When a taxpayer advises they have filed for bankruptcy or if you suspect this may be the case, contact your Examination Bankruptcy Coordinator in Technical Services.
To find your Examination Bankruptcy Coordinator in Technical Services, look to the Technical Services Program Assignment Directory in the Exam section of the SBSE Website at http://sbse.web.irs.gov/compliance/About/directories/TechServProgAssign.asp .
A check of TXMODA or IMFOLT for individuals and BMFOLT for partnerships and corporations may reflect a TC 520, closing code 60, 61, 62, 63, 64, 65, 66, 67, 81, 83, 84, 85, 86, 87, 88, or 89. See IRM 22.214.171.124.1, Closing Codes. AMDISA should reflect an "X" freeze for petitions filed after October 21, 1994, and an "U" freeze for petitions filed before October 22, 1994. You may simply see the word "bankruptcy" reflected on the AMDISA print. If you do not see these indicators, advise your Examination Bankruptcy Coordinator in Technical Services.
It is imperative that examiners contact Insolvency as soon as they are aware that a taxpayer under examination has filed for bankruptcy. Insolvency needs to advise Bankruptcy Court by a specific date, known as the bar date, of all IRS tax debt of a taxpayer. You will need to provide to Insolvency any potential deficiencies, penalties, and interest. Provide Insolvency with a copy of the report of adjustments if requested. Estimate any amounts if you have not completed the examination. Refer to IRM 126.96.36.199(2), Proof of Claim. If you later change the amounts, provide a revised report to Insolvency. Advise Insolvency when you close the case and how it is being closed (no-change, agreed, forwarded to Appeals or to Technical Services for issuance of deficiency).
Examiners must consider collectibility during the pre-planning phase and throughout the examination. Refer to IRM 4.20, Examination Collectibility. If you decide to survey the return, please advise Insolvency.
Procedures outlined in this IRM apply to all bankruptcy cases commenced after September 30, 1979, the effective date of the Bankruptcy Reform Act of 1978. The impact of revisions to the Code made by the Bankruptcy Tax Act of 1980 and by the Bankruptcy Reform Act of 1994, and Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 are also included.
In order to better comprehend bankruptcy law and effectively examine bankruptcy cases, familiarity with bankruptcy terminology is essential. See IRM Exhibit 5.9.1–1, Glossary of Common Insolvency Terms, for common bankruptcy definitions and concepts. For commonly used acronyms, refer to IRM Exhibit 5.9.1-2, Acronyms.
Examiners should contact their Associate Area Counsel for case specific legal advice and guidance. For more information about the role of Counsel, refer to IRM 188.8.131.52.1, Associate Area Counsel.
Examination will promptly inform Associate Area Counsel and Insolvency when:
A case meets referral criteria for significant bankruptcy case processing procedures;
Litigation is brought against the IRS in the bankruptcy proceedings, such as when an objection to proof of claim is filed;
Contemplating assertion of taxpayer’s tax liabilities against a transferee of the taxpayer’s assets;
Receiving an administrative offer in compromise (OIC) based on doubt as to liability. As a rule, the IRS will not consider an OIC from a taxpayer in bankruptcy; however, we may work with the taxpayer outside of the context of an administrative offer in compromise when it is in the best interest of the IRS and the taxpayer to do so. See IRM 184.108.40.206, Offers in Compromise and Bankruptcy; or
Assets transferred outside of the ordinary course of business within 90 days before filing of the bankruptcy petition or within 1 year to an insider.
It is the responsibility of Examination to promptly respond to all requests from both Area Counsel and Insolvency with any supporting data, documents, or other examination information from the administrative file. Examination should be aware of and comply with the deadlines and requirements imposed by the Bankruptcy Court that affect the examination process.
Examiners who suspect bankruptcy fraud should contact their fraud technical advisor for assistance and guidance. Refer to IRM 220.127.116.11.2, Fraud Technical Advisor. Fraud indicators are listed in IRM 18.104.22.168.3, Fraud Indicators.
All cases which meet the referral criteria listed in IRM 22.214.171.124.3, Referrals on Significant Bankruptcy Case Issues, should be immediately referred to Associate Area Counsel. This is for the purpose of permitting identification of those cases that may require coordination on a more expedited or more extensive basis. The referral criteria should be applied to all taxable years of the taxpayer that have ended prior to the petition date and any known tax transactions that have occurred in the current year but prior to the petition date. It is not mandatory that every tax year be opened and included in the examination. Normal examination criteria should be used to determine which tax year will be included in the audit.
The following types of cases should be referred to Area Counsel immediately:
Coordinated Industry Cases (CIC);
All corporate taxpayers for which an Industry Technical Advisor (TA) issue is present;
All cases in which technical advice or ruling requests are pending, including requests for change of method of accounting if the outcome of the request has a significant tax impact on the taxpayer or on the taxpayer’s industry;
All cases for which the aggregate potential tax liability, excluding interest and penalties, will exceed $1 million;
All cases in which the outstanding assessed liability exceeds $10 million;
All cases involving taxpayers with assets of $50 million or more:
For debtors of this size which reorganize, being able to determine the tax attributes that survive bankruptcy may become critically important to the debtors and/or the Service.
For debtors of this size which liquidate all or a substantial portion of their assets in bankruptcy, the Service will often need to be able to predict on an expedited basis whether the debtors will recognize substantial current year income and, the resulting regular or alternative minimum tax (even if the debtors historically have not paid income taxes due to their net operating losses);
All cases with potential tax liabilities for which there may be significant publicity;
All cases for which criminal tax prosecution is being considered or is pending;
Present or previously consolidated subsidiaries that file for bankruptcy for which the parent and/or sibling entities fall within the above criteria;
Cases raising substantive tax issues such as:
(1) Difficult or significant post-confirmation tax issues in either the disclosure statement or the plan of reorganization: Examples of these cases include reorganization plans that may provide for the creation of a separate post-confirmation tax entity (such as a liquidating trust or qualified settlement fund) or where the debtor may be seeking to fix the tax consequences of its plan or the amounts of its future tax attributes.
(2) Cases involving either taxpayers or entities within the taxpayers' controlled group, that raise pension excise tax or other ERISA issues. Factual situations that may warrant immediate factual inquiry by the Service include cases where the Pension Benefit Guaranty Corporation (PBGC) is identified as one of the debtor's 20 largest unsecured creditors, where the PBGC is a member of the unsecured creditors' committee, or where the debtor's or a controlled group member's pension plan(s) has recently been or will be terminated.
(3) See Exhibit 4.27.1-1, Substantive Tax Issue Bankruptcy Checklist.
Special care must be taken when only part of a consolidated corporate taxpayer files for protection under the reorganization provisions of the Bankruptcy Code. Members of the group are severally liable; therefore, referral should be based on an analysis of the consolidated corporate taxpayer and not just the debtor company.
The identification of particular taxpayers using the referral criteria is not intended to make these cases subject to mandatory examinations. However, Examination should give due consideration to the views of Counsel about whether to survey or audit the taxpayer and should consider the finality of a decision not to survey or audit a taxpayer’s recent tax years before the claims bar date.
The employee responsible for the case at the time the bankruptcy proceeding is identified will prepare the referral, and forward it to Associate Area Counsel through the Examination Bankruptcy Coordinator in Technical Services, as soon as one or more of the above criteria are found to be present. The referral should be in writing, such as a memorandum, and labeled "Significant Corporate Bankruptcy Referral."
The Examination Bankruptcy Coordinator in Technical Services will ensure that the referral is forwarded to the Associate Area Counsel, with a copy sent to Insolvency, in order for a timely proof of claim to be filed with the Bankruptcy Court.
Within three days, Counsel will provide Examination with a written response as to whether the facts and circumstances warrant expedited examination procedures.
Upon receipt of a referral, a determination will be made as to which Counsel office and which attorney(s) will be selected as coordinators for the issues of the debtor taxpayer.
Counsel will also provide oral and written advice as to whether issuance of a statutory notice of deficiency will be authorized.
Counsel will establish a liaison with Department of Justice (DOJ) attorneys who have responsibility for the case.
If Counsel confirms that a case warrants expedited examination procedures, a meeting will be held with all Service personnel involved in the case to review Counsel’s written response, discuss the case, and establish an action plan.
The meeting will be coordinated by the Examination Bankruptcy Coordinator in Technical Services and should include representatives from Insolvency (for further information regarding claim bar dates, filing proofs of claims, and other bankruptcy procedures) and from Tax Exempt and Government Entities (if pension plan problems are known to exist or may be indicated by the debtor’s schedules). Consideration should also be given to inviting DOJ attorneys who have responsibility for the bankruptcy case. The plan should set forth the actions to be taken by Counsel and each affected function of the Area office, with copies given to each party. Monthly updates should be made.
At the meeting, it should be established which area will control particular aspects of the case. With CEP cases, the area where the CEP examination is controlled will probably also control claim assertion and claim defense strategies. Each case will be handled by the "team approach." All tax years included in the examination are to be viewed as a single unit.
All settlements of tax years or specific issues should be reviewed by the Counsel attorneys handling the case to assess the impact of the settlement on all open tax years.
The debtor should be informed of the coordinated effort and the urgency needed to expedite years under examination. The notification should be in writing and an acknowledged copy should become part of the audit file.
To ensure expedited technical advice from the Headquarters Office, copies of all requests must be sent in addition to the appropriate function, to the Special Agent in Charge (SAC) (Field Service) and to the Special Agent in Charge (SAC) (General Litigation) for coordination.
All contact with the taxpayer should be documented. This is especially important when assessing taxpayer’s timely response and good faith cooperation with respect to information document requests.
If in the course of the examination, issues are addressed which have a tax effect on subsequent year returns, copies of Form 906, Closing Agreement on Final Determination Covering Specific Matters, or other agreements and relevant workpapers should be sent by the examiner or Appeals Officer to the Area PSP Manager before the case is closed. This information should be processed using Form 5346, Examination Information Report. Any future audit issues identified by Counsel should be similarly processed through the Area PSP Manager, and followed-up by an appropriate survey and/or audit of the former debtor’s future tax year returns when filed.
The Examination Bankruptcy Coordinator in Technical Services will review DOJ bankruptcy referrals.
If the Examination Bankruptcy Coordinator determines an examination is not warranted, they will advise DOJ of their decision.
If the Examination Bankruptcy Coordinator determines an examination may be warranted, they will make a referral to PSP. The referral will be made using Form 3449, Referral Report, and notate the bar date or any other response date needed at the top of the form.
Technical Services will advise DOJ of PSP's decision.
The filing of a bankruptcy petition under any chapter creates a bankruptcy estate. However, for purposes of federal tax liability, only an individual Chapter 7 or 11 bankruptcy estate creates a separate taxable entity. The trustee or debtor-in-possession (DIP) of an individual bankruptcy estate is required to file tax returns and to pay any tax which may be due if the estate has gross income that meets or exceeds the amount required for filing (IRC section 1398(c)). This amount is the total of the personal exemption amount and the basic standard deduction for a married individual filing separately. The trustee or DIP must obtain a taxpayer identification number for the estate. The filing of a tax return for the bankruptcy estate does not relieve the individual debtor of his or her tax filing requirement.
No separate taxable entity shall result from the commencement of a bankruptcy case involving a partnership or corporation. See IRC section 1398, IRC section 1399, IRC section 6012(b)(3), and 11 USC section 362 for applicable law.
Certain tax attributes of the estate must be reduced by any excluded income from cancellation of debt occurring in a bankruptcy proceeding. The amount of debt cancellation (debt discharged) and the amount to be offset against the estate’s tax attributes are shown by filing Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (also, IRC section 1082, Basis of Adjustment,) in the year of discharge. This form should be attached to the tax return of the bankruptcy estate. Tax attributes remaining under IRC section 1398(i) at the time the case is closed by the Bankruptcy Court revert to the debtor in that year. It may be several years after the discharge date depending on the complexity of the case. The tax attributes are not available for the taxpayer’s use during this period prior to the close of the case. For additional information concerning passive activity losses, credits, and at risk amounts, see Treas. Reg. section 1.1398–1 and Treas. Reg. section 1.1398–2.
There are special rules for the deductibility of administrative expenses of the bankruptcy estate, allowance of net operating losses, and carryback of tax attributes arising in post-petition taxable years. See IRC section 1398 and Notice 2006-83, 2006-40 I.R.B. 596.
SUBSTANTIVE TAX ISSUES
The purpose of this checklist is to assist in identifying substantive tax issues in bankruptcy which, due to the technical complexity of the bankruptcy proceeding, may go unnoticed. It is intended to supplement the Large Bankruptcy Case criteria set forth in CCDM 34(10)30 and will be updated as new issues arise and are identified. Terms that may "red flag" the issue in the disclosure statement or plan of reorganization are listed.
If any of the following issues appear to be present and the case is in Insolvency Support function, it should immediately be referred to Area Counsel. In most cases relevant information would be contained in the debtor’s disclosure statement, but the original petition and schedules should also be reviewed. In cases requiring large case coordination, Area Counsel should refer plans and disclosure statements to Counsel's National Office for review to identify substantive tax issues which may be grounds for a plan objection and /or basis for an audit issue in future years. Area Counsel will also make a determination, based on the facts of each case, as to issues present in the case which require coordination with Counsel's National Office. If not referred, Area Counsel should take all appropriate action to protect the Service’s position.
(1) Does the plan of reorganization create a separate taxable post-confirmation entity? (Liquidating trust, liquidating trustee, grantor trust, disbursing agent.) (2) Does the plan create a trust, corporation, or association that will sell assets transferred to it from the bankruptcy estate? (3) Does the plan create a "settlement fund" to pay tort, securities fraud, or criminal victims? (IRC section 468B) (4) Does the bankruptcy involve the substantive consolidation of several debtors' estates? This will usually be initiated by a motion to substantively consolidate before a disclosure statement and/or plan has been filed. (5) Is the debtor a member of consolidated group (either parent or subsidiary)? (6) Is a corporate debtor claiming in its disclosure statement that its reorganization will be tax free? (7) Does the plan of reorganization provide for the termination of a pension plan? (8) Does the plan of reorganization provide for the transfer of assets from one pension plan to another? (9) Does the debtor have a pension plan with assets in excess of $1 million? (10) Is the Pension Benefit Guaranty Corporation (PBGC) involved in the case? (11) Does the plan propose a sale or transfer from bankruptcy estate to a key person or officer of the corporation? (12) Does the plan provide or does a motion request that the principal purpose of the plan is not the avoidance of taxes? (IRC section 269; BC section 1129(d)) (13) Is the debtor seeking a determination of the tax consequences of the plan from the Bankruptcy Court? (14) Has the debtor requested or indicated it intends to request a private letter ruling? (15) Does the plan expressly state that the feasibility of the plan turns on or will be affected by future tax consequences? (16) Does the plan attempt to deal with post-confirmation tax years?