I. The Power to Determine Tax Liability
The Bankruptcy Code explicitly empowers bankruptcy judges to rule on the merits of any tax claim or penalty of a debtor under its jurisdiction.[1] Congress used expansive statutory language in granting bankruptcy courts with broad authority to determine a debtors’ tax liability,[2] providing that:
the court may determine the amount or legality of any tax, any fine or penalty relating to a tax, or any addition to tax, whether or not previously assessed, whether or not paid, and whether or not contested before and adjudicated by a judicial or administrative tribunal of competent jurisdiction.
11 U.S.C. § 505 (a)(1) (emphases added). The powers in § 505 (a)(1) are very broad,[3] extending bankruptcy authority over tax matters of the estate as well as the personal tax liability of the debtor.[4] This authority has also been found to include the court’s power to calculate interest on the debtor’s claim,[5] to determine tax liability beyond the year stated in a proof of claim,[6] and to determine tax treatment of partnership items affecting debtor-partner’s ultimate liability.[7] Even though the statute does not mention state taxes, courts have broadly interpreted § 505 to include the authority to determine both state and federal tax liability claims.[8] Such expansive authority allows for the quick resolution of tax claims so as not to delay bankruptcy proceedings.[9]
II. Limits on Bankruptcy Power to Determine Tax Liability
While bankruptcy courts undoubtedly maintain broad subject matter jurisdiction over bankruptcy and related proceedings as well as substantial authority to determine a debtor’s tax liability, their power is not unfettered. There are several limitations on this authority. First, and perhaps most obvious, the court’s broad authority over a debtor and the debtor’s estate generally does not extend to parties who are not the debtor in bankruptcy.[10]
Secondly, § 505 also proscribes certain limitations on the power of bankruptcy courts to determine tax liability.[11] First, § 505(a)(2)(A) reflects principles of res judicata, precluding bankruptcy courts from ruling on the merits of tax claims that were contested before and adjudicated by a tribunal of competent jurisdiction prior to the commencement of the bankruptcy case.[12] Section 505(a)(2)(A) effectively strips the bankruptcy court of the subject matter jurisdiction it otherwise would have had under § 505(a)(1).[13] This is a mandatory requirement, prohibiting bankruptcy courts from disregarding and relitigating tax court adjudications.[14]
A tax matter is generally considered to be “contested” if, before filing for bankruptcy, a debtor has filed a petition with the taxing authority and the authority has filed an answer.[15] This contested requirement serves as a protection for debtors who cannot afford to challenge their tax liability determinations, ensuring they are not bound by such determinations made prior to filing bankruptcy.[16] However, a matter must be actually contested and adjudicated for § 505(a)(2)(A) to preclude bankruptcy court authority.[17] The mere opportunity for judicial review is not enough.[18] On the other hand, a particular claim does not necessarily have to be “actually litigated” in tax court to be “contested.”[19] Even a Tax Court judgment reached by agreement is entitled to preclusive effect because an agreed order is still contested before and adjudicated by a tribunal of competent jurisdiction.[20]
A matter is “adjudicated” when “a judgment of a court of competent jurisdiction has been decreed.”[21]A case does not have to be tried on the merits to be considered “adjudicated,”[22] nor does there have to be an evidentiary hearing.[23] Even informal, quasi-judicial proceedings can be sufficient to preclude bankruptcy authority over tax matters.[24]
Tax determinations that have become final prior to the commencement of the bankruptcy case are generally considered to be contested before and adjudicated by a tribunal of competent jurisdiction. [25] But if a taxpayer files for bankruptcy before a tax determination made by a non-bankruptcy tribunal becomes final, bankruptcy courts may determine the debtor’s tax liability because the matter is still pending.[26] Tax determinations are generally given preclusive effect in bankruptcy proceedings when the debtor has had a full and fair opportunity to contest the matter and the determination has become final.[27]
A second statutory limit to the broad authority bankruptcy courts have over determine a debtor’s right to a tax refund. Specifically, the court is precluded from determining the bankruptcy estate’s right to a tax refund before the earlier of 120 days after the trustee properly requests the refund from the applicable taxing authority or a determination by the taxing authority of such request.[28] However, if the taxing authority has not acted upon the refund request within 120 days, then bankruptcy court may make a determination on the refund claim.[29] Therefore, bankruptcy courts are statutorily prohibited from determining tax refunds unless the two procedural requirements in § 505(a)(2)(B) are met: (1) the trustee must “properly request” the tax refund from the governmental authority; and (2) the governmental authority must rule on the trustee’s refund request or 120 must elapse.[30]
Courts have interpreted the “properly requests” language in § 505(a)(2)(B) to constitute an additional requirement for establishing bankruptcy court authority to determine a debtor’s tax refund claim.[31] This “properly requests” requirement limits the bankruptcy court’s authority to determine tax refund claims to situations where the debtor has first complied with applicable taxing authority procedures,[32] barring courts from determining tax refund claims that are raised for the first time in bankruptcy proceedings.[33]Furthermore, § 505(a)(2)(B) contains an administrative exhaustion requirement. The bankruptcy trustee, and not a plan-appointed representative, must administratively exhaust a refund claim before bringing the refund claim in bankruptcy court in order to confer bankruptcy court authority over the matter.[34]
Finally, while bankruptcy courts clearly have the power to determine the tax liability of a debtor in bankruptcy, whether or not they should make such determinations is an entirely separate question. Congress’s use of the word “may” shows the court is not required to make tax liability determinations.[35] Instead, this verbiage vests the bankruptcy court with discretionary authority to make tax redeterminations.[36] Moreover, the legislative history of § 505 supports the notion that a bankruptcy court should decide which court is the proper forum to determine the merits of a tax liability claim.[37]
Courts often look to several factors when deciding whether to abstain, including: (1) the complexity of the tax issues to be decided, (2) the need to administer the bankruptcy case in an orderly and efficient manner, (3) the burden on the bankruptcy court’s docket, (4) the length of time required for trial and decision, (5) the asset and liability structure of the debtor, and (6) the prejudice to the taxing authority.[38] Courts frequently consider the potential delay in bankruptcy proceedings in light of § 505’s purpose of providing a forum for the ready determination of the legality or amount of tax claims. When no bankruptcy purpose is served by determining a debtor’s tax liability, courts will usually abstain.[39]
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[1] IRS v. Luongo (In re Luongo), 259 F.3d 323, 328 (5th Cir. 2001) (noting that “the legislative statements accompanying § 505 make clear that the section authorizes the bankruptcy court to rule on the merits of any tax claim involving an unpaid tax, fine, or penalty relating to a tax, or any addition to a tax, of the debtor or the estate”). The Bankruptcy Code also grants the court the general authority to determine the amount of a proof of claim filed by a creditor against the bankruptcy estate, including tax claims. 11 U.S.C. § 502 (b).
[2] United States v. Bond, 762 F.3d 255, 260 (2d Cir. 2014) (noting that § 505(a)(1)’s “language is broad, conferring jurisdiction over any tax,” outside certain exceptions); Cent. Valley AG Enterprises v. United States, 531 F.3d 750, 759 (9th Cir. 2008) (“The Bankruptcy Code broadly authorizes the district court to ‘determine the amount or legality of any tax, any fine or penalty relating to a tax, or any addition to tax, whether or not previously assessed, whether or not paid, and whether or not contested before and adjudicated by a judicial or administrative tribunal of competent jurisdiction.””).
[3] Starnes v. United States (In re Starnes), 159 B.R. 748, 749–50 (Bankr. W.D.N.C. 1993) (holding that the plenary authority of the bankruptcy court to hear and determine the amount or legality of any tax claim gives the court jurisdiction to determine a debtor’s tax liability in an adversary proceeding commenced after the debtor’s discharge).
[4] IRS v. Luongo (In re Luongo), 259 F.3d 323, 336 (5th Cir. 2001) (“Section 505(a)(1) vests the bankruptcy court with broad jurisdiction over tax matters of the estate and the debtor, including determinations with respect to the personal liability of the debtor.”).
[5] In re Vendell Healthcare, Inc., 222 B.R. 564, 568 (Bankr. M.D. Tenn. 1998).
[6] United States v. Kearns, 177 F.3d 706, 710 (8th Cir. 1999) (“Thus, we read § 505 to confer on the bankruptcy courts jurisdiction to determine tax liability beyond the year stated in the proof of claim when that liability involves deductions resulting from repayment of embezzled funds.”).
[7] Cent. Valley AG Enterprises v. United States, 531 F.3d 750, 760–61 (9th Cir. 2008) (finding that the Bankruptcy Code establishes jurisdiction over chapter 11 partner-debtor’s tax liability and to any partnership items affecting that liability). The court noted “we have consistently treated them as fundamentally interrelated and inseparable in considering the proper forum for a partner’s tax dispute.” Id. at 761. This jurisdictional provision is not overridden by non-bankruptcy code provisions specifying certain tax treatment. Id. at 762 (finding that statute requiring tax treatment of items related to a partnership be determined at the partnership level and precluding individual partners from contesting that determination did not override the Bankruptcy Code’s broad jurisdictional provisions). See United States v. Wilson, 974 F.2d 514, 516 (4th Cir. 1992) (holding that the court’s subject matter jurisdiction over tax claims persists even after the automatic stay is lifted and noting that “[t]he Bankruptcy Code requires bankruptcy courts to defer to the tax court only where the claim was contested and adjudicated by the tax court before the commencement of the bankruptcy case”).
[8] In re Bulk Petroleum Corp., 796 F.3d 667, 670 (7th Cir. 2015). See New Haven Projects Ltd. Liability Co. v. City of New Haven (In re New Haven Projects Ltd. Liability Co.), 225 F.3d 283, 286 (2d Cir. 2000) (“Subject to certain limitations, § 505 empowers a bankruptcy court to redetermine the amount of a debtor’s tax liability even when a debtor has failed to comply with state law procedures for challenging such liabilities, including applicable state law statutes of limitations.”).
[9] In re Diez, 45 B.R. 137 (Bankr.S.D.Fla.1984) (noting that the history of § 505 “makes it clear that its purpose was to afford a forum for the ready determination of the legality or amount of tax claims, which determination, if left to other proceedings, might delay conclusion of the administration of the bankruptcy estate”).
[10] Am. Principals Leasing Corp. v. United States, 904 F.2d 477, 480–81 (9th Cir. 1990) (“Despite section 505’s broad language, virtually all the courts which have considered the issue most recently concluded that § 505(a) does not extend the bankruptcy court’s jurisdiction to parties other than the debtor.”). But see Quattrone Accountants, Inc. v. I.R.S., 895 F.2d 921, 925 (3d Cir. 1990) (“We conclude that Section 505 does not deny the bankruptcy court jurisdiction of claims of non-debtors; rather, its purpose is to deny jurisdiction to the bankruptcy court when, prior to bankruptcy, a tax claim has been “contested before and adjudicated by a judicial or administrative tribunal of competent jurisdiction.’”).
[11] See 11 U.S.C. § 505(a)(2), which provides:
“(2) The court may not so determine–
“(A) the amount or legality of a tax, fine, penalty, or addition to tax if such amount or legality was contested before and adjudicated by a judicial or administrative tribunal of competent jurisdiction before the commencement of the case under this title;
“(B) any right of the estate to a tax refund, before the earlier of–
“(i) 120 days after the trustee properly requests such refund from the governmental unit from which such refund is claimed; or
“(ii) a determination by such governmental unit of such request; or
“(C) the amount or legality of any amount arising in connection with an ad valorem tax on real or personal property of the estate, if the applicable period for contesting or redetermining that amount under applicable nonbankruptcy law has expired.”
[12]Mantz v. Cal. State Bd. of Equalization (In re Mantz), 343 F.3d 1207, 1213–14 (9th Cir.2003) (“Section 505(a) is also a statutory embodiment of traditional principles of res judicata.”); Matter of Teal, 16 F.3d 619, 621 (5th Cir. 1994) (“At bottom, Section 505(a)(2) expresses in jurisdictional terms, traditional principles of res judicata, or claim preclusion.”).
[13] In re Mantz, 343 F.3d 1207, 1211 (9th Cir. 2003).
[14] Matter of Teal, 16 F.3d 619, 622 (5th Cir. 1994) (internal quotation marks omitted) (“A bankruptcy court, however, is barred by § 505(a)(2)(A) from employing its equitable powers to look behind the judgment of the tax court.”); see In re Harker, 357 F.3d 846, 849 (8th Cir. 2004) (holding that the bankruptcy court lacked jurisdiction under § 505(a)(2)(A) to redetermine the debtor’s tax liability that was established in a prior Tax Court decision). However, some courts have held that § 505 (a)(2)(A) is not a jurisdictional bar. See In re El Tropicano, Inc., 128 B.R. 153, 157 (Bankr. W.D. Tex. 1991) (“Section 505(a)(2)(A), far from further defining the court’s jurisdiction, merely defines the extent of the relief available to the debtor or trustee under Title 11, affording the defendants a de facto affirmative defense which they have the burden to raise.”).
[15] In re Baker, 74 F.3d 906, 909 (9th Cir. 1996); IRS v. Teal (In re Teal), 16 F.3d 619, 621 n. 4 (5th Cir.1994) (quoting 124 Cong.Rec. 32250, 32413 (Sept. 28, 1978) (statement of Rep. Edwards); 124 Cong.Rec. 33989, 34013 (Oct. 5, 1978) (statement of Sen. DeConcini)).
[16] In re Mantz, 343 F.3d 1207, 1211 (9th Cir. 2003) (“Section 505(a)(2)(A) requires that the debtor have contested the tax liability in question.”).
[17] Cent. Valley AG Enterprises v. United States, 531 F.3d 750, 758 (9th Cir. 2008) (emphasis in original) (finding that the IRS Appeals Office’s Notice of Final Partnership Administrative Adjustment becoming final due to debtor’s failure to file a timely petition for readjustment in Tax Court to be insufficient for precluding bankruptcy court authority in determining debtor tax liability). See City Vending of Muskogee, Inc. v. Oklahoma Tax Comm’n, 898 F.2d 122, 125 (10th Cir. 1990) (“A federal court, therefore, will have jurisdiction under § 505 to consider state tax issues where the debtor has failed to assert any challenge to the assessment prior to commencing bankruptcy proceedings, or where the debtor has challenged the assessment through state proceedings which are still pending at the time the bankruptcy petition is filed.”).
[18] Id. (“Congress did not intend a default judgment to preclude the bankruptcy court’s determination of the amount and validity of State taxes and penalties.”) (quoting Tapp v. Fairbanks N. Star Borough (In re Tapp), 16 B.R. 315, 318–20 (Bankr.D.Alaska 1981)). Some courts have found it insufficient to preclude bankruptcy authority over a tax matter when an order merely becomes final due to the debtor’s failure to actually contest it.
[19] In re Bunyan, 354 F.3d 1149, 1153 (9th Cir. 2004) (finding that final order regarding debtor’s tax appeals sufficiently constitutes adjudication of the legality of the tax claims as well).
[20] Matter of Teal, 16 F.3d 619, 621–22 (5th Cir. 1994) (“An agreed judgment is entitled to full res judicata effect.”); In re Baker, 74 F.3d 906, 910 (9th Cir. 1996) (“For res judicata purposes, an agreed or stipulated judgment is a judgment on the merits.”).
[21] Matter of Teal, 16 F.3d 619, 621 (5th Cir. 1994) (internal quotation marks omitted) (“In any event, ‘adjudicate’ is ‘synonymous with adjudge in its strictest sense.’” (quoting Black’s Law Dictionary 42 (6th ed. 1990)). Other circuits have also adopted this definition of “adjudicate.” See In re Baker, 74 F.3d 906, 909 (9th Cir. 1996) (“The Tax Court ‘adjudicated’ the [debtors’] tax liability when it entered judgment against them.”).
[22] Baker v. Internal Revenue Serv. (In re Baker), 74 F.3d 906, 909 (9th Cir.1996) (per curiam) (“A case not tried on the merits can nonetheless be ‘adjudicated’ within the meaning of the statute.”); City Vending of Muskogee, Inc. v. Okla. Tax Com’n, 898 F.2d 122, 125 (10th Cir.1990) (“Although the merits of plaintiff’s claims were never addressed, the instant appeal does not present the situation where the debtor has failed to assert any challenge to the assessment.”).
[23] In re Cody, Inc., 338 F.3d 89, 95 (2d Cir. 2003) (finding that Town Board of Assessment Review procedures of resolving tax claims on the paper record without an additional hearing were adequate to constitute “adjudication” and thereby prevent bankruptcy review, where the board was able to receive live testimony and documentary evidence and the taxpayer had the opportunity to appear in person); see In re Baker, 74 F.3d 906, 909 (9th Cir. 1996) (finding that a stipulated judgment reached without presenting evidence to the court was still adjudicated because the Tax Court is not required to fully litigate all cases to foreclose taxpayers from relitigating their tax liability in bankruptcy court).
[24] Texas Comptroller of Public Accounts v. Trans State Outdoor Advertising Co. (In re Trans State Out-door Advertising Co.), 140 F.3d 618, 621 (5th Cir.1998) (agreeing with the district court that a state administrative proceeding was “quasi-judicial, and therefore amounted to an adjudication by an ‘administrative or judicial tribunal’ under § 505(a)(2)(A) of the Bankruptcy Code” because it was an adversarial proceeding before a tribunal of competent jurisdiction); but see Cent. Valley AG Enterprises v. United States, 531 F.3d 750, 758–59 (9th Cir. 2008) (distinguishing “informal” IRS Appeals Office conference, which resembled a settlement conference, as “materially different” from the more formal administrative hearing in Trans State).
[25] City Vending of Muskogee, Inc. v. Oklahoma Tax Comm’n, 898 F.2d 122, 125 (10th Cir. 1990) (finding that since debtor had already “vigorously challenged” tax assessment in state court but then failed to invoke the appropriate state remedies prior to the determination becoming final, the bankruptcy court lacked authority to consider tax claims)
[26] See Mantz v. Cal. State Bd. of Equalization (In re Mantz), 343 F.3d 1207, 1213 (9th Cir.2003) (holding that the jurisdictional bar in § 505(a)(2)(A) did not apply where the decision of the State Board of Equalization upon a petition for redetermination did not become final until 30 days after its service under state law and where the debtors filed for bankruptcy during the 30-day period).
[27] See IRS v. Teal (In re Teal), 16 F.3d 619, 622 (5th Cir.1994) (finding that the bankruptcy court lacked jurisdiction pursuant to § 505(a)(2)(A) over adversary proceedings to determine debtor’s tax liabilities where debtor “had the full and fair opportunity to contest the assessed penalties in the Tax Court litigation,” even though the Tax Court decision was reached by agreement); see also Texas Comptroller of Pub. Accounts v. Trans State Outdoor Advert. Co., 220 B.R. 339, 344 (S.D. Tex. 1997), aff’d sub nom. Matter of Trans State Outdoor Advert. Co., Inc., 140 F.3d 618 (5th Cir. 1998) (finding that the requirements of § 505(a)(2)(A) were met where the taxpayer had a full and fair opportunity to contest the tax assessment before a tribunal of competent jurisdiction and that decision on the challenge to the tax assessment became final under state law).
[28] 11 U.S.C. § 505(a)(2)(B).
[29] In re Luongo, 259 F.3d 323, 329 n.4 (5th Cir. 2001) (“[A]bsent the express statutory limitations in § 505(a)(2)(A) and (B), bankruptcy courts have universally recognized their jurisdiction to consider tax issues brought by the debtor, limited only by their discretion to abstain”.). The purpose of § 505(a)(2)(B) is to keep a refund claim from “languishing in the administrative process,” not to deprive the court of jurisdiction. Id.
[30] United States v. Bond, 762 F.3d 255, 260 (2d Cir. 2014).
[31] In re Penking Tr., 196 B.R. 389, 396 (Bankr. E.D. Tenn. 1996) (“A ‘proper request’ under § 505(a)(2)(B) connotes correctness and dictates conformity with the pertinent taxing authority’s mechanism for seeking a refund.”).
[32] In re Venture Stores, Inc., 54 F. App’x 721, 723 (3d Cir. 2002) (citing In re Custom Distribution Services, 224 F.3d 235, 241 (3rd Cir.2000)); In re Graham, 981 F.2d 1135, 1138 (10th Cir.1992) (holding that trustee’s filing of refund claim was prerequisite to grant bankruptcy court jurisdiction over debtors’ tax refund). These administrative procedures, however, are not required when the debtor is seeking a tax refund as an offset or a counterclaim to a proof of claim by the taxing authority. See In re Custom Distribution Servs. Inc., 224 F.3d 235, 244 (3d Cir. 2000) (noting that the legislative history of § 505 “leads [the court] to conclude that where a refund is sought as an ‘offset,’ no claim need be filed first with the taxing authority”).
[33] Id. at 243.
[34] Bond, 762 F.3d at 257.
[35] Cent. Valley AG Enterprises v. United States, 531 F.3d 750, 764 (9th Cir. 2008) (Section 505(a)(1) is a permissive empowerment—as established by the operative verb ‘may.’ It is not a mandatory directive.”); In re Luongo, 259 F.3d 323, 330 (5th Cir. 2001); In re New Haven Projects Ltd. Liab. Co., 225 F.3d 283, 288 (2d Cir. 2000) (finding that the bankruptcy court was not required to redetermine debtor’s tax liability under § 505 because the plain meaning of the phrase “the court may determine” is merely a permissive grant of authority rather than a mandatory requirement). But see In re Smith, 122 B.R. 130, 133 (Bankr. M.D. Fla. 1990) (finding that to § 505 “is a grant of power to determine tax liability and not merely a permissive option to do so” and that “the bankruptcy court may not abstain from exercising jurisdiction of a Motion filed pursuant to § 505 unless the interest of the creditors and the Debtors would be served by abstention”).
[36] Cody, Inc. v. County of Orange (In re Cody, Inc.), 338 F.3d 89, 92, n. 1 (2d Cir.2003) (quoting New Haven Projects Ltd. Liability Co. v. City of New Haven (In re New Haven Projects Ltd. Liability Co.), 225 F.3d 283, 288 (2d Cir.2000).
[37] In re Luongo, 259 F.3d 323, 328 (5th Cir. 2001).
[38] Id. at 330 (citing In re Hunt, 95 B.R. 442, 445 (Bankr. N.D. Tex. 1989).
[39] In re Diez, 45 B.R. 137, 139 (Bankr. S.D. Fla. 1984) (abstaining from determining debtor’s tax liability where IRS was the only creditor in debtor’s no asset case and debtor’s sole purpose was to seek an alternative forum to litigate her tax claim); see Bush v. U.S., 393 F.3d 839 (7th Cir. 2019) (finding that § 505(a)(1) is not jurisdictional and holding that the bankruptcy court should not exercise its power to determine tax liabilities where nothing remains to be done in the bankruptcy proceeding and the debtor is unlikely to pay the tax obligations).
