The recently-decided case of Tenholder v. United States addresses how certain actions on behalf of a taxpayer to prevent collection of an unpaid tax can impact the taxpayer in unexpected ways. The case discusses the tolling of the three-year statutory lookback period for purposes of discharging debt in bankruptcy because the taxpayer filed a request for a collection due process (CDP) hearing.
The taxpayers filed bankruptcy on December 30, 2017. The case was closed on March 15, 2017, but it was reopened because the taxpayers argued that their 2011 tax debt should have been discharged in the bankruptcy. The IRS took the position that the applicable lookback period was tolled when the taxpayers requested a CDP hearing, and the tax debt could therefore not be discharged. The bankruptcy court sided with the IRS and the Southern District of Illinois affirmed.
The flush paragraph of 11 U.S.C. § 507(a)(8) states that the lookback period is “suspended for any period during which a governmental until is prohibited under applicable nonbankruptcy law from collecting a tax . . . plus 90 days,” provided the prohibition is a result of the debtor requesting a hearing or appeal relating to the tax. Section 503(a)(1)(A) of the Bankruptcy Code precludes the discharge of tax debt to which § 507(a)(8) applies; therefore, if the CDP hearing request resulted in a prohibition of the IRS’s tax collection, the debtors’ tax debt survived bankruptcy.
The debtors claimed that the language of § 507(a)(8) is unambiguous—specifically that the word “prohibition” clearly requires a total prohibition of collection efforts. Because a CDP hearing prevents the IRS from levying but does not prohibit other forms of collection, the debtors maintained that the lookback period was not tolled and had therefore expired prior to the end of the bankruptcy proceedings. The court disagreed, finding that the language is ambiguous because it is unclear whether it requires a prohibition on “allcollection activities or just somecollection activities.” Tenholder, 2018 BL 335213, at *4 (quoting In re Lastra, No. 7-12-10560 TA, 2012 BL 336869, at *3 (Bankr. D.N.M. Dec. 21, 2012)). Looking to the legislative history, the court held that Congress intended for the section to apply when a taxpayer requests a CDP hearing and subsequently files bankruptcy.
The court emphasized that levying is an important and widely-used recourse for the IRS. So while CDP hearing requests do not result in a total prohibition of collection—and, under the court’s reasoning, they do not need to in order to toll the lookback period under the Bankruptcy Code—they do “severely hinder the IRS’s ability to collect a tax.” Id.at *6. The court further found that the result is a fair balance of the interests of the IRS and taxpayers: taxpayers benefit from the availability of CDP hearings because the IRS cannot use one of its primary collection methods, so it is only fair for the lookback period to toll during the pendency of the hearing.
This recent case shows how important it is to carefully consider the impact of filing for certain types of tax debt relief may have on a taxpayer’s ability to discharge the debt in other ways. Had the Tenholders not requested a CDP hearing, the tax debt may have qualified for discharge in bankruptcy. Because the CDP hearing tolled the lookback period, the taxpayers remain responsible for the unpaid taxes.