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Corporate Bankruptcy (Portfolio 790)

Tax Management Portfolio, Corporate Bankruptcy, No. 790-2nd, analyzes the tax issues that arise when a corporation files for bankruptcy, and does so in the chronological order in which those issues arise in a typical case.

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Tax Management Portfolio, Corporate Bankruptcy, No. 790-2nd, analyzes the tax issues that arise when a corporation files for bankruptcy, and does so in the chronological order in which those issues arise in a typical case.

After providing an overview of the tax practitioner's role in the corporate bankruptcy process, the portfolio discusses the tax calculus of the decision to file, the tax significance of first-day orders, and the protective steps that should be considered early in the case to preserve the debtor's tax attributes during and after bankruptcy. The portfolio then discusses the effect of the bankruptcy filing on tax compliance, the proper treatment of certain key items on the debtor's tax returns, requests for refunds by the debtor, tax audits of the debtor's pre-petition years, and the filing of tax claims against the debtor.

The portfolio next analyzes the tax consequences of the plan of reorganization to the debtor, its creditors, and current shareholders. The portfolio then discusses the role of the creditors in the reorganization process. Finally, the portfolio concludes by describing the contents of the plan of reorganization and the disclosure statement from a tax professional's point of view.


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AUTHORS

CARL M. JENKS
Carl M. Jenks, J. D. Harvard Law School (1980); Ph.D. Duke University (1979), M.A. Duke University (1973); B.A. Carleton College (1967).

CANDACE A. RIDGWAY
Candace A. Ridgway, LL.M. Georgetown University Law Center (1995); J.D. Cornell Law School (1987); M.B.A. Arizona State University (1984); B.A. University of Connecticut (1974).

EDWARD A. PURNELL
Edward A. Purnell, J. D. Harvard Law School (1990); B.A. Princeton University (1976).

COLLEEN E. LADUZINSKI
Colleen E. Laduzinski, LL.M. New York University (2004); J.D. Tulane Law School (2000); M.B.A. A.B. Freeman School of Business at Tulane University (2000); B.A. Boston University (1996).

TABLE OF CONTENTS

Detailed Analysis

I. The Role of the Tax Practitioner in the Corporate Bankruptcy Process

Introductory Material

A. The World of Corporate Bankruptcy

B. Overview of the Corporate Bankruptcy Process

1. General Impact of a Bankruptcy Filing

a. The Automatic Stay

b. Bankruptcy Court Approval for Non-Ordinary Course Transactions

c. Prohibition on Payment of Pre-Petition Debts

d. Shift in Management's Fiduciary Duty

e. Parties in Interest in a Chapter 11 Case

(1) United States Trustee

(2) Unsecured Creditors’ Committee(s)

(3) Secured Creditors

(4) Trustee of the Debtor

(5) Examiner

2. Major Elements of a Chapter 11 Case

a. Pre-Petition Activities

b. Commencement of the Chapter 11 Case

c. Unexpired Leases and Executory Contracts

d. Sales of Property

e. Recovery Powers

f. Substantive Consolidation

g. Claims Process

h. Debtor-Creditor Dynamics

i. Plan Proposal and Confirmation

j. Classification of Claims

k. Solicitation and Acceptance

l. Cramdown

C. The Decision to File for Bankruptcy

D. The First-Day Orders

E. Preserving Tax Attributes During Bankruptcy

F. The Impact of Bankruptcy Filing on Tax Compliance

G. The Impact of Bankruptcy Filing on the Debtor's Tax Return

1. Filing Status

2. Accrual of Post-Petition Interest

3. Deductibility of Professional Fees

H. Tax Refunds in Bankruptcy

I. Tax Audits in Bankruptcy

J. Tax Claims Against the Debtor

K. Tax Consequences of the Reorganization to the Debtor

L. Tax Consequences of the Reorganization to the Creditors and Equity Holders

M. The Role of the Creditors

N. The Plan of Reorganization

O. The Disclosure Statement

P. Partnerships and Partners in Bankruptcy

Q. Liquidating Bankruptcies

R. International Aspects of U.S. Corporate Bankruptcies

S. The Role of Tax Sharing Agreements

T. Post-Confirmation Tax Issues

II. The Decision to File for Bankruptcy

Introductory Material

A. Tax Consequences of Debt Restructuring Inside and Outside Bankruptcy

1. Discharging Debt

2. Limitation on Future Use of NOLs

3. Comparing Alternatives

4. Which Members of the Consolidated Group Should File for Bankruptcy?

B. Impact of Venue of Bankruptcy Filing on Tax Analysis

III. The First-Day Orders

A. Function of First-Day Orders

B. Authorization to Pay Pre-Petition Taxes - Scope of Authority Sought

1. Traditional Approach

2. Aggressive Approach

3. Intermediate Approach

4. General Considerations

C. Responsible Person Liability Issues

1. Federal Income Tax Rules for Responsible Persons

a. Who Is a Responsible Person?

b. Trust Fund Liabilities

c. Non-Trust Fund Liabilities

2. State Tax Rules for Responsible Persons

a. Who Is a Responsible Person?

b. Trust Fund Liabilities

c. Non-Trust-Fund Liabilities

(1) Sales and Use Taxes

(2) Other Non-Trust-Fund Taxes

d. Personal Liability Based on Charter Forfeitures

3. Addressing Responsible Person Liability

D. Oversecured Property Taxes

1. Interest Accrual in Bankruptcy

2. Interest on Oversecured Property Taxes

3. Strategies for the First-Day Motion

IV. Preserving Tax Attributes During Bankruptcy

Introductory Material

A. Potential Threats to Tax Attributes

1. More Than 50% Change of Stock Ownership

2. Worthless Stock Deduction

a. The Debtor's Stock Is “treated ... as becoming worthless”

b. By a “50-percent shareholder”

c. “[A]nd such stock is held by such shareholder as of the close of such taxable year”

3. Use of Attributes by Profitable Members of Consolidated Return Group

4. Acquisitions of Claims Against the Debtor

5. Deconsolidation of Subsidiary with Outstanding Preferred Stock

B. Use of Injunctions and Agreements to Protect Tax Attributes

V. The Impact of Bankruptcy Filing on Tax Compliance

A. Introduction

B. Continuing Duty to File Tax Returns

C. Audits and Assessments

D. Prohibition on Payment of Pre-Petition Taxes

1. Effect of Automatic Stay on Payment of Taxes

2. Establishing a Tax Claim's Priority Under the Bankruptcy Code

3. Pre-Petition vs. Post-Petition Analysis for Specific Types of Tax

a. Income and Gross Receipts Taxes (B.C. 507(a)(8)(A))

(1) Overview

(2) Case Law

(a) Incurred by the Estate?

(b) Of a Kind Specified in B.C. 507(a)(8)

(3) How to Bifurcate?

(4) Straddle Years Post-2005 BAPCPA

b. Property Taxes (B.C. 507(a)(8)(B))

(1) Summary of Property Tax Assessment Process

(2) Evaluation of Pre- or Post-Petition Property Tax Claims

(a) When Did the Property Tax Accrue?

(b) When Did the Claim Arise?

(c) When Did the Lien Attach?

(d) Other Approaches

(e) Impact of Personal Liability

(f) Who Owned the Property During the Tax Period?

(3) State-by-State Analysis

(a) California

(b) Florida

(c) Illinois

(d) Indiana

(e) Louisiana

(f) Michigan

(g) Mississippi

(h) New York

(i) North Carolina

(j) Ohio

(k) Pennsylvania

(l) Tennessee

(m) Texas

(n) Washington

(4) Evaluation of Pre- or Post-Petition Claims for Taxes Due Under a Lease

(a) The Montgomery Ward Decision

(b) Impact of the Montgomery Ward Decision

c. Trust Fund Taxes

d. Sales and Use Taxes (B.C. 507(a)(8)(E))

(1) Pre-Petition Sales and Use Taxes

(2) When Is a Sales or Use Tax “Incurred” for Purposes of the Pre-Petition Classification?

e. Franchise Taxes/Annual Reporting Fees/Doing Business Fees

f. Unclaimed Property

(1) Pre-Petition Unclaimed Property

(2) Conflict Between Bankruptcy Code and Unclaimed Property Statutes

(a) B.C. 1111(a) – Timely Filing of Proofs of Claim

(b) B.C. 347(b) – Proceeds of Unpresented Distribution Checks Revert to the Debtor

(c) B.C. 1123(a)(4) – Creditors in the Same Class Must Be Treated Equally

4. Responsible Person Liability Concerns

5. Effect of Classification on Notice, Other Considerations

a. Bar Dates

b. Time of Payment

c. Interest

d. Penalties

e. State Voluntary Disclosure Agreements

(1) Voluntary Disclosure Agreements Defined

(2) Unpaid Voluntary Disclosure Agreements in Bankruptcy

(a) Analogy to Federal “Closing Agreements”

(b) VDA as an Executory Contract

(c) VDA as Mere Tax Claim

E. Managing the Tax Department Post-Filing

1. Changed Mentality: Compliance vs. Fiduciary Duty to All Creditors

2. Planning Ahead

F. Conclusion

VI. The Impact of Bankruptcy Filing on the Debtor's Tax Return

A. Introduction

B. Procedures Governing Administrative Period Returns

C. Accrual of Post-Petition Interest

1. Framing the Issue

2. The Statutory Scheme

a. Internal Revenue Code

b. Bankruptcy Rules: Allowed Claims vs. Ultimate Distributions

c. Book/Tax Differences in Accounting for Post-Petition Interest

3. Conclusion

D. Treatment of Professional Fees

1. Overview

2. Background: Bankruptcy Professionals and Their Fees

3. Statutory Framework

4. INDOPCO Regulations

5. Treatment of Professional Fees for Financial Reporting Purposes

6. Case Law

7. Mass Tort Bankruptcies

8. Fees Associated with Debt

9. Practical Applications of Deduction and Capitalization Rules

E. Tax Consequences of Bankruptcy Recoveries

F. Abandonment of Assets

G. Conclusion

VII. Tax Refunds in Bankruptcy

Introductory Material

A. Heightened Significance of Tax Refunds in Bankruptcy

1. Immediate Source of Cash When Cash Is Short

2. Creditor Interest in Tax Carrybacks

B. Refund Procedures in Bankruptcy

1. “Quickie Refund” Claims

a. Processing

b. Administrative Freeze vs. Setoff

c. B.C. 503(b)(1)(B) Claims

2. Amended Tax Returns

C. Possible Worthless Stock Deduction

1. Meeting the “Disposition” Requirement of Regs. 1.1502-80(c)

2. Electing Not to Reconsolidate the “Prodigal Subsidiary”

D. Can Certainty About Refunds Be Obtained Before Emergence?

1. Limitations on B.C. 505

2. Objecting to B.C. 503(b)(1)(B) Claims

E. Whose Refund Is It?

F. Conclusion

VIII. Tax Audits in Bankruptcy

A. Taxing Authorities as Claimants

1. Historical Introduction

2. Debtor Notification of Taxing Authorities

B. Auditing Pre-Petition Years

C. Managing the Audit Process

D. Extending the Statute of Limitations

E. Dealing with the Straddle Year

F. Reflecting Federal Adjustments on State Returns

IX. Tax Claims Against the Debtor

Introductory Material

A. The Claims Process in General

B. Claims for Taxes

C. Impact of Tax Claims on Overall Case Management

D. Litigation vs. Consensual Resolution of Tax Claims

E. Consensual Resolution of Tax Claims

1. Discussions with Audit and Appeals Staff; Documentation of Proposed Agreement

2. Obtaining Bankruptcy Court Approval

3. Interim Reductions to Tax Claims

F. Litigation of Tax Claims

1. Jurisdiction of Bankruptcy Court to Determine Tax Claims

2. Objecting to Tax Claims

3. Brief Summary of Litigation Procedures in Bankruptcy

4. Burden of Proof

5. Lifting Stay to Allow Litigation Elsewhere

G. Interest on Tax Claims During Bankruptcy

1. General Rule Against Interest

2. Exceptions to the General Rule

H. Status of Tax Penalties in Bankruptcy

I. Use of B.C. 505(b) to Determine Post-Petition Tax Liabilities

1. Statutory Language of B.C. 505(b)

2. History and Purpose of B.C. 505(b)

3. Bankruptcy Court Discretion and Scope of B.C. 505(b)

a. Non-Debtors

b. Debtor's Tax Liability

4. IRS Re-examination After B.C. 505(b) Determination

J. Payment of Eighth Priority Tax Claims

K. Property Taxes and Property Revaluations

1. Bankruptcy Court Jurisdiction to Determine a Debtor's Local Property Tax Liability

2. No Bankruptcy Court Jurisdiction to Redetermine Taxes Paid if the Debtor Did Not Timely Seek a Refund

3. Bankruptcy Court Jurisdiction to Redetermine Unpaid and Uncontested Taxes

a. Bankruptcy Court Has Broad Discretion in Determining a Debtor's Tax Liability for Taxes Under B.C. 505

b. Factors Considered by Bankruptcy Court in Deciding Whether to Exercise Its Authority Under B.C. 505

(1) Complexity of Case and Asset Structure

(2) Debtor's Liability Structure and Potential Benefit to Unsecured Creditors

(3) Prejudice to Taxing Authorities and Uniformity of Taxes

X. Tax Consequences of the Reorganization to the Debtor

Introductory Material

A. Income Tax Consequences

B. Cancellation of Debt - Attribute Reduction

1. Cancellation of Debt

a. In General

b. Debt

c. Cancellation for Stock vs. Contribution

d. Debt Cancellation Through Modification or Reissuance

e. When Cancellation Occurs

2. Attribute Reduction

a. In General

b. Election to Reduce Depreciable Basis

c. Time of Attribute Reduction

d. Attribute Reduction in Subchapter C Reorganizations

e. Non-IRC 381 Acquisitions

f. Consolidated NOLs

g. Preserving NOLs at the State Level

(1) Separate Reporting

(2) Combined Reporting with Separate NOL Calculation

(3) Combined Reporting with Combined NOL Calculation

(4) Consolidated Returns

h. Impact of B.C. 346(j) for State Purposes

C. Change of Ownership – Attribute Limitations

1. IRC 382 – In General

2. NOLs and BILs Subject to Limitation

a. Loss Allocations for Year of Change

b. Amount of Debtor Corporation's NUBIL/NUBIG

3. IRC 382(l)(6)

4. IRC 382(l)(5)

a. In General

b. Corporation Under Bankruptcy Court Jurisdiction

c. Qualified Creditors

(1) Creditors’ Holding Period

(2) Ordinary Course Debt

d. 50% Ownership by Qualified Creditors

e. Subsequent Ownership Change

f. Reduction in Pre-Change Interest Accruals

5. Limited Carryovers to Survivors for State Tax Purposes

a. States That Mirror the Federal Consolidated NOL Amount

b. States That Follow Federal Loss Limitation Rules, But Do Not Limit State NOL Availability to Amount of Federal NOLs

c. States That Eliminate State NOLs Upon Merger Regardless of Federal NOLs

d. States with No NOL Limitations Based on Federal Consolidated NOLs and That Eliminate Absorbed Entity's NOLs on Merger

D. State Transfer Tax Consequences of Reorganization

1. Sales Taxes

2. Real Estate Transfer Taxes

a. Transfers by Operation of Law

b. Transfers by Deed

c. Lease Transfer Taxes

3. Motor Vehicle Taxes

XI. Tax Consequences of the Reorganization to the Creditors and Equity Holders

A. General

B. Equity

1. In General

2. Non-controlling Equity Interests

a. No Recovery

b. Partial Recovery

3. Controlling Parent - Consolidated Group

a. No Recovery

b. Partial or Full Recovery

c. Effect on Consolidated Group Tax Attributes

4. Affiliated But Not Consolidated Parent Corporation

a. No Recovery

b. Partial Recovery

C. Holders of “Securities”

1. Definition of “Securities”

a. “Securities” Under IRC 354

b. “Securities” Under IRC 165(g)(2)

2. No Recovery

3. Partial Recovery

D. Holders of Non-Securities Debts

1. No Recovery

2. Partial Recovery

E. Reporting and Withholding

1. Reporting by Creditors

2. Reporting/Withholding by Debtor (or Distribution Agent)

XII. The Role of the Creditors

A. The Creditors’ Committee and Its Advisors

B. Creditor Access to Debtor Tax Information

C. Creditor Involvement with Tax Audits and POR Planning

XIII. The Plan of Reorganization

Introductory Material

A. The Bankruptcy POR

1. Provisions for Claims

2. Plan Implementation

a. Restructuring Transactions

b. Organization, Governance, Operations

c. Plan Distributions

3. Post-Effective Date Claims Resolutions

B. Non-Taxable Transactions

1. In General

2. E Reorganization

3. G Reorganization

a. Transfer in Title 11 or Similar Case and Pursuant to “Plan”

b. Distribution Pursuant to “Plan”

c. Distribution in an IRC 354 or 355 Transaction

d. IRC 354: “Substantially All” Assets

e. IRC 354: Distribution of Stock, Securities and Assets by Transferor Corporation

f. IRC 355: Distribution of “Controlled” Acquiror's Stock/Securities

g. IRC 355: Active Business

h. IRC 355: Non-“Device”

i. IRC 355: Distribution of “Control”

j. Continuity of Interest

k. Continuity of Business Enterprise

l. Business Purpose

m. Effects of G Reorganization

(1) Transferor and Acquiror Corporation

(2) Shareholders and Creditors

4. A Reorganization

5. Other Non-Taxable Transactions

a. B Reorganization

b. IRC 351 Contributions to Controlled Corporations

C. Taxable Transactions

1. In General

2. Taxable Creditor Acquisition (“Bruno's”)

3. Taxable Non-Creditor Acquisition

XIV. The Disclosure Statement

A. In General

B. Description of Direct Tax Consequences

C. Other Tax Considerations

1. Pre-Bankruptcy and In-Bankruptcy Transactions

2. Claims and Recoveries

3. Effect of Confirmation/Effectiveness of the POR

4. Post-Effectiveness Transactions and Arrangements

XV. Partnerships and Partners in Bankruptcy

A. Effects of Filing by Partnership

B. Discharge of Partnership Debt

1. Recognition or Exclusion of COD Income

a. The Bankruptcy Exclusion

b. Exclusion of Qualified Real Property Business Indebtedness

c. Exception for Deductible Items

d. The Equity-for-Debt Exception for Partnerships

e. Elective Deferral of COD Income

2. Allocation of COD Income

3. Deemed Distributions to Partners

4. Election to Reduce Outside Basis

C. Bankruptcy of a Partner

1. Effect on Partnership

2. Effect on Designation of Tax Matters Partner

D. COD Income and IRC 1446 Partnership Withholding

1. Insolvent U.S. Partnership with Foreign Partners

2. Taxation of Foreign Investors in a U.S. Business Partnership

3. The Dilemma: Withholding on COD Income

4. A Solution by Analogy to IRC 1445

XVI. Liquidating Bankruptcies

Introductory Material

A. Liquidation Process

B. Liquidation Tax Issues

1. Minimizing Gains on Asset Dispositions

2. Protecting Fiduciaries from Personal Liability

a. Holywell Case

b. Complying with State Tax Requirements

XVII. International Aspects of U.S. Corporate Bankruptcies

A. Introduction

B. Deferral of U.S. Tax and Subpart F

1. Foreign Personal Holding Company Income

2. Foreign Base Company Sales Income

3. Foreign Base Company Services Income

4. Investment of Earnings in U.S. Property

a. Prudential Lines Arguments

b. PBGC Statutory Liens

C. IRC 482 and International Transfer Pricing

D. Foreign Tax Liabilities, the Automatic Stay Rule and the Revenue Rule

1. Seeking a Foreign Law Stay of Foreign Tax Collection

2. Possible Application of the Revenue Rule

3. Application of the Revenue Rule in the Foreign Country

4. Application of the Revenue Rule in the U.S. Plan of Reorganization

5. Paying a Foreign Tax Claim During Bankruptcy

6. 2005 BAPCPA Provisions for Cross-Border Cases

XVIII. The Role of Tax Sharing Agreements

A. The Government and Tax Sharing Agreements

1. Role of the Common Parent

2. Liability for the Group's Tax Obligations

3. Effect of Tax Obligations on Member Earnings and Profits

B. Why Tax Sharing Agreements Exist

C. Status of Tax Sharing Agreements as Executory Contracts in Bankruptcy

D. Enforcement of Tax Sharing Agreements in Bankruptcy

E. Tax Sharing in the Absence of a Tax Sharing Agreement

XIX. Post-Confirmation Tax Issues

Introductory Material

A. Framing the Issues

B. Dealing with Certain Debtor Assets Post-Petition

1. Liquidating Trusts

2. Limited Liability Companies

C. Dealing with Certain Creditor Claims Post-Petition

1. Disputed Claims Reserve

a. Mechanics of Reserve

b. Taxation of Disputed Claims Reserve

(1) Disputed Claims Reserve as Taxable Trust

(2) Disputed Claims Reserve Taxed as Qualified Settlement Fund

(3) Disputed Claims Reserve Treated as Grantor Trust

(4) Choice of Entity Considerations

2. Qualified Settlement Funds

D. Post-Petition Reporting and Withholding Requirements


WORKING PAPERS

Working Papers

TABLE OF WORKSHEETS

Worksheet 1 Sample First-Day Tax Motion Language - Traditional Approach

Worksheet 2 Sample First-Day Tax Motion Language - Aggressive Approach

Worksheet 3 Sample First-Day Tax Motion Language - Intermediate Approach

Worksheet 4 Sample Letter to Taxing Authority Regarding Pre-Petition Taxes

Worksheet 5 Sample Tax Section of Disclosure Statement

Worksheet 6 Internal Revenue Manual Principal Topic Headings and Sections

Bibliography

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