Matthew Cavitch on State and Local Taxes and Bankruptcy Cases

Matthew Cavitch on State and Local Taxes and Bankruptcy Cases

In bankruptcy cases involving businesses, a key consideration is often what happens to certain tax attributes, such as net operating losses, when the debtor business presumably re-emerges from the bankruptcy proceeding.

Excerpt:

In addition to the Bankruptcy Code and the Internal Revenue Code, state and local law will impact the treatment of a corporation that has filed a bankruptcy case. These state and local laws include laws that determine a corporation's taxable income, its carryover of tax attributes for state income tax purposes, the taxability of a corporation's discharge of indebtedness income, and the taxation of any transfer of assets. Certain provisions in the Bankruptcy Code, however, preempt state and local taxation provisions.

[2] Jurisdiction of the Bankruptcy Court

Corporations that are undergoing financial hardships are often in arrears for state and local taxes. Further, in cases where there is a genuine dispute about the taxes owed, a corporation with financial troubles is much less likely to settle with the state on the disputed liability. For these reasons and others, state and local taxing bodies are often creditors in a corporate bankruptcy case. As creditors, issues such as priority, validity, and discharge arise as to their claims just as they would for the claims of other creditors.

While usually the state or local government would have authority over state and local taxing authority claims, the bankruptcy court has jurisdiction over "all civil proceedings arising under title 11, or arising in or related to cases under title 11." Further, the Supreme Court has held that state agencies do not enjoy sovereign immunity under the Eleventh Amendment  with respect to a proceeding authorized by the Bankruptcy Code to set aside a debtor's preferential transfer to the state taxing authority. The Court further stated that "the history of the Bankruptcy Clause, the reasons it was inserted in the Constitution, and the legislation both proposed and enacted under its auspices immediately following ratification of the Constitution demonstrate that it was intended not just as a grant of legislative authority to Congress, but also to authorize limited subordination of state sovereign immunity in the bankruptcy arena.

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Matthew P. Cavitch, A.B., J.D., is a member of the Tennessee Bar.

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