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