Tax Claims and Payments in Bankruptcy

Going through bankruptcy is difficult and complicated, whether you're filing for personal bankruptcy or it's your business that's facing financial crisis. There are several types of bankruptcy filings, including Chapter 7 liquidation, in which all debts are wiped out, and all assets are used to settle debts. When the bankruptcy process is done, a business will usually cease to exist, and a person will start their financial life from scratch.

A major part of the bankruptcy process is determining which creditors will be paid and how much they will get under the framework of the Bankruptcy Code. Familiarity with how certain claims, particularly claims arising from tax liens, are prioritized can help you navigate your course through the bankruptcy process.

Creditors and Claims Aren't All Equal

In a bankruptcy, creditors and their claims probably won't be treated equally, and in a Chapter 7 bankruptcy, there likely won't be enough assets to pay off all claims. The Bankruptcy Code contains a complex framework for figuring out which creditors are to be paid and how much they'll get.

As you'd expect, claims related to taxes have a high priority for payment in a bankruptcy case. The Bankruptcy Code allows some tax claims to take a lower position in line behind other priority claims that aren't secured by the filer's assets. This is called subordination. These claims might not be paid if it weren't for the allowances made by Bankruptcy Code § 724(b).

All types of property are included in the scope of § 724(b), including things like your business's liquor license or real property. This section of the law applies regardless of whether the property is held by your bankruptcy trustee (the person administering your bankruptcy estate), or is in the hands of a creditor.

Claims Taking Priority and Distributing Assets

In subordinating a tax claim, several Bankruptcy Code sections come into play, and § 507(a)(1) through 507(a)(7) includes some familiar types of claims, known as unsecured priority claims, that are impacted by the subordination provisions of the Bankruptcy Code. Your obligation to pay child or spousal support is one type of an unsecured priority claim. The following example is the best way to gain an understanding of how subordination of a tax claim works.

Let's say the bankruptcy trustee in your case sold a piece of land you owned, with net proceeds of $50,000. Of the secured claims against that piece of property, there is a first priority or first-in-line tax lien for $14,000, and a mortgage for $35,000. Your bankruptcy case also has $13,000 in unsecured priority claims, maybe for items like past due child support or wages you owe an employee. The $50,000 is paid out as follows: Your bankruptcy trustee steps into the shoes of the holder of the tax lien, likely a government body, and as allowed by Bankruptcy Code § 724(b), applies up to $14,000 to unsecured priority claims, like the child support and wage claims. There is $13,000 worth of these claims. The remaining $1,000 would then be paid on the tax lien claim. Next in priority is the mortgage for $35,000, which can paid in full, leaving $1,000 left over from the $50,000 sales proceeds, and § 724(b)(5) directs that this amount will also be paid to the tax lien holder.

You can see how the subordination of the tax claim makes a big impact on which creditors are paid in a bankruptcy case and how the amount of their payments can be affected. While the facts of your case might be very different from the example, having an idea of how subordination of tax claims works can help you understand your bankruptcy case and help you communicate effectively with your bankruptcy lawyer.

Exceptions to Subordination of Tax Claims

Not all tax liens are subject to subordination. The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 created an exception to subordination for ad valorem taxes on real or personal property. Your local property taxes would be an example. There are two categories of priority claims that could trump a lien for ad valorem taxes: claims for wages, salaries and commissions, and claims for contributions to employee benefit plans, as allowed under § 507(a)(4-5) of the Bankruptcy Code.

Questions for Your Attorney

• Do I have any control over which creditors are paid in my bankruptcy case, or does the bankruptcy trustee make those decisions?
• I don't think there's much value to be had from selling my property; at what point will the bankruptcy trustee seek subordination of tax claims in order to pay unsecured priority claims?
• How will the sale of my business's liquor license and other licenses be handled, and are the tax liens on my licenses subject to subordination?

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