Bankruptcy can be a great way to get rid of older tax debts. The bankruptcy process is supposed to provide a fresh start. The In re Christensen, 15-29773, 15-29783 (2016 Bankr. D. Utah), case is an example where the IRS attempted to use the bankruptcy process not to provide a fresh start, but to collect more taxes than it might have otherwise been able to collect.
Facts & Procedural History
The taxpayer filed for Chapter 7 bankruptcy. He owned his residence at the time. The property was subject to a mortgage. It was also subject to IRS and state tax liens for non-dischargeable taxes (taxes for older years are generally discharegable; whereas, taxes for newer years are not). The mortgage and tax liens totaled $417,494.84. This total amount was approximately the same as the fair market value of the property.
The IRS’s Plan
With respect to the taxpayer’s residence, the bankruptcy trustee is generally required to abandon the property if its sale would not generate funds for the benefit of the bankruptcy estate. This would have been the case here, as the secured creditors claims equaled the fair market value of the property. If the trustee abandoned the property, the bankruptcy estate would not have sufficient assets to satisfy the taxes that were due to the IRS. The IRS would then have to attempt to collect from the taxpayer on its own.
Instead of doing this, the IRS suggested that the bankruptcy trustee administer and sell the property in exchange for the trustee being paid $10,000. This would allow the IRS to recoup nearly all of the tax as part of the bankruptcy and, leave the taxpayer with a small amount of non-dischargeable taxes that would be subject to the IRS’s existing lien.
To carry out this plan, the trustee had to deny the taxpayer’s homestead exemptions (which amounted to $51,000) and get the court to approve the sale and the $10,000 payment. Despite the taxpayer’s objections, the bankruptcy trustee put the property up for sale. A third party offered to buy the property for $425,000. The trustee then asked the court to approve the sale and $10,000 payment.
The Bankruptcy Court Rejected the IRS’s Plan
The court described the IRS’s plan as follows:
At the behest of the IRS, the trustee agreed to market and sell the debtors’ homes despite the fact that they were over-encumbered. In exchange, the IRS agreed to subordinate its lien insofar as necessary to provide $10,000 to the estate, while the trustee and his counsel would use 11 U.S.C. § 724(b) to have their fees and costs paid in full from the sale proceeds prior to the IRS. The debtors, however, would not receive any payment in satisfaction of their claimed homestead exemptions. Instead, they would lose their homes without any funds in return with which to acquire a new place to live, and proceeds from the sale of the homes would go to the trustee and his counsel instead of toward the IRS’s claim.
The court noted the tax aspect of the harm that would befall the taxpayer given the IRS’s plan:
These types of arrangements between trustees and the IRS have the potential to cause another devastating consequence for debtors. …. In essence, by paying a trustee and trustee’s counsel before the IRS, the value in the debtor’s home that would ordinarily be available to pay tax debts would instead be used to pay the trustee’s administrative expenses, leaving unpaid tax debts that are foisted onto that debtor’s shoulders. If this bargain were permitted, trustees would sell debtors’ homes, potentially force debtors to pay for it, and give nothing to debtors from the sales.
The court noted that the trustee was only entitled to be paid for work that benefited the bankruptcy estate. It concluded that the only benefit of selling the over encumbered property was to benefit the trustee and the IRS, to the taxpayer’s detriment. The court even said that this plan pushed by the IRS was not the fresh start contemplated by the Bankruptcy Code. The court denied the trustee’s request for compensation.