Bankruptcy Courts Can Determine Tax Liability Under Section 505 if it Might Affect the Estate At the Time of Filing

In Bush v. United States of America, No. 16-3244, decided September 20, 2019, the Court of Appeals for the Seventh Circuit held that the Bankruptcy Court has jurisdiction to determine the amount of tax liability under Section 505 if it could possibly effect the creditors and the bankruptcy estate at the time the case is filed. The decision is centered on 11 U.S.C. § 505, which allows the bankruptcy court to "determine the amount or legality of any tax, any fine, or any penalty relating to a tax ...." In Bush, the debtors owed nearly $200,000 in taxes and penalties. The debtors petitioned the Tax Court for review and when trial was imminent, they stipulated to owing $100,000 in taxes but the amount of penalties were still in dispute. The debtors filed for bankruptcy on the date set for trial. The bankruptcy court declined to lift the automatic stay and the debtors then brought an adversary proceeding asking the bankruptcy court to set the penalty at 20% of their unpaid taxes pursuant to Section 505. The IRS sought to dismiss the adversary proceeding, which the bankruptcy court denied. The district court disagreed and found it did not have subject matter jurisdiction to resolve the dispute.

On appeal to the Seventh Circuit, the Seventh Circuit's opinion first discussed that Section 505 is not jurisdictional but rather, merely instructive, and provides a task for bankruptcy judges. Looking then to jurisdiction, the court found there was subject matter jurisdiction under the "related to" language of 28 U.S.C. § 1334 only if the resolution of the dispute could "conceivably have any effect on the estate" based on the status of the estate at the time of the filing of the case. The Seventh Circuit essentially agreed with the bankruptcy court that a bankruptcy judge has the authority to determine the tax liability, but questioned whether the judge should actually exercise that authority.

Ultimately, the Seventh Circuit remanded the case with an instruction to abstain because there was nothing further to do in the bankruptcy case and the Tax Court should decide the dispute.

For the full opinion, click here. If you have any questions, please contact Melissa Lowe or any of the other attorneys at Shulman Bastian Friedman & Bui LLP at 949-340-3400.

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