DISCHARGING CALIFORNIA SALES TAXES IN BANKRUPTCY
By. Elizabeth Gonsalves, ESQ.
A recent 9th Circuit case, Ilko v. California State Board of Equalization, 2011 WL 2520271 (9th Cir., 2011) outlined the requirements for successfully discharging sales tax in bankruptcy. Until recently, California sales taxes were interpreted as “trust fund” taxes that are never eligible for discharge in bankruptcy. A debate has ensued in the courts for decades over whether the legislative history associated with statutes governing priority of certain creditor claims intended sales taxes to be a type of tax liability that could never be discharged or a type of tax liability that can be discharged after rigid and specific time requirements and filing requirements are met.
Many cases have involved arguments by taxpayer’s counsel that sales tax should be interpreted as a tax to be categorized as either a type of “gross receipts” tax (dischargeable under 11 U.S.C. s. 507A) or, in the alternative, as an “excise tax” (dischargeable under 11 U.S.C. s. 507E). Until recently, the 9th Circuit held sales tax was to be treated as a trust fund tax that was not dischargeable in bankruptcy. In re Shank, 792 F2d 829.
In 2011, in Ilko v. California State Board of Equalization, 2011 WL 2520271 (9th Cir, 2011) the 9th Circuit ruled sales tax was dischargeable under both 507A and 507E. In finding sales tax was dischargeable under both 507A and 507E, the court noted sales tax could be interpreted as either a type of gross receipts tax or a type of excise tax.
Ilko only discusses discharging sales tax in circumstances where there has been a personal bankruptcy filing as to the owner of the business who has been assessed “responsible person” sales tax liabilities (as opposed to a corporate bankruptcy filing). It is required that the business has ceased operations because only then does the three year statute begin to run for assessing a responsible person who can then seek relief from personal liability through bankruptcy (the 3 year statute for assessing a responsible person only applies if the owner gave notice to the BOE that the business ceased operations, otherwise it is an 8 year statute for assessing a responsible person).
The Ilko court ruled that the following elements, if met, may serve to successfully discharge “responsible person” sales taxes:
- The business must have terminated because a “responsible person” cannot be assessed personal liability for the unpaid sales tax under Tax Code § 6829 until the corporation terminates or abandons its business or dissolves; and
- The State Board of Equalization must receive timely notification that the business has terminated (this is important to establish a 3 year assessment statute because balances which are not assessed before bankruptcy but which are still assessable after the bankruptcy filing are never discharged, thus an 8 year assessment statute should be avoided); and
- Filing a custom personal tax return for the sales tax liability (because the corporation and the “responsible person” are viewed as separate persons under Tax Code § 6005.18); and
- At least 3 ½ to 4 years must pass before filing a personal bankruptcy case (to provide for timing requirements as set forth for excise tax and gross receipts tax in 11 U.S.C. § 507(a)(8)(A) & (E), §523(a)(1).
It is important to note that there is a strong likelihood that the state will file a lien against the responsible person personally assessed sales taxes. Any perfected lien survives bankruptcy and is enforceable against the real property or personal property of the responsible person after bankruptcy. Therefore, even if the responsible person successfully discharges responsible personal sales tax assessments from collection action against them personally, their attachable property may be subject to the sales tax after bankruptcy.