Seventh Circuit declares that it has jurisdiction to hear tax claims and penalties…but you need to act promptly.

Don’t Win the Battle and Lose the War. 

On September 20, 2019, the Seventh Circuit issued a clear word to the wise. If you are in a tax dispute with the IRS and you want the amount of tax or the amount of penalty determined in a bankruptcy court and not the Tax Court, then you must act promptly to file your bankruptcy petition and to thereafter promptly file your adversary case seeking a determination of the tax or penalty. The decision in Donald Bush v. US, No. 16-3244 (2019), put the Seventh Circuit in line with the nine other circuits that have considered the ex ante (before the event) versus the ex post (after the event) basis for jurisdiction. The Bush case began in 2013 when the IRS demanded that Bush pay $107,000 in taxes plus a fraud penalty in the amount of $80,000. The fraud penalty was based upon the 75% charge authorized by the Tax Code. Bush proposed that a negligence penalty of 20% be applied. The matter worked its way through the tax court and was set for trial. The day before trial, Bush filed for bankruptcy protection. The IRS contended that the bankruptcy court did not have subject-matter jurisdiction under section 505 of the bankruptcy code to hear the adversary case and that only a potential effect on creditors’ distributions could justify a ruling by a bankruptcy judge on a tax dispute. Section 1334 creates jurisdiction if the matter arises in the bankruptcy litigation, arises under the bankruptcy code, or if it is related to the resolution of the bankruptcy proceeding. The Bush court determined that tax liabilities do not qualify under the arising in the bankruptcy litigation or arising under the bankruptcy code, but found that the determination of taxes and penalties was related to the resolution of the bankruptcy proceedings. The jurisdiction argument led to a discussion about whether jurisdiction is correctly based upon ex ante or an ex post analysis of the facts. The Seventh Circuit found that jurisdiction must be determined on an ex ante basis (before the event). This means that it will be proper for a bankruptcy judge to hear and determine an adversary case asking for a determination of the tax liability or the penalty liability. This is consistent with the clear dictates of 11 U.S.C. 505(a)(1) which states that “except as provided in paragraph (2) of this subsection, the court may determine that amount or legality of any tax, any fine or penalty relating to a tax, or any addition to tax, whether or note previously assessed, whether or not paid, and whether or not contested before and adjudicated by a judicial or administrative tribunal of competent jurisdiction.” The Seventh Circuit decision in Bush is in line with the decisions reached by the nine other circuits on this question. The bad news for Bush was the court’s ultimate ruling that the matter should go back to the tax court because the bankruptcy case was otherwise done and there was no point in the bankruptcy judge wasting his/her time when the tax court could readily resolve the matter and conduct their own trial. The moral of this story is that if you want the bankruptcy court – and not the tax court -to determine your tax liability or tax penalty, then you should promptly file your bankruptcy petition and adversary case and under no circumstances should you wait until the day before the tax court has set a trial on the very issues. The bankruptcy court clearly has jurisdiction to resolve these matters, but the bankruptcy court won’t waste its time and resources if you, as the debtor, don’t act promptly. If you want your tax claim resolved by a bankruptcy judge, then you, as my father used to say, must move like you have a purpose.

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